In Deep: Underwater Borrowers (From WSJ)

Source: http://s.wsj.net/public/resources/documents/info-NEGATIVE_EQUITY_0911.html

Here is an update of the US housing market. It's mind boggling that close to 50% of all homeowners with mortgages in the states of Arizona and Florida had negative home equity (mortgage owned is more than market value of the home) in the 3rd quarter of 2009, with the country's average at 23%.

The US economy is recovering, if we consider the rise in existing home sales as one of the supportive indicators. However, this is only in the beginning of removing excessive housing inventory. We are in an uncharted territory of our financial history. Little was done since the financial crisis of 2008 to address the problem of excessive risk taking, except more debts was piled on. Also, the latest burst in stock market indices only masked away dire needs for a reform in our financial structures.

Excessive money with very low interested flooded the market (see chart below), so it would not be a bad idea to be extra cautious in the short-term as assets are getting bid up.

Money Stock; M1 Yr/Yr% , (total amount of money available in an economy at a particular point in time)

(SA Billions $) (Source: Moody's)

An Alternative to Mutual Funds

kaChing has officially launched its investment business idea.

This is a radical idea with exceptional benefits if succeeded.

Here is a brief video interview with the kaChing management from "CNBC Squawk on the Street":

http://www.cnbc.com/id/15840232?video=1300149728&play=1

Wrong Way? Wall Street Journal February 26, 2007

The following article was published on WSJ on February 26, 2007 and is still very much relevant as of today. Recently, a lot of media attentions were on the anniversary of the September 2008 financial collapse. Yet, this recession did nothing to cure our urge to "play" the stock market.

Investors are trading so quickly they may not see the risks in the market for the speed.

In the stock market, the idea of holding on to an investment for the long term doesn't seem to hold much allure any more. According to Sanford C. Bernstein chief investment officer Vadim Zlotnikov, the average holding period for stocks on the New York Stock Exchange and American Stock Exchange last year was less than seven months. In 1999 -- stereotyped as a time of rapid-fire day trading -- the average holding period was more than a year.

In fact, the last time stocks were being held for as short a period as they are now was 1929, when students of history may recall something happened to the market.

Mr. Zlotnikov's analysis doesn't include the increasingly popular, and complex, derivative strategies that investors use to gain exposure to stocks without actually holding shares. On the Chicago Board Options Exchange, for example, the trading volume on individual stock options was 40% higher last year than it was in 2005.

Technology has a lot to do with the increase in turnover. Increased computing power means strategies that 10 years ago existed only in theoreticians' notebooks now can be put into everyday use. Lower trading costs and the 2001 switch to decimalization -- the pricing of stocks in dollars and cents rather than dollars and fractions -- have let investors profit from price anomalies that used to be too expensive to exploit.

Also driving the increase: the rising prominence of hedge funds. Because they tend to be judged by each year's performance, few professional fund managers have the luxury to ignore short-term price swings and invest for the long haul. Losing your job and then having history prove your investing acumen right is nobody's idea of fun. For hedge-fund managers, the short-term performance pressures can be intense -- first, because the high fees they charge make their investors intolerant of losses, second because some of the trading strategies they use mean the losses they face if a position goes wrong can be steep.

The result is a constant trading in and out of positions to capture returns. In today's marketspeak, hedge funds are emphatically working to "generate short-term alpha." What it boils down to is the age-old practice of stop-loss trading -- automatically buying and selling stocks when they rise or fall to specified levels.

Despite all the moving in and out of stocks, stock-price movements have been remarkably quiescent. Stock market volatility -- as measured by actual price movements, rather than the options price-generated "implied" volatility measured by CBOE's market volatility index -- is at its lowest level in 10 years. (Implied volatility is near a decade low.) It may be that the combined effect of all the sophisticated trading strategies in place today have put the stock market into a state of dynamic tension, where all the tugging and pulling effectively cancels each other out, muffling price movements.

At the same time, investors' intolerance of short-term losses could mean that if the stock market seriously stumbles, the droves of fund managers engaging in stop-loss selling could overwhelm the market. When volatility comes back, it could do it in a grand fashion.

I recommend John Bogle's "The Little Book of Common Sense Investing." The book presents a very persuasive argument on index investing but is hardly followed in the real world. Mr. Bogle simply put it this way: "We investors as a group get precisely what we don't pay for. So if we pay nothing, we get everything."

What's happening in the world is exactly the opposite. One example, optionXpress Holding Inc., a highly profitable online brokerage, has a 80% profit margin and after all operating and tax expenses still produce a healthy 20% net profit margin. Its "Daily Average Revenue Trades", a measurement of expected revenue from commissions or fees, increased from $13,600 in 2004 to $36,500 in 2008 as more users opened accounts with optionXpress.

