Bitcoin’s Roadmap to Relevance

My brother sent me the following video, as part of our ongoing discussion regarding the future and place of bitcoin. Working at an excellent startup, he is very in touch with and opinionated about the tech world (all in all a solid follow on twitter). I started to reply, but after passing the 500 word mark, I decided to post my thoughts here instead. Here’s the video:

As of now, the general public has yet to embrace bitcoin. In order to build a niche in the modern payment network, it is difficult to foresee any alternative to bitcoin taking on more characteristics of a traditional currency. To its credit, the video immediately states that bitcoin is a “crappy currency.” The reason that the modern financial world runs primarily on credit and debits is that it is backed by the US Dollar, an entity with several crucial characteristics that give the public the requisite confidence to electronically send/receive money.

To start, bitcoin’s value relative to the USD has been remarkably unstable. In the past year, the value of 1 bitcoin has ranged from $100 to over $1100, and is not sitting around $450. In the time since I started writing this piece, it has fallen all the way from $500! You can see the movements on this chart:

5.1.14 Bitcoin


One of the main characteristics people look for in money is its “store of value,” namely an entity’s ability to be set aside for a time and not drastically lose its value when that entity is retrieved. I’m reasonable confident, for example, that if I stash $100 in my bedroom for a year, its purchasing power will not drastically fall. Given bitcoin’s wild swings in exchange rates, it currently fails this test.

Secondly, bitcoin isn’t accepted in most places. People use money as a “medium of exchange” rather than bartering for goods. If you can’t spend or receive bitcoins in the places you’d like to, however, then it is unable to serve as that medium.

I recently started using Venmo, an app that allows mobile payments to be transmitted simply and safely between friends. First of all, Venmo is great, and I can see the parallels between what it does and how people would like Bitcoin to function. The other night, I was sent some payments on Venmo as a reimbursement for dinner. Rather than deposit the $12 to my bank account, I’ve let the money sit in my Venmo account, so that I can use it down the road when the need arises to pay back my friends. Notably, there are no fees for any of these actions.

It’s not hard to envision bitcoin functioning like Venmo, but on a broader scale: people buying and selling goods, both online and off, using an entity that sidesteps some of the issues we have with the modern payment network. It would be great not to need banks or credit agencies to send money digitally! Before we can cut out the middleman, however, there are several steps that must come to pass to permit a more substantial proliferation of bitcoin:

  1. The primary notoriety of bitcoin must shift from a mechanism for speculation to an electronic form of money. It’s easy to discount the media’s reporting on bitcoin as overly sensational, but as history shows us, a currency is only as good as the public’s faith in it (which often takes it cues from the media). For more information on the consequences of discounting public faith in a currency, see here, here, or feel free to read my thesis on hyperinflation, which is at the bottom of this page.
  2. Relatedly, our individual views towards bitcoin must change. If we played a word association game and I said “Euros” or “Dollars,” most people would reply “money.” Try that same game with “bitcoin,” and the responses include “Silk Road,” “Winklevoss twins,” and “Huh? What the f%$# is that??” Most of bitcoin’s fame thus far has come from speculation; while useful in bringing attention to its existence, this is the anathema to fostering stability. As we’ve witnessed time and time again, the financial system is held up by the trust that people have in it. If the public loses confidence in a bank, a currency, or an economy, it can plummet in value, shattering the public’s trust in a way that is hard to rebuild.
  3. The exchange rates to established currencies must be more stable. Nobody is going to care about Mastercard’s 2% cut when they’re worried about a 50% slide in the convertible value of bitcoin. Before we enter a hypothetical world where bitcoins are traded around with ease, it must be seen as safe by the bulk of the population – I’m talking Middle America, not just highly educated tech geeks living in San Francisco.
  4. Make it as close to free as possible! Nobody will fret over Mastercard’s 2% cut when Mt. Gox’s successors are taking 1%. Analogously, individuals wouldn’t leave the comfort of Facebook for a social network that’s marginally better. Facebook may not be quite as good as this hypothetical competitor, but unless the alternative is markedly superior, the consumer will value the comfort and security they’ve built with Facebook over the past decade. The same goes with the current payment network.

As my thesis verifies, I’ve been fascinated by the concept of money and currency for some time. If nothing else, bitcoin is an intriguing mix of economics, technology, and innovative thought. Money has been around for thousands of years, and marked improvements come around infrequently. I’m looking forward to seeing where bitcoin is headed, and if it can fulfill its potential as a decentralized form of widespread digital payments.


