How to quickly exclude stocks from further research

Welcome to Value Investing School, article 1 – How to quickly exclude stocks from further research.

With this article I wish to show how investing is mostly a game of exclusion if you are a bottom up value investor and you know what to look for. I’ll analyse L’Occitane en Provence as an example.

Things to learn are:

  • Investing is a game of mostly exclusion.
  • Focusing on the business yield, current or future, makes things easy.
  • Don’t be a relative investor, be an absolute investor.

locicitane

Source: L’Occitane

During the week I look at lots of stocks but what makes it easy for me to separate the interesting investments from the other, is the business return or the future potential business return. I look for current or even better, future double-digit yearly business returns and if a business doesn’t show that potential it is quickly skipped.  This makes me an absolute value investor and not a relative investor, a very costly and risky mistake many investors currently make. As would Buffett say, we invest in businesses and not a stock that goes up and down during a day.

I am currently researching a stock list from an Asian Value investing fund with some very interesting names but also some strange decisions like the L’Occitane en Provence stock. On this stock, I wish to explain:

  • 1) the risks of not focusing on the business yield
  • 2) the risks of relative versus absolute investing and,
  • 3) how easy it is to say no to an investment.

The business yield

If you are an investor in businesses, not stocks, all you care about is the yield of the business, the earnings and how the same earnings are reinvested or distributed at the end of the year. The higher the return on equity, your equity, the better. When buying stocks, your equity is the price you pay for the stock and the yield is derived by comparing the price you pay with the earnings. For example, L’Occitane is a growing company with revenues (1) tripling over the last 10 years (FY (fiscal year) 2019 revenue reached 1.42 billion EUR) and net income (2) almost doubling.

2 revenue

Source: Morningstar

However, when I look at the net income, I see that the average over the last 5 years is around 100 million EUR. I compare it to the current market capitalization (the value of all the stocks outstanding) is 20.6 billion HKD or 2.6 billion EUR. This means that the business yield the company currently provides is at 3.84% given the price earnings ratio of 26 (100/26 = 3.84%).

3 stock

That is far too low for me but then I must look at the growth the company promises. I look at the growth and see that same store growth is actually very low at 2%.

4 growth

Source: L’Occitane

And that all of the growth the management hopes for comes from acquisitions and emerging markets. From reading a bit about the company there is a new management, the company is restructuring and it is something Warren Buffett despises, a turnaround. From the conference call transcript:

5 trust

Source: L’Occitane

When you find words like ‘new management, new strategy, build trust’ it could be truth, but it could be also lots of baloney. Not what a value investor gets in to. So, when I see that I am already at ohhhhh.

Just another one for the record. On top of the new management, the company that made about a billion in profits over the last decade, suddenly decides to make an acquisition of a cosmetics brand and pays $900 million for a company with $40 million in EBITDA.

6 acquisition

Source: Elemis acquisition announcement

All of the above is simply too risky, it might work, I hope it works for them, but it might also backfire as that kind of corporate actions often do. The plan is to scale the brand, a totally new brand, in China.

7 skincare

Source: Elemis acquisition announcement

It could happen it might not, too much risk and the actual business yield is below 4%. Enough for a value investor. So, let me finish this with why are other investors investing in this? Well, they do so because they are relative and not absolute investors.

Relative vs. absolute investors

This is a concept well described in Seth Klarman’s book Margin of Safety and L’Occitane is a great example. A relative investor looks at the company and says:

“I have a great global brand growing at double digit rates that just made a potentially transformational acquisition trading at a PE ratio of just 26. A fair valuation in this market should be 40, thus the stock is undervalued by 30%.”

This might be true and the market might revalue the stock, or re-rate it as the lingo goes,  in case it shows faster growth in the future and improving margins. However, as a value investor you want both future growth and good earnings or value already there, not in some future promise. Also, the fact that the stock was much higher in the past, means absolutely nothing. Actually, it confirms that it was overvalued in the past and the market is slowly but surely re-rating it.

Conclusion

That is it, this is how I mostly spend my time, looking at companies that are not that interesting but from time to time, there is something interesting. To finish with a nice quote that summarizes this:

“Whatever you do, do it with all your might. Work at it, early and late, in season and out of season, not leaving a stone unturned, and never deferring for a single hour that which can be done just as well now.”

That is how bottom up value investing is done. You exclude more than 99% of businesses you look at and with time it becomes a fast process. Buffett says how it takes him 5 minutes to read through a business. Therefore, the more stones you turn, the better are the investments you will find.

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Stock market news – the FED, interest rates and global economic slowdown

Today we are going to talk about the economy and how it affects us investors and what to expect in the next 20 years! The news of the week was that the FED that will keep interest rates low:

1 FOMC

And the second very important news is that the global economy is slowing down and the growth is lowest since the financial crisis!

global economy, what will you focus on

Source: Bloomberg

How does that affect our investing? Is it important at all?