May the best trader wins.

Warren Watch: Bite into this, Mr. Buffett

http://www.omaha.com/article/20090823/MONEY/708239979

From Warren Buffett Watch - CNBC.com

The Omaha World-Herald relates Buffett's response to a New Jersey nutritional dentist who had written a letter encouraging him to eat more healthy food and take nutritional supplements:

"My diet, though far from standard, is somewhat better than usually portrayed. I have a wonderful doctor who nudges me in your direction every time I see him. All in all, I’ve enjoyed remarkably good health — largely because of genes, of course — but also, I think, because I enjoy life so much every day."

He's also been exercising more in recent years.

Back in 2007, Buffett told CNBC that his doctor had given him a choice two years before: "Either you eat better or you exercise." Buffett said he chose exercise, the "lesser of two evils."

Some Financial Headlines in August 2009

Climate Change

- Officials, who yesterday estimated agricultural damage from Typhoon Morakot amounted to at least 4.2 billion Taiwan dollars (about $130 million at current exchange rates).

- Auto sales in China rose 63.6% in July from a year earlier to 1.09 million vehicles, the fifth straight month of more than one million vehicles sold.

- China's auto sales rose to 7.2 million vehicles in the first seven months of 2009.

- Car sales in India rose an annual 31 percent in July, an industry body said on Monday, as demand was boosted by new launches and increasing availability of cheaper loans.

- India companies sold 115,067 cars during the month, compared with 87,901 cars a year earlier, data from the Society of Indian Automobile Manufacturers showed.


US Mortgage

How to Save an ‘Underwater’ Mortgage WSJ - OPINION By MARTIN FELDSTEIN

- More than three million homes are now in serious default (nonpayment for 90 days or more) or foreclosure, nearly double the number a year ago. Sales of properties in foreclosure or serious default made up one third of all home sales in May and June.

- So far only about 200,000 mortgages have been modified this way, far fewer than the administration’s goal of modifying three million mortgages.

- Nearly half of all modified mortgages go into default within six months. That’s partly because, even when they can afford the reduced mortgage payments, many homeowners default anyway because they owe more on the house than it is worth. Thanks to this “negative equity,” they just walk away.

- Today one-third of all homes with mortgages have mortgage debt that exceeds the value of the home. Among these homeowners, half of the loan-to-value ratios exceed 130%.

- Any homeowner with a loan-to-value ratio over 120% could apply for a reduction in his mortgage balance. The government and the creditor would then share equally in the cost of writing the loan balance down to 120% of the value of the home. But the homeowner who opts for this write-down would be obliged to convert the remaining mortgage to a loan with full recourse that could not be discharged in bankruptcy. Federal legislation would be needed to modify state mortgage and bankruptcy rules to allow homeowners to obtain the new type of mortgage.

- An example shows how this would work. Consider someone with a home worth $200,000 and a mortgage of $280,000, i.e., a loan-to-value ratio of 140%. If the borrower and the creditor both agree, the loan could be reduced by $40,000 to $240,000 (120% of the home value.) The government would give the creditor $20,000 to offset half of the write-down. The homeowner would convert the remaining $240,000 mortgage to a bank loan with full recourse that could not be discharged in bankruptcy.- If this plan succeeds in stabilizing house prices at the present level, the one-time cost to the taxpayers would be capped at $200 billion, even if every homeowner with a loan-to-value ratio over 120% accepted the government-assisted write-down. That $200 billion is less than a 2% fall in house values.

- Existing home sales rose 3.8% to a seasonally adjusted annual rate of 4.76 million units in the second quarter from 4.58 million units in the first quarter, according to the National Association of Realtors (NAR). That is still 2.9% below the second quarter of 2008.

- But foreclosures are rising, and that's pulling down home prices. Foreclosure filings were reported on 360,149 properties in July, according to a RealtyTrac report today. That's an increase of nearly 7% from the previous month and a jump of 32% from July 2008.

- Moody’s latest CMBS Delinquency Tracker (DQT) records the aggregate rate of delinquencies among US CMBS conduit and fusion loans at 2.67%, based on data through the end of June. This represents a 40 basis point increase from the prior month’s 2.27% rate.

- By comparison, the DQT was 0.46% a year ago and is now 245 basis points above the low of 0.22% measured in July 2007.