Russia’s foil? American natural gas exports

For those of you who have ventured over to the ‘Library’ section of my site, you’ll notice one book that is neither financial nor fiction. George Friedman’s The Next 100 Years introduced me to the idea of geopolitical thinking, the field encompassing geography, politics, and foreign relations. First of all, I was marveled by the depth of the intricacies behind his predictions for the next century. When this book was published (2009), the prospect of the US negotiating with Iran seemed as preposterous as a new cold war brought about by Russian aggressiveness… situations not so preposterous now.

Beyond his specific predictions, however, what Friedman helped me to develop is trying to think beyond the present. Much of the media is fixated with what’s going on in the here and now. Huge car accident on the 405! Guilty verdict for white trash mother! Bridgegate! Missing planes! Tesla stock jumps 8%! On and on it goes… and it’s easy to get lost amongst all the flashy new stories thrown at us each day. Instead, try taking a step back, cut through the noise, focus on the important stories, and then try to make educated estimates for where they’re headed. This process is invaluable in business, politics, and certainly in investing.

Over the past few weeks, the (simultaneously tragic and bizarre) airplane story has shifted the world’s attention away from Crimea. As terrible as the airplane’s disappearance is, however, it is not nearly as consequential in the long-run as Russia’s invasion and annexation of the formerly Ukrainian region. So, in trying to channel George Friedman, let’s think ahead and try to think of what geopolitical trends this could set in motion!

Russia was able to make this bold move because it was confident that any punishment would be minimal. At the end of the day, it knew that Crimea (and Ukraine as a whole) was of far greater value to it than to the major European powers or the United States. The US is in the process of drawing down its military presence, and is hesitant to get involved in such a situation so far from home. Europe is unwilling to do much for a different reason; they rely on Russia’s energy exports, and it is this factor that I’m focused on.

Crimea’s importance to Russia is high and will be for the foreseeable future. The United States is unlikely to be any closer in proximity to Ukraine anytime soon either. There’s no reason, however, why Europe has to stay perpetually reliant on Russian energy exports! The annexation has cast light on the problems of Europe’s dependence on Russia, and I believe that the US will go to great lengths to ease this dependence. The best way to do that would to begin providing natural gas exports to Europe, a move that would require some changes to existing regulations on exporting US energy.

Such a move would allow the US to decrease Europe’s reliance on Russian energy. This could not happen overnight, but it would pose a serious threat to the financial prosperity of Russian elite. As the recent Iranian sanctions have shown – if you want to compel an adversary to negotiate, go after his wallet.

So, which companies are best positioned to profit should the US change its regulations limiting natural gas exports? Exxon Mobil (following its 2010 acquisition of XTO) is the country’s largest producer. Chesapeake Energy, Anadarko, and Devon Energy are also significant players, and would similarly stand to benefit. Their opportunities are currently constrained by the export regulations; should those be modified (or even eliminated) in the attempt to diminish Russian influence over European politics, we could witness surging revenues from those companies.

I’m not advocating investing in these companies solely on the expectation that geopolitical developments could alter the energy industry’s global outlook. However, it’s a useful factor to take into account when evaluating companies such as Exxon Mobil or Chesapeake Energy. Instead of focusing on news stories as they happen, try to use current geopolitical trends to anticipate where we’re headed. Doing so could allow you to make an investment before the rest of the market figures out what you know!

Trouble Ahead for the Nasdaq

“This time is different.”

Those are four terrible words.

By now, investors have been told countless times to be aware when those four wretched words are being thrown around to justify beliefs that “this time is different.” By now, the investing community has had decades of access to Warren Buffett’s aphorisms and George Soros’ philosophy. By now they have witnessed the awful consequences of irrational exuberance, animal spirits, and the like. So, why aren’t people more concerned with the insane valuations of so many technology stocks???

2000’s dot-com bubble (and its buildup) has become infamous for investors’ willingness to buy companies without profits – or even an iffy for regarding future earnings. Back at that time, much investing was driven by the prospect of explosive growth in a brand new theatre: the internet. Investors were willing to buy in at high multiples because of the pervading belief that a company’s future developments would eventually justify current prices. There was a problem with this theory, of course, as many such companies would never develop sufficiently to merit such crazy multiples. Once the market figured this out, calamity ensued (see the third chart below).

One of the important takeaways from that crash was the temporary paradigm shift from prizing growth and market share over profits. The two former concepts are certainly positive, but what good are they without profits? Say that the world’s governments granted a company the rights to 100% of the world’s oxygen, but on the condition that they could never charge anything for the oxygen. What value would the company have?