- Fitch Ratings yesterday said that delinquencies for loans in US commercial mortgage backed securities (CMBS) rose by nearly half a percentage point in July to 3.04 per cent, the highest level since the rating agency began tracking this index of loans in 2001. The loans in the index represent about $480bn in CMBS, or two-thirds of the market.

- To help revive the sector, the Federal Reserve has included CMBS in the term asset backed securities loan facility (TALF), where it lends investors money to buy new deals, though none have been arranged.

- Almost $165 billion in U.S. commercial real estate loans will mature this year and need to be sold or refinanced as rents and occupancies fall, according to First American CoreLogic

US Equities

- Berkshire’s operating earning results for the second quarter and first six months of 2009.

- A Commerce Department report on Thursday showed total retail sales edged down 0.1 percent after increasing 0.8 percent in June, compared with market forecasts for a 0.7 percent gain.

- Initial US Jobless claims 558K and the four week average at 565K. Continuing claims down to 6.202 million from 6.343 million

- AAII Index (American Association of Individual Investors) has risen to the 50% for the first since May 9, 2008 (only 35% are bearish). March 6, 2009 was at 18.9.

- Market Vane Sentiment (a survey of traders) up to 48% now, which is the highest since June 20, 2008.

- The government sold a record $37 billion in three-year notes on Aug. 11 and $23 billion in 10-year notes yesterday. Sales of 3-, 10 and 30-year securities have become monthly, raising $65 billion in July, as the U.S. tries to fund a record budget deficit.

- Today’s sale is the largest-ever offering of the 30-year bond, the prior record being the $14 billion sold in May and February and in February 2006. The U.S. sold $11 billion of the securities in July. At last month’s auction, the notes drew a yield of 4.303 percent.

- Indirect bidders, a class of investors that includes foreign central banks, bought 48.1 percent of the notes at today’s auction. They bought 50.2 percent of the securities in July, the most since February 2006. They purchased 49 percent in the June auction. The average for the past 10 auctions is 32.8 percent.

- The shortfall so far for the fiscal year that ends Sept. 30 totaled $1.27 trillion compared with a $389 billion year-to-date gap in 2008, the Treasury said today in Washington. The excess of spending over revenue for July climbed to $180.7 billion compared with a $102.8 billion gap in July 2008 as the government spent more than in any month in U.S. history.

Breakfast with Dave

Mr. David Rosenberg is a pretty popular figure in the industry and media nowadays. He has been a bear for sometime.

Here is a nice list of the economic background from last October compared to today.

•The unemployment rate was 6.6% then, today it is 9.4%

•The level of employment (nonfarm payrolls) was 136.35 million; today it is nearly 4.0% smaller at 131.5 million

•The level of nominal GDP was $14.347 trillion; today it is $14.143 trillion

•The level of real GDP was $13.149 trillion; today it is $12.892 trillion

•The 4-quarter trailing operating EPS was $49.50; today it is $39.90.

•The 4-quarter trailing reported EPS was $14.90; today it is $7.90.

•The dividend yield was 2.9%; today it is 2.3%

•The P/E ratio (operating earnings) was 19.6x; today it is 25.2x

•The “real” yield (5-year TIP), which is a bond proxy for “real” growth expectations was 3.0% back in October; today it is 1.7%

•Industrial production was 106.2 (index); today it is 10% smaller, at 96.0

•Industry wide capacity utilization rates were 75.4% then; they are 68.5% today

•Manufacturing inventory-to-shipments ratio was 1.33 back then; now it is at 1.42

•Housing starts were 763k (annualized) units; today even with the recovery they are 581k (24% smaller)

•Commercial construction was $729 billion then, it is $712 billion today

•Oil prices were $71/bbl then, about where they are today

•The “real” yield on the Baa corporate yield was 5.2%; today it is 8.6%

•Bank credit was $9.5 trillion back in October; it is $9.2 trillion today

•The federal deficit was running at a $550 billion 12-month run-rate; today it is $1.3 trillion

•Corporate spreads were 450bps back then; they are 300bps today (this, along with ISM, home sales and consumer confidence polls, are better, and that’s about it).

Bashing Goldman Sachs Is Simply a Game for Fools: Michael Lewis

I love Mr. Lewis's book "Moneyball", and his latest commentary from bloomberg is quite an entertaining one on some supposedly Goldman Sachs rumors.

Rumor No. 1: “Goldman Sachs controls the U.S. government.”

Rumor No. 2: “When the U.S. government bailed out AIG, and paid off its gambling debts, it saved not AIG but Goldman Sachs.”

Rumor No. 3: “As the U.S. government will eat the losses if Goldman Sachs goes bust, Goldman Sachs shouldn’t be allowed to keep making these massive financial bets. At the very least the $11.4 billion Goldman Sachs already has set aside for employees in 2009 -- $386,429 a head, just for the first six months -- is unfair, as the U.S. taxpayer has borne so much of the risk of the wagers that generated the profits.”

Rumor No. 4: “Goldman employees all look alike.”

Rumor No. 5: Goldman Sachs is “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.”

I enjoy his explanation to rumor No. 2 the most.

The full article is at http://bloomberg.com/apps/news?pid=20601039&sid=a2X3hNaWcbeg

Philip Fisher's 15 Points - Common Stocks and Uncommon Profits

I feel foolish for not reading this book earlier in my investing career. "Common Stocks and Uncommon Profits" by Philip Fisher is by far one of the best books on investment. The book was published in the 1950's, but honestly I could not tell a difference because the information in the book is just as relevant today as it was some 50 years ago.

I am borrowing the list from a Morningstar article about Mr. Fisher's 15 points on a worthwhile investment (I will go into more detail and apply the principles in future articles).

1. Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years? A company seeking a sustained period of spectacular growth must have products that address large and expanding markets.

2. Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when the growth potentials of currently attractive product lines have largely been exploited? All markets eventually mature, and to maintain above-average growth over a period of decades, a company must continually develop new products to either expand existing markets or enter new ones.

3. How effective are the company's research-and-development efforts in relation to its size? To develop new products, a company's research-and-development (R&D) effort must be both efficient and effective.

4. Does the company have an above-average sales organization? Fisher wrote that in a competitive environment, few products or services are so compelling that they will sell to their maximum potential without expert merchandising.

5. Does the company have a worthwhile profit margin? Berkshire Hathaway's BRK.B vice-chairman Charlie Munger is fond of saying that if something is not worth doing, it is not worth doing well. Similarly, a company can show tremendous growth, but the growth must bring worthwhile profits to reward investors.

6. What is the company doing to maintain or improve profit margins? Fisher stated, "It is not the profit margin of the past but those of the future that are basically important to the investor." Because inflation increases a company's expenses and competitors will pressure profit margins, you should pay attention to a company's strategy for reducing costs and improving profit margins over the long haul. This is where the moat framework we've spoken about throughout the Investing Classroom series can be a big help.

7. Does the company have outstanding labor and personnel relations? According to Fisher, a company with good labor relations tends to be more profitable than one with mediocre relations because happy employees are likely to be more productive. There is no single yardstick to measure the state of a company's labor relations, but there are a few items investors should investigate. First, companies with good labor relations usually make every effort to settle employee grievances quickly. In addition, a company that makes above-average profits, even while paying above-average wages to its employees is likely to have good labor relations. Finally, investors should pay attention to the attitude of top management toward employees.

8. Does the company have outstanding executive relations? Just as having good employee relations is important, a company must also cultivate the right atmosphere in its executive suite. Fisher noted that in companies where the founding family retains control, family members should not be promoted ahead of more able executives. In addition, executive salaries should be at least in line with industry norms. Salaries should also be reviewed regularly so that merited pay increases are given without having to be demanded.

9. Does the company have depth to its management? As a company continues to grow over a span of decades, it is vital that a deep pool of management talent be properly developed. Fisher warned investors to avoid companies where top management is reluctant to delegate significant authority to lower-level managers.

10. How good are the company's cost analysis and accounting controls? A company cannot deliver outstanding results over the long term if it is unable to closely track costs in each step of its operations. Fisher stated that getting a precise handle on a company's cost analysis is difficult, but an investor can discern which companies are exceptionally deficient--these are the companies to avoid.

11. Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition? Fisher described this point as a catch-all because the "important clues" will vary widely among industries. The skill with which a retailer, like Wal-Mart WMT or Costco COST, handles its merchandising and inventory is of paramount importance. However, in an industry such as insurance, a completely different set of business factors is important. It is critical for an investor to understand which industry factors determine the success of a company and how that company stacks up in relation to its rivals.

12. Does the company have a short-range or long-range outlook in regard to profits? Fisher argued that investors should take a long-range view, and thus should favor companies that take a long-range view on profits. In addition, companies focused on meeting Wall Street's quarterly earnings estimates may forgo beneficial long-term actions if they cause a short-term hit to earnings. Even worse, management may be tempted to make aggressive accounting assumptions in order to report an acceptable quarterly profit number.

13. In the foreseeable future will the growth of the company require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholders' benefit from this anticipated growth? As an investor, you should seek companies with sufficient cash or borrowing capacity to fund growth without diluting the interests of its current owners with follow-on equity offerings.