Fourteen years ago I saw the danger in buying something if it requires fundamental change in order to justify its current price. This lesson extends beyond stocks. It’s probably a mistake, for example, to buy jeans that are too small based on the expectation that you’ll lose weight and eventually fit into them. If you lose the weight, the jeans will be worth what you spent. If your weight increases or stays the same, however, then you wasted the money. Skinnier jeans (like exciting tech stocks) may be sexier, but why take the risk? The remedy isn’t difficult; instead of making speculative purchases, just buy things that are worthwhile right now!

Last week marked the 5th anniversary of the market’s bottom in March, 2009. The S&P 500 and the DJIA hit their lows on March 6th; the Nasdaq followed suit three days later. Since that time, the Nasdaq has consistently beaten the other two indices. For the life of me I cannot figure out why this doesn’t get more media attention. The most prominent index funds (such as the famed Vanguard 500 Index Fund) track the S&P 500, which conventional wisdom says is one of the best long-term bets when investing. Indeed, even Warren Buffett has endorsed such S&P index funds for the passive investor. The reality, however, is that the Nasdaq (.IXIC) has solidly outperformed the S&P 500 (.INX) and the DJIA (.DJI) over the past five years:

3.11.14 NSDQ performance

What concerns me here is that this chart looks somewhat familiar. Of course, these recent years are not identical to 1995-2000. The differentiation in returns between the indices has occurred over a longer period of time, and is not as drastic as it was from 1999-2000. Still, it concerns me, as here’s the chart of the 5 years building up to the dot-com bubble burst…

3.11.14 NSDQ performance 95-00

… as well as the 5 years the followed, when the Nasdaq was pummeled…

3.11.14 NSDQ performance 00-05

It is not a coincidence that many of the notable recent winners trade on the Nasdaq. Netflix, Facebook, Amazon and Tesla are all there, for example, and their recent price surges have helped to fuel the impressive performance of the index as a whole.

On the one hand, I’m not prophesizing a collapse of the Nasdaq à la the year 2000; the index’s average P/E ratio was 42 back then, whereas now it’s at 21 (this level is higher than the DJIA at 16, the S&P 500 at 18, and even the Nasdaq itself one year ago, when it was at 17). I have, however, come to believe that many of these overpriced tech companies are headed for a fall. It’s simple math – their prices relative to earnings are just way too high. Netflix, for example, would have to increase its EPS 10x to reach a historically sustainable level, and that’s assuming the price doesn’t continue to rise! Facebook would likewise need to increase its EPS 5x, Amazon would need a 30x increase, and Tesla would have to generate profits – something it has yet to do for an entire fiscal year.

I don’t hate companies like these; I just don’t like their prices. In order to justify their current values, one of two things must occur. Either the earnings must drastically rise (like I described in the last paragraph), or there must be a permanent paradigm shift in the way we value companies. Neither scenario seems particularly likely. The last time that growth potential and technological market share superseded profitability in the eyes of investors, we ended up with the dot-com bubble.

I’d like to think that I learned this lesson back in 2000 (see the image at the top of the blog). Despite everyone’s’ assurances to the contrary, last time wasn’t different, and I don’t think this time is either. The joyride for these overpriced tech stocks is coming to an end. The question that lingers is if their downfall will take everyone else down with them.


Two posts by Scott Krisiloff of Avondale Asset Management that got me thinking about this topic are here and here. I wrote this post yesterday, before I had a chance to read another piece from Mr. Krisiloff on the subject that makes several similar points to mine. 

Fly Leasing: Undervalued Assets and Earnings

My oldest holding is about to reach the 4 year anniversary, marking the day that I became a shareholder back in 2010. In percentage terms, it has been the second best investment I’ve made, and it is one that I foresee holding for some time. Here’s why:


Less than a year after college, I bought a small stake in Babcock & Brown Aircraft Management (NYSE: FLY). I knew much less about investing than I do today, but I was primarily attracted to the company’s business model, low P/E ratio, and high dividend yield. Before long the company changed its name to Fly Leasing (following the collapse of its original parent company), and the stock has produced strong returns for me ever since.

Barring some unforeseen change, it’s possible I may never sell this company as it currently exists. It was my largest holding at the time of purchase; now it is by far the smallest in my portfolio. Recently, I put together an updated estimate for an asset-based valuation of Fly Leasing. Even though changes in the company’s stock price now have little impact on my overall portfolio, I still want to have some quantitative idea of what the company is worth!