14. Does management talk freely to investors about its affairs when things are going well but "clam up" when troubles and disappointments occur? Every business, no matter how wonderful, will occasionally face disappointments. Investors should seek out management that reports candidly to shareholders all aspects of the business, good or bad.

15. Does the company have a management of unquestionable integrity? The accounting scandals that led to the bankruptcies of Enron and WorldCom should highlight the importance of investing only with management teams of unquestionable integrity. Investors will be well-served by following Fisher's warning that regardless of how highly a company rates on the other 14 points, "If there is a serious question of the lack of a strong management sense of trusteeship for shareholders, the investor should never seriously consider participating in such an enterprise."

Diversification is the golden rule?

When it comes to investing, people often question whether they have enough diversification.

"Concentration to create wealth" and "Diversification to preserve wealth" is my usual response. I am not sure where I got those ideas from, but the following from Warren Buffett's letter to shareholders in 1991 is an excellent illustration on this topic.

If my universe of business possibilities was limited, say, to private companies in Omaha, I would, first, try to assess the long-term economic characteristics of each business; second, assess the quality of the people in charge of running it; and, third, try to buy into a few of the best operations at a sensible price. I certainly would not wish to own an equal part of every business in town. Why, then, should Berkshire take a different tack when dealing with the larger universe of public companies? And since finding great businesses and outstanding managers is so difficult, why should we discard proven products?

John Maynard Keynes, whose brilliance as a practicing investor matched his brilliance in thought, wrote a letter to a business associate, F. C. Scott, on August 15, 1934 that says it all: "As time goes on, I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one's risk by spreading too much between enterprises about which one knows little and has no reason for special confidence. . . . One's knowledge and experience are definitely limited and there are seldom more than two or three enterprises at any given time in which I personally feel myself entitled to put full confidence."

The true question then becomes how strong is your willingness to create wealth, and do you understand the implications behind that. In addition, how do you know that your full confidence is not a sense of illusion. The principle of "Margin of Safety" is really the best discipline tool one can use (Simple example: buy asset for 50 cents when it is worth a dollar).

With a margin of safety, the probability of investment success is at a higher percentage but by no mean a guarantee. Just as someone who holds a pair of aces before the flop in a poker game does not guarantee him/her a winner of that round. But by being selective, over the long term, concentrating on good starting hands will eventually pay off more significantly than trying to pick the pots with many marginal hands.

Behavioral Finance 001

Here is an interesting chart from a study done in 2002 where two groups of professionals are asked to predict some near-term future outcome. One group of analysts are asked to predict the level of S&P 500 in the next month and half. Another group of weather men are asked to predict the average temperature in April for a location (about same one month and half time frame).

Each group are given three mutually exclusive and collectively exhaustive selections of greater than X, between X and Y, and less than Y. A sensible human being, from a mathematical perspective would have a confidence level of 33% (1/3 chance to be correct). Yet, the average level of confidence was about 58% for analysts and 49% for weather men, suggesting overconfidence in our ability may be a nature tendency.

What's more interesting is from the group of respondents that incorrectly predict the outcome. As a side note, about 1/3 of the analysts made the correct choice and about 2/3 of weather men did so as well. Participants who made incorrect forecast are asked for a reason for their inaccuracy. Interestingly enough, none of the analysts mentioned the outcome as lack of experience or insufficient data. Most attributed to the "single prediction" and “ceteris-paribus” defense mechanisms (definition below).

To be a better investor, I think it's more important to understand one's own emotional strengths and stay honest to one's own action than to crunching analysis. The issues mentioned here seems trivial but are very difficult to overcome. The following is a good checklist to remind our brain every once in awhile.


Optimism and Overconfidence:

- Optimism

Well documented trait among young individuals who feel the odds of something bad occurring in their lives are very low or even non-existent. Example: Young adults are far more likely to become disabled than they are of dying, yet the vast majority does not carry disability insurance.

- Overconfidence

People tend to place too much confidence in their ability to predict. They tend to systematically underestimate the risk, which lead to higher probability of surprises.

- Increased Trading

Belief that you can interpret information better than the average investors and often leads to undiversified portfolios.

- Overconfidence in Forecasters

Primary factor leading to overconfidence in professionals is knowledge (education or experience). They feel their forecasts are based upon skill (i.e., an illusion of knowledge)

Forecast defence mechanisms

1. The “if-only” defence.
2. The “ceteris-paribus” defence.
3. The “almost-right” defence.
4. The “it hasn’t happened yet” defence.
5. The “single predictor” defence.