As an foreign company, Fly Leasing files a 20-F every year with the SEC. Their most recent 20-F was for 2012; the one for 2013 is due out next month. Using press releases and the financial results they release each quarter, however, I was able to piece together an up-to-date inventory of their aircraft (with some minimal guesswork required due to insufficient information released by the company). At the end of 2012, the company owned 109 aircraft. Since that time, they have sold 10 aircraft and bought 14; selling off older aircraft and bringing in newer ones. Here’s a summary of the aircraft at the end of 2012 until the present:

2.19.14 fleet

In order to get a ballpark idea for the value of each airplane, three bits of information need to be uncovered. The first is the age of each aircraft. That information was found in the company’s last 20-F, and in the press releases announcing the recent aircraft purchases over the past year. Next, I had to research the useful life of aircraft. On average, the useful life of an aircraft is about 30 years. Using trade journals, I came up with the following table:

2.19.14 useful life

Last, I had to find the original cost of each aircraft type. There were 15 total types of aircraft (two types of A340’s, five types of 737’s, two types of 757’s, and one type of each other class), so finding the original cost for each type was found from numerous sources across the web. Once all the information had been compiled, I was able to find estimated values for the entire fleet. Here are two examples:

2.19.14 airbus and boeing


Using such calculation across all the aircraft types, I calculated that the total value of the aircraft was $5,617,566,000. This is a very optimistic estimate, considering that the most recent balance sheet has Flight Equipment valued at $2,868,678,000, which is just 51% of the value I calculated.

So, how does this translate into a per share valuation of the company?

First, I looked at the assets and liabilities, excluding the ‘deferred tax asset,’ ‘other assets,’ and ‘other liabilities.’ Below are the balance sheets as declared by Fly Leasing (on left) and adjusted to reflect my aforementioned calculations (on right), along with the per share values:

2.19.14 balance sheet

As I alluded to before, the calculations I made were very aggressive, and essentially assume that management was taking an extremely conservative attitude towards depreciation. In their most recent 20-F, the company states:

Flight equipment held for operating leases are recorded at cost and depreciated to estimated residual values on a straight-line basis over their estimated remaining useful lives. Useful life is generally 25 years from the date of manufacture. Residual values are generally estimated to be 15% of original manufacturer’s estimated realized price for the flight equipment when new.

These depreciation methods are typical for this niche industry, with other major players having identical/similar methodology.

Still, my calculations give an upper limit of what the company’s flight equipment may be worth in the open market. Using the values from Fly Leasing’s balance sheet, we can see that the company is worth $17.70 per share, which is a 15% premium to the current share price. To be clear, I don’t view the company as being worth the $84.25 per share I calculated. I merely think that these calculations indicate that company is worth more than the $17.70 per share its balance sheet indicates, however, and certainly more than the $15.34 it is selling at! These calculations indicate that the depreciation methodology used by the industry is quite conservative; by loosening those standards just a bit, the value of the aircraft (and therefore, the company) drastically increases.

In addition to the asset-based valuation, it’s important to remember two things: first, there’s a 6.5% dividend yield that the company is dedicated to paying (it increased by 13% last year). Unlike many asset-based companies, Fly Leasing also has strong earnings (especially relative to its price). The P/E ratio sits at 6.07 – a level much lower than its rivals.

Sure, I have concerns about the company; there are valid reasons why I’ve never upped my stake in the company. My primary worries are the rising debt, the recent dilution, and the age of the fleet. The company has taken steps to address the latter, as the average age of the fleet has decreased in the past year (through the sales of older aircraft and the purchases of newer ones). Analysts frequently complain that Fly Leasing’s fleet is older than its rivals, but I’d counter that this has yet to manifest meaningfully in a negative way on the company’s earnings, or with the demand for the company’s aircraft.

The other two concerns are of greater magnitude. Through the years, management has frequently stated that they are always on the lookout for deals, provided that the aircraft market is conducive to such purchases. 2013, it appears, met management’s standards. In order to fund the aggressive acquisition program, however, management relied on debt issues and an offering of common shares. The company has traditionally been quite leveraged; the funding of new aircraft with borrowed money wasn’t too upsetting as it has been the modus operandi of the past. The company’s basic business model has been to borrow money, buy aircraft, secure the loan with the aircraft, and then have airlines around the world sign long-term leases on those planes. This has been successful, so I couldn’t get too upset by them issuing $300 million in senior notes a few months back.

The announcement to issue 11.4 million new shares, however, sent me up a wall. The company only had 28 million shares before this transaction, so it represented a major dilution of the existing shares. Furthermore, I viewed it as sneaky; the dilution was announced on July 9, priced on July 11, and finalized within a week. On the one hand, I understand that management saw the market as ripe for acquisitions and needed to raise cash to fund their moves. On the other hand, I was thoroughly pissed off (as any shareholder would be) that they went about it in such a manner. Should this happen again in a similar or larger fashion, I will consider selling off my shares.