Examples from financial-education.com:

“The “if only” defense says their forecast would have been correct if the advice or analysis they had provided had been followed. This defense is popular because it cannot be proven wrong since historical events will seldom follow a specific analysis. However, the basis of the original forecast was presumably to predict the likely outcome, not the outcome if a certain set of actions occurs. A conditional forecast should also outline the consequences of conditions varying from those set out.

The “ceteris paribus” defense says something interfered with the original forecast. “They would have gone bankrupt but their competitor bought them out.”
The “I was almost right” defense says the forecast almost happened. This applies primarily to averted catastrophes. “Long-term Capital Management’s collapse almost brought down the entire financial system.” If one was predicting the collapse of the financial system, close doesn’t count.

The “it just hasn’t happened yet” defense says the next hedge fund collapse will be the one that brings down the financial system. Either that, or the one following it.
The “single prediction” defense acknowledges that the conditions of the forecast were met but the prediction was still incorrect. However, forecasts are pointless so don’t hold it against the analysis that led to the forecast.”

Loss Aversion:
Individual’s reluctance to accept a loss. A stock may be down considerable from its purchase price, but the investor holds on to it hoping that it will recover. Loss aversion can also lead to risk-seeking behavior.

Reference:
Hersh Shefrin, Portfolios, Pyramids, Emotions, and Biases
James Montier, Behavioural Investing
Schweser CFA Level III Notes
http://financial-education.com/2007/09/09/ego-defense-mechanisms/

Warren Buffett Power Lunch for Glide Foundation

TELUS: Excellent Value for a Canadian Telecom Company

Brief History:
TELUS is a national telecommunication conglomerate in Canada. The company has expanded itself from a local wireline phone company in Alberta, Canada to a national company that offers services in digital broadband/TV, wireline/wireless communication, and healthcare data services.

TELUS was established in 1990, following the reorganization of Alberta Government Phone Commission that established in 1958. In 1998, TELUS become a prominent telecommunication company in Western Canada when it merged with BC TELECOM, a legacy telecommunication company based in British Columbia, Canada.

Why TELUS is a BUY:
• When compared to its 2001-2008 share data, TELUS currently has the highest dividend yield at 6.1% and lowest P/E ratio at 9. TELUS share enjoyed strong dividend growth in the past five years with a current payout ratio of 66%
• If we think TELUS’s equity as a bond, it has a 10% floor return, which 4% is from annualized growth of book value per share in the past five years and 6% from current dividend yield.
• As the number of smartphone users increases, TELUS will be able to collect fees on wireless data usage like a toll bridge. Currently, data plan consist only 7% of total wireless revenue for TELUS
• TELUS, with BELL Canada as its partner, is ready to launch a nationwide GSM network in early 2010 to compete with Rogers communication and capture the advantage of being on a network that has over 80% of the global wireless phone users
• TELUS has a strong presence in Western Canada, a region that is expected to have higher economic activities compare to other parts of Canada.
• TELUS operates in a highly regulated business with high barriers to entry and few industry players. The long-term outlook for this business remains viable with new demand drivers for broadband/wireless communication

Company Analysis:
TELUS (TU), BELL Canada (BCE), and Rogers Communication (RCI) are the main players in Canadian wireless telecommunication industry. Each company controls roughly 30% of total wireless subscribers. Rogers Communication is the only national GSM network provider and has enjoyed substantial growth over the past couple years as most popular smartphones were available only on the GSM network. All companies have other complementary business segments such as cable TV, broadband, and wireline phones. Wireless communication makes up bulk of the revenue (close to or over 50%) for these companies and will be a key revenue growth for these companies going forward.

Couple new entrants, namely Shaw communications and Globalive, made substantial bids and acquired wireless licenses from government of Canada in 2008 and emerged as potential competitors. However, due to global economy turmoil and financing issues, Shaw, a cable based company in Western Canada, has abandoned its plan to build a wireless phone network in the near future. Globalive will likely roll out its wireless network later this year or early 2010, but its ability to be profitable is unclear. Globalive will need to spend $1.8B between the next ten years to establish its wireless business. The competitive landscape is likely to remain the same as the big threes throwing punches at each another.