Barring such a move, however, I’m confident in the company’s ability to continue growing, paying its dividend, and generate earnings. Despite its dilution last year, I maintain confidence in management’s ability to successfully buy, lease, and sell aircraft at a profit. More importantly, I see the company as undervalued relative to both its earnings and its assets, and therefore will continue to hold shares for the foreseeable future.

Intel Good, Microsoft Bad

I’m impressed with Intel. I’m unimpressed with Microsoft.

Together, these two companies ruled the PC era. While numerous PC manufacturers came and went, you could count on these two companies contributing to each desktop you brought home. That era, however, is over.

As Benedict Evans shows in this chart, smartphones are about to pass PCs worldwide. Tablets are also gaining ground, and I see little reason why these trends would drastically change soon:

1.29.14 pcs vs phones

Putting aside these companies as investments, I’ve been thinking about each on a qualitative level. The recent decisions regarding Microsoft’s leadership show a company trying to recapture its former glory. After being run by a businessman for 14 years, they’re returning to an engineer CEO. Furthermore, Bill Gates is returning to an active role. This signifies a desire to operate, grow, and – most importantly – think like the company did in its heyday. That may be an improvement over today’s Microsoft, but I believe it to be inadequate to compete in the markets where the company hopes to thrive. Today’s competition is too fierce, too dynamic, and simply too far ahead for Microsoft to catch by trying to recapture the magic.

I want to clarify that I’m not criticizing the choice of Satya Nadella, personally. By all accounts he is capable and bright, and could very well lead Microsoft to improved fortunes. Furthermore, I’m generally skeptical that “superstar” or “celebrity” CEO hires are worthwhile; Alan Mulally would have been a sexy pick, but what the hell does he really know about the technology industry after 45 years at Boeing and Ford? I think he would have found competing against Google much more daunting than battling GM and Chrsyler.

Intel, on the other hand, is showing signs of promise. At CES, the company gave viewers insights into its upcoming products and focuses. It showed off Jarvis, a wireless headset that functions without the cloud (damn you, Siri!!). It revealed a look at a wireless charging bowl for consumers to drop gadgets into. It also accentuated its new fixation: “make everything smart.” In other words, Intel is undertaking a widespread effort to expand the market for wearables – everyday devices (i.e. glasses, clothes, watches, etc.) with a computer chip put inside.

I was impressed because Intel appears to be thinking ahead. Don’t fall into the trap of chasing Google, Apple, and Samsung! Instead of focusing the announcements on new tablet chips, for example, Intel spent a good portion of CES talking about wearables, a segment that shipped 8.3 million units worldwide in 2012! At this point, it’s going to be tough for companies to beat Google at search or Apple at premium phones. Microsoft has tried and failed on both. So, what is Intel doing? They’re recognizing that they missed on smartphones and tablets. Instead, they’re trying to position themselves to reclaim dominance when the consumer electronics market moves onto the next thing. More broadly, to quote Sun Tzu:

 “He will win who knows when to fight and when not to fight,”


“There is no instance of a country having benefited from prolonged warfare.”

Apple: The giant who gets bullied

Out of the dozen or so analyses I read about what happened to Apple yesterday, the most succinct insight came from Howard Lindzon, who said “The stock market is clearly voting with Larry’s vision and daring spending at Google over Tim Cook’s cash flow at Apple.”

This irritates me to no end, seeing as how the latter is my largest holding.

It’s badly kept secret; Wall Street plays favorites. Different companies aren’t treated the same, due in part to our personal and collective biases. Yesterday Apple reported an EPS that was 98% of what analysts were predicting, and that “shortfall” led to an 8% buzzcut in the stock price.

Rhetorically… would Google or Amazon have suffered similar price declines if they missed earnings by 2%? I’ll let you decide for yourself.

Perhaps unsurprisingly, I see Apple as being fundamentally misunderstood by much of Wall Street. Investors generally buy shares because they expect returns to be primarily driven by future growth and/or price correction (if company is currently undervalued). I believe much of Apple’s 16-month malaise is due to it being in “limbo”; no longer seen as a growth stock, but not priced low enough to be seen as a value stock.