As of fiscal 2008, Rogers enjoyed the highest average revenue per user (“ARPU”) at $75 dollar per month thanks to its exclusivity of GSM network and a number of smartphones. TELUS and BELL Canada, operators of CDMA network, have “ARPU” at about $63 and $54. When compared to the US counterparts, using AT&T as an example, AT&T has an “ARPU” of $55 (using a rate of $1.10 CAD/USD). If we make the assumption that future competitive pricing will trend towards AT&T’s “ARPU”, the revenue impact as a result of pricing competition will be minimal for TELUS because organic growth of wireless users can potentially offset the lower “ARPU”. As of fiscal 2008, Canadian wireless market only exhibit a 70% market penetration rate, whereas US has a much higher rate of above 80%.

Comparing some basic metrics on the attractiveness of TELUS share against BCE and RCI, TELUS currently has a comparable dividend yield against BCE at 6.1% with a much lower payout ratio of 66% to BCE’s 88%. Rogers has similar payout ratio but only a 3.4% dividend yield. When looking at P/B, P/E and P/S ratios, TELUS has the lowest ratio between the three companies, and TELUS, looking on a standalone basis, is attractively priced at a P/B of 1.3, P/E of 8.18, and P/S of 0.98, with ROE of 15% and EV/EBITDA of 4.2 times.

Another positive is TELUS’s stable senior management team. Darren Entwistle, CEO, and Robert McFarlane, CFO, have both worked in TELUS since 2000 and successfully implement TELUS’s goal to become a national telecommunication company. Book value per share, after share buyback and dividend payout, grew roughly 4% for the past five years. If we expect that 4% is the future book value growth, adding the current dividend yield of 6% will yield a floor return of 10%. This assumption is highly probable given the near-term competitive landscape, the company's stable senior management team, and the users’ demand for wireless services.

Other positives for TELUS include better projected economic prospect in Western Canada, strong brand awareness in Western Canada, overfunded pension plan, and high barriers to enter the wireless market. Also, it could be argued that TELUS may benefit from currency translation gain as Canadian dollar strengthen against US dollar in the long run. Some short-term speculative sparks includes Vancouver’s 2010 Winter Olympic game, GSM network deployment, and foreign investors’ appetite for investing in Canadian businesses.

There are key negative issues to consider. First, TELUS has poor cash position with only $58M cash on hand. TELUS does have a $2B credit facility with about $1B available at prime rate, an attractive 2.25% cost of borrowing. However, prime rate is a variable rate set between the Canadian banks, and an interest rate hike put TELUS at a significant disadvantage. In addition, Capital expenditure going forward should be considered as well. Capex intensity, which is capital expenditure by a percentage of total sales, has been rising from 17% in 2004 to 28% in 2008. The 28% figure includes the cost to obtain wireless licenses from government of Canada in 2008 and is non-recurring. Without the one time cost, the Capex intensity is about 19%, which is still higher when compared to BCE’s 17% and RCI’s 16%. Finally, continuous monitoring on the economic environment where TELUS operates and potential entrants such as Shaw and Globalive is required. It is unlikely for Shaw to give up without a fight, especially when Shaw spent $190M to acquire a significant percentage of wireless licenses in Western Canada from the 2008 auction.

Overall, TELUS has a solid business plan going forward, and its share is priced at a reasonable rate of risks. TELUS is unlikely to achieve admirable share appreciation like what some of the smartphone companies did in the last couple years. But no matter which smartphone company comes out on top in the future, TELUS will be there to collect its fees from customers. Warren Buffett often said “A bird in the hand is worth two in the bush” and the 10% floor return being offered by Mr. Market today is worth some serious consideration.

(All figures and sources are either from company’s SEC filings, Yahoo! Finance, or Financial Post articles)

(Disclosure: Recently long in TELUS)

Harbin Electric (HRBN) Company Update

Eight months passed by since the last investment rationale was posted. HRBN experienced significant price volatility during the period. HRBN has remained profitable and its business prospects have stayed positive.

It was disappointing to see HRBN made little progress with their Shanghai auto micro-motor facility. Production may finally begin in 2Q09, after two quarters of delay from customers and another quarter or two from construction constraints.

Revenue has dipped in the last two quarters, and the $58M Hengda acquisition has not benefited HRBN’s shareholders. Since acquired in July 2008, Hengda has contributed about $1M of net income, a dismal annualized return of 2.3% from its price tag.

In addition, on a pro forma basis, if we include Hengda’s result in the 1Q08, as if business were acquired on January 1, 2008, the year-over-year quarterly revenue between 1Q09 and 1Q08 declined by 7%.

Some encouraging sights in 1Q09 were the significant reduction in accounts receivable and inventory from the previous two quarters, down from $66M to $43M. HRBN further solidified its balance sheet and has over $64M cash, which is almost enough to service its total debt.

Another encourage news is the recent filings by HRBN to sell additional shares up to $120M. HRBN can sell the shares any time at its own discretion. This has both costs and benefits for the current shareholders. On one hand, there is more share dilution, but on the other hand, more predominated institution investors will join the mix. This will increase the visibility of the company in the long-run.

The SEC filing from HRBN on June 5, 2009 outlined the long-term debt repurchase agreement between HRBN and Citadel Equity Capital. I am speculating that Citadel would want to receive equity shares as part of its early debt redemption. Details are unknown at the moment, so we don't really know if this is a good or bad news for current shareholders. From a top level perspective, this debt repurchase is indeed good news for HRBN because HRBN further establishes itself as a creditable company for willing risk takers.

Overall, HRBN is still a long-term buy given its business prospects, balance sheet strengths, and future expected appreciation of RMB. One thing to keep at the back of mind is managements tend to over-promise and under-deliver, it seems like this is the culture enticed from the CEO himself to make sure HRBN always present itself in the most favorable ways, while downplay any negative developments as much as possible.

(Disclosure: I am long on HRBN)

Value Investing: A Balance Approach by Martin Whitman

Here are couple bulleted lists that I drew from Mr. Whitman's book. The book did not grab my attention as some of other value investing based book, but I think the following lists are full of wisdom.

Value Investing: A Balance Approach Martin Whitman

• Value Investing (VI) uses a balanced approach to analysis so that there is no a priori primacy given to any one factor in an appraisal.
  
• In VI, the essential goal is to value a business or the workout potential for credits issued by trouble companies.
  
• In VI, equity holdings are viewed as permanent or semipermanent commitments, subject only to a risk arbitrage exception.
  
• In VI, macrofactors such as the level of stock averages (e.g., the DJIA), forecasts of interest rates, or the GDP are ignored.
  
• In VI, as part of a balanced approach, businesses are viewed as both going concerns and as resource converters, deploying and redeploying their asset bases and liabilities into new areas including mergers and acquisitions, changes in control, massive refinancing, IPOs, and LBOs.

What has worked in investing

Tweedy, Browne Company LCC, a well established value based investment firm and worked as the broker for Warren Buffett with the acquisition of Berkshire Hathaway in the early 1960's

The firm has published a very insightful booklet for prospect investors called :

"WHAT HAS WORKED IN INVESTING - Studies of Investment Approaches and Characteristics Associated with Exceptional Returns"

There are 5 specific points:

1. Low Price in Relation to Asset Value
2. Low Price in Relation to Earnings
3. A Significant Pattern of Purchases by One or More Insiders (Officers and Directors)
4. A Significant Decline in a Stock's Price
5. Small Market Capitalization
   

Buffett Is Less Bullish on U.S. Than You Think: Alice Schroeder

Bloomberg has an interesting article by Alice Schroeder, the author of "The Snowball". Ms. Schroeder presented a different case on the "Buy America" bullish calls from Mr. Buffett.

If you have not had a chance to read "The Snowball", which is about the size of a brick, I would recommend it because it is probably one of the most intimate book about Mr. Buffett's life. The book is more about Mr. Buffett's life and his family and friends. It is not a typical "how to invest like Buffett" book, and I found the book quite entertaining yet very educational at the same time.

Fed Sees Up to $599 Billion in Bank Losses

For those who are interested with the banking stress test result, WSJ got a nifty interactive chart

The purpose of stress test is to test and forecast that if worse case scenarios do occur, how much capital lifeline will the banks needed in order operate at a regulatory requirement level.

Meanwhile, Taleb and Roubini tagged up again saying we are in the most difficult period of humanity because governments no long have the control they once did

Both are entertaining stories that one must read with a grain of salt.

Happy weekend! comparing all the key metrics between the different financial institutions.

Biggest Event This Weekend for the Market

Berkshire Hathaway held its annual meeting this weekend in Omaha, NB. Qwest Center arena, the location of the event, was jam packed with 35,000 anxious investors, which I believe is a new record attendance.

CNBC as usual for the last couple years, has a complete coverage about the event you can access here.

Also, Everythingwarrenbuffett, another blogspot site that is dedicated to news on Mr.Buffett, has a nice summary of the event which I will burrow from, and you can access it here.

In addition, I finally get a chance to watch the I.O.U.S.A movie this weekend, and it is an excellent piece of documentary that I recommend everyone to watch it. It is just a little bit over one hour, and you will have a better understanding about the seriousness of all these multi-trillion and billion of leverage could do to our future generations.

We are in a globalized world, and everyone will have to face the problem together. The system is so interconnected that we can no longer categorize serious issues as someone else's problems.