So what’s happening here? As Scott Krisiloff and Benedict Evans explain, concerns about Apple’s growth have been overblown. On the one hand, Apple is gargantuan; as the largest company in the world, it’s not going to grow at the same rate as Snapchat. Investors need to update their expectations for Apple; its industries are more saturated than they were 5 years ago. When comparing it to other huge companies, however, its growth blows the others away. As the majority of the world moves to smartphones in the coming decade, Apple is very well-positioned to maintain its sizeable portion of the market.

Furthermore, it’s inexpensive! If you look at Apple as a value stock, it checks off many of the boxes you’d typically look for: undervalued (P/E at 12.6), low debt (D/E of 13.1%), insanely profitable (net profit margin at 22.7%, ROE at 41.4%), and with an incredible competitive advantage in its industry.

So why the beatdown? Apple is the stock that Wall Street loves to hate. We were spoiled by its incredible run from 2002-2012, and now that (under Tim Cook) it’s behaving more like Microsoft than like Google, the market is treating it as such. For now, it seems that investors are content to pummel Apple. However, I have every confidence that before too long we will see a shift in the collective mindset regarding this company. It’s growing, it’s well managed, it’s profitable, it’s taking care of shareholders, and it’s undervalued… I see little not to like.

GM’s Dividend and My Early Missteps

Earlier this week I read the news that General Motors (GM) declared its first quarterly dividend since 2008. It plans on distributing 30 cents per share, which at today’s prices means that the annual yield will be at 3.11%. Although the stock price has gained only 10% since GM’s return to the NYSE in late 2010 (the S&P 500 has increased 55.33% over that same timespan), the price has nearly doubled in the past 1.5 years. Given recent performance, this new dividend is yet another reason for shareholders to be optimistic.

1.20.14 gm chart

On the one hand, GM’s shareholders and management are to be commended for their recovery; it’s a development that few (myself included) foresaw when they declared Chapter 11 in June, 2009. Of course, they had a little help along the way, but nonetheless, they do appear to have learned from some of their past mistakes: poor gas mileage, high debt levels, employing Rick Wagoner, and in general, making cars that were pieces of s#@%.

For many reasons, I have little intention of investing in GM anytime soon. But this news reverberated with me, as it made me think back to the first investments I made as an adult. As the top of this page indicates, I did start investing in 1998, but the first time I made investment decisions entirely on my own was in 2008:

1.20.14 stock trades

The good news is that I avoided GM. The bad news is that’s the only good news.

About one week apart in December 2008, I purchased small stakes in Citigroup and General Electric, and cannot begin to tell you how excited I was. Citigroup had fallen all the way from around $55 in 2007; I swooped in at $7.06. GE had also cratered in the prior year, dropping from a high above $41 to the bargain price of $18.49!

A little background… I had spent the prior summer analyzing and writing about the markets while working for a Forex broker, which was great because I felt really in touch with what was happening in the markets  (you can see the ‘Old Archives’ section at the bottom of this page for some of my work from that summer). This facilitated one of my finest moments: I sent an email to my family on June 28th, 2008, explaining why they needed to exit the stock market immediately. They totally ignored me, but I can always say that I told them to exit before the market crashed.

But I digress… having saved a little money in a new IRA, I was ready to pounce. By the time 2008 was winding down, investors were in full-fledged panic mode. It’s easy to forget how scared people were by the economic climate at the time, and I was no exception. But like my heroes (Buffett, Soros, Munger, etc.), I had put my fear aside and purchased two companies so ludicrously cheap that there was no way I could lose!

Except I could. And I did. I thought I had beaten the system, but instead I had forgotten one of the most important rules of investing: buy great companies!

At the time, Citi was not a great company. It was hemorrhaging money, up to its neck in bad loans, and didn’t seem to fully grasp the trouble it was in (they continued to issue dividends through Q1-2009).  GE wasn’t in a great place either. In the decades prior, it had increasingly shifted its focus into finance (away from its manufacturing origins), and was subsequently hurting as the global financial system took a nosedive.

Over the next few years, it became clear I had done one thing right (investing in the market when everyone else was fleeing). Unfortunately, I had picked the wrong companies. Citi eventually declared a reverse 1:10 split, pay a meaningless 1 cent dividend each quarter, and is still 25% below my purchase price (adjusted for the split). GE fared a little better; it slashed the dividend in 2009, but since bottoming out that year the price has slowly crawled upwards. I sold both in July of 2011. In the two 2.5 years I had owned them, my Citigroup holdings lost 48%, while GE had earned me just under 4%.

As I said, it was a painful lesson. The reason it comes to mind is that when I had bought Citi and GE, my college roommate had urged me to invest in Ford as well. Granted, he was speculating along the same lines as I was on Citi, and I quickly dismissed his advice. At the time, I had a much higher opinion of the two companies I had bought, and thought I understood financial firms more thoroughly than a car manufacturer.  This was also right after the CEOs of GM, Ford, and Chrysler had embarrassed themselves in front of congress. The markets expected all three to declare bankruptcy, but Ford kept insisting that it wouldn’t need to declare. Bear in mind, however, that GM was saying the same thing.

You probably know the story from here. Ford received a loan from the US government and was the only one of the “Big Three” to avoid Chapter 11. The stock price soared; I missed out on a company that has produced a 51.52% annualized total return over the past 5 years.

Looking back on it now, learning the rule of only buying great companies was a painful lesson. Examining the annualized total 5-year returns for the largest financial firms in the US, Citigroup has easily performed the worst:

1.20.14 financial firms

As for the largest firms in the industrials sector, GE has been near the bottom for the annualized total 5-year returns:

1.20.14 industrial firms

There are numerous conclusions I can draw from my early “adventures” as an investor. The first, encouragingly, is that I had the right idea! Buying when everyone is selling is undoubtedly an amazing opportunity for long-term gains.

The lifespan for entire industries is far longer than that of individual companies. Banks, for example, will come and go. On the other hand, banking has been around for centuries, and isn’t going anywhere. This paradigm holds true even for younger industries, such as technology or telecommunications. In times of economic crisis, the most important concept becomes buying the best companies, even if they’re not the cheapest. When an industry is crashing, most/all of the companies will be available at a discount, so look for the strongest firm instead of the one trading at the greatest discount! Before deciding on Citigroup, I considered buying Goldman Sachs. Even though they appeared to be in a stronger position than Citi, I decided to pass since they were more expensive.

To illustrate the extent of my mistakes in 2008, I’ve created a chart to examine the fall and rise in share price for Ford, Goldman Sachs, Citigroup, and General Electric. The share prices for each on January 1, 2008 (blue bars) have been indexed at 100, with the subsequent values reflecting the movement in share price. The red bars indicate the month that I bought Citi and GE, and the green bars indicate the month where the markets hit their bottom.  Note that the values on the y-axis are not actual stock prices; this chart is indexed to reflect the movement in the share price, rather than the actual price levels themselves.

1.20.14 rise and fall

As I said… the good news is that I didn’t buy GM. The bad news is that I bought Citi and GE, and the worst news is that I didn’t buy Ford or Goldman Sachs in December of 2008. Lesson learned.


Linking Up – 1/20/14

To start, a few quotes from MLK:

“Darkness cannot drive out darkness; only light can do that. Hate cannot drive out hate; only love can do that.”

“If I cannot do great things, I can do small things in a great way.”

“The ultimate measure of a man is not where he stands in moments of comfort and convenience, but where he stands at times of challenge and controversy. The true neighbor will risk his position, his prestige and even his life for the welfare of others.”

“Even if I knew that tomorrow the world would go to pieces, I would still plant my apple tree.”


On to some things worth reading:

Everyone’s favorite pastime is calling out economic bubbles… How do we define them? (Harvard Business Review) And why is today’s tech industry not in a repeat of the dot-com bubble? (USA Today)

Speaking of bubbles… Bitcoin was labeled a commodity – not a currency – in Finland. (Bloomberg)

An op-ed looking at greed on Wall Street, being both allured and repulsed by it. (NY Times)

It’s important to toss away biases towards certain industries… they all rise and fall with time. (Reformed Broker)

Great investing outlook summaries… I totally agree with both of these! (Crossing Wall Street and Oddball Stocks)

An awesome take by Altucher on the psychological lessons found in (one of my ultimate pump-up songs) “Lose Yourself” by Eminem. (The Altucher Confidential)

Chasing after Spotify’s market; looking at new entrants into streaming music. (WSJ)

Important things to note about what happened to net neutrality. (GigaOM)

Some reviews of what happened in economics and earnings last week. (The Big Picture and Avondale Asset Management)


Lastly, here are two long-forms I enjoyed, totally unrelated to anything on this blog:

A look at the anomalistic history of treating mental health in a tiny, old town in Belgium called Geel, located about an hour from Antwerp.  (Aeon Magazine)

A writer’s journey to the far side of the world in search of a modern-day miracle, found in the form of a boy who did nothing but meditate for nearly 10 months. (GQ)

The Value of Intrinsic Value

Originally, I was planning on this post being a condensed version of my most research report. Usually I’ll assemble an outline when I sit down to write, but today I neglected doing so since the plan was to use existing material. Fast forward an hour… I had written over 500 words, none of which had anything to do with Keweenaw Land Association. I’ll save that for another time, as today I ended up expounding a basic explanation of ½ of my investing philosophy: finding undervalued companies. This post is primarily aimed at those who have invested with me, as I hope it gives you better perspective on my approach.


Every transaction lies at the intersection of several questions: How badly do I want this? What can I afford? What is this thing truly worth? The first two are fairly personal questions, as the only relevant arbiter is the person asking them. The third question, however, is of particular importance, as it is the only one determined by outside forces.

Transaction Diagram

Answering the third question is as much art as a science. Amongst investors, the allure of knowing an investment’s precise value is tremendous. If we are 100% sure that Microsoft is actually worth $45, but is selling for just $35, we would certainly buy shares of Microsoft. To that end, investors have created many methods trying to find that quixotic value. Discounting future cash flows, comparing similar companies, examining relevant transactions, adding up the distinct parts of a company – all these methods are among those used in the attempt to assess a company’s worth.

There are some who are content with the notion that the market price inherently reflects a company’s true worth. This theory has been disproven so many times (such as here and here) that they gave the Nobel Prize in Economics to the economist who first proposed it. Luckily for us, there was another economist in the last century who had a better understanding of how to view the stock market.

When Benjamin Graham birthed the idea of Mr. Market – a parable for the stock market’s tendency to misprice equities, thus providing opportunities to enter or exit the market at advantageous times – he also refined our collective understanding of finding a security’s true worth. Calling it a stock’s intrinsic value (IV), he articulated the notion that although an exact IV was not calculable, creating a range of possible IVs was both possible and of tremendous utility. Since nobody knows exactly what the future holds, we can use fundamental analyses of a company to create a range of what it is likely to truly be worth. To paraphrase Graham, we don’t need to know exactly what a man weighs in order to tell that he’s fat.

Finding out a stock’s range of IVs is useful because of the flip side to Mr. Market; while he may be irrational on one day, he won’t stay that way forever. In other words, a company may be priced above or below its actual worth, but eventually it should return to a price more reflective of its IV. This process is explained thoroughly by Oddball Stocks, which substitutes the idea of gravitational pull in place of Mr. Market.

The need for finding an approximation of a company’s intrinsic value casts light on the difference between speculating and investing. Anyone can say that they expect a company to increase in price for qualitative reasons. Because said reasons are qualitative, they’re likely to sound convincing and be tough to refute. As humans we love the concept of the narrative.  Once we’ve chosen one, however, we typically seek factual sounding statements to support this narrative, even if that means dismissing facts supporting the other side. This helps explains why conservatives tend to watch Fox News, and why liberals tend to watch MSNBC; we enjoy hearing reasons why we’re right from figures that sound authoritative. Our tendency to do so violates another of Graham’s philosophies, as he realized the danger in investing based on a company’s story instead of its numbers. Stories can be twisted, altered, created or erased. Numbers can be interfered with (such as Enron), but they themselves do not lie, and therein lays the difference.

As I’ve alluded to before, I have no idea what the future holds. Furthermore, I caution you when a person speaking to you says that they know what’s going to happen, as it’s either insider trading or they’re full of s&%! (either way you should steer clear). But it’s because I concede that I’m uncertain about the future that I follow Graham’s advice. The range is there to accommodate our uncertainty about the future. Use it wisely!

Linking Up – 1/9/14

Over the past 7 years, returns from LT treasuries, corporate bonds, and stocks have all ended up at the same level. Never would’ve expected this. (Research Puzzle)

Another fight that at its core is about economics vs. politics. I think we’ll hear more about this in the coming year. (Businessweek)

I’m planning on writing a post soon about narrative vs. numbers. In the meantime, this is Ritzholtz’s summary of the gold market’s wild ride. (Bloomberg)

Hedge funds, wearing it.  More proof that investors often make things way too complicated, like avoiding US companies last year. (Businessweek)

An example of a good, straightforward letter to investors. It seeks to manage their expectations about the future while not resorting to excuses about external factors.  (Avondale Asset Management)

Is the ACA/Obamacare working? One of the president’s top economics explains why he says yes.  (Wall Street Journal)*

For the Microsoft CEO hunt, who’s next after Mulally is out? I actually like that they’re taking time to make this search, as I’ll discuss another time. (BGR)

Setting goals like Google. (Business Insider)



Fascinating exposé on a side of Mexico’s Drug War that we rarely hear about. Good chance it will change your view of that situation. (Human Rights Watch)


*If you don’t subscribe to the Wall Street Journal or other news site with a paywall, try to search for the article in Google and access it that way. It often works!