Let’s start with the FED, some think the current interest rate is close to the neutral rate and that should be it.

2 neutral rate

Source: Oxford Economic

Plus, that last interest rate hikes, have slowed down economic growth in the United states but have brought it to what is expected to be normal long term.

3 us growth

Source: Trading Economics

What does it all mean for investors?

Well, the FED will protect you as much as it can and as in Europe, they will do whatever it takes to keep the situation calm. As long as we don’t have inflation things will be good. Plus, it is hard to have inflation when there is so much supply of everything due to the same low interest rates.

However, lower interest rates just postpone the inevitable, which is that the economy is always cyclical and after all it all boils down to productivity. Policy can influence growth in the short term, prevent crises, which also means you can’t time a crisis. Nobody knows what kind of recession will come next and when it will strike.

Postponing means that you might make 20% per year for 5 years and then lose just 20% in one year when there is a recession. The point is that even if it all looks terrible in the form of high debt, low interest rates, it might go on for a decade, or inflation might change things. Therefore, try to find both good investments and protection in case of inflation. The best investments will always be quality.

Global economic situation

On a possible global recession, and something to keep in mind also when watching the specific country growth rates, on one side we will have the slowest global growth since the financial crisis but on the other hand, global growth has been 3% compounded over the last 10 years.

The average since 2000 is probably 4%. This means that over the last 20 years, despite the global financial crisis in 2009, the global economy more than doubled. It will probably double again in the next 20 years and there will probably be one or two recessions. Keep that in mind when investing.

What did stocks do over the last 20 years? Stock doubled!

4 doubled

Source: Macrotrends

Given that the current PE ratio, in the lowest tax environment I expect we are going to see going forward.

6 corporate tax

Source: Wiki

But even if taxes go up, the difference in return will be 1% or something per year, not significant and something not to worry even if the media has already started talking about it.

5 pe ratio

Source: Multpl

I would say, passive investors should expect their money to double over the next 20 years, perhaps a bit more than that with significant ups and downs during the period.

How to invest for the long term?

If you want higher returns, from these levels I think one can easily beat the S&P 500 and other indexes because it was a hard thing to do from 1982 when the PE ratio was 7, thus the return 15%. Now that the return is around 5%, by looking at businesses that offer more, you can do that over the next 20 years. What is the difference?

$100 * 1.05^20 = $265

$100 * 1.1^20 = $672

$100 * 1.15^20 = $1636

My mission is to help those who want more than 5% per year.

The message is simple and I will never get tired of repeating it because it is so important:

Invest in value that will give you a good return over the long time, that will benefit from the fact that the global economy will probably double over the next 20 years and that gives you a margin of safety.

You might buy an airport, fertilizer stocks that we will discuss on Sunday or who knows what. But keep those things in mind. The global economy will double in the next 20 years, no matter the news. Some businesses with quadruple, some will go bust, looking long term, you have a chance to find those that will quadruple.

Long term investing is the most important advantage we have. It allows us to take advantage of the irrationalities that emerge from Wall Street’s and everyone’s focus on the short term.

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Thor Industries Stock Analysis

Over the past months I have received more than 10 emails from various investors about how Thor Industries is a great, cheap, value investment.

1 stock price tho

Source: CNN Money – THO

The first emails started coming in when the stock price fell from above $150 to around $120. Since then, the stock fell another 50% to the current $60. Ouch.

In this article I want to talk about this because it is an excellent example of how many value investors get trapped.

How value investors get trapped?

We have:

  • An extremely cyclical industry that makes the fundamentals look amazing at cycle peak

You would look and see amazing growth selling for a PE ratio of just 15 or lower as it was the case during 2018 when the earnings were $8.14 and the stock price was between $150 and $100.

2 thor fundamentals

Source: Morningstar

However, then reality struck. Earnings halved, revenues declined and the company took a lot of debt to buy an European RV produces at cycle peak.

They did make $1.6 billion in operating cash flows in the last 10 years, but they also spent $927 billion on acquisitions not including the last acquisition.

cash flows

The acquisition and positive RV environment in the US allowed for nice growth. Investors usually look at the past and think the same story will continue, but it doesn’t have to be so. In a highly cyclical industry things change fast. The company’s last quarter shows a loss and if there are more troubles or costs from the recent acquisition, the decline in sales continues, we could see negative earnings for 2019 which would not make this look like a bargain anymore.

3 second quarter

I think the same story happened with TATA Motors, when many saw it as cheap with a PE ratio of 7 and a high dividend yield.

4 tata motorst stock

The long term chart of TATA is similar to Thor’s. The only difference is that the exuberance with THO was much shorter.

5 thor stock price

On the chart, many just look at the drop from $150 to $60 and invest on the hope it will go back there. If you look at a chart when you invest, please also look that the stock was trading around $50 from 2014 to 2016 which doesn’t make it look like a bargain. I get probably 10 emails per week about how this stock is cheap because it fell 50%, nobody sees that it went up 200% prior to that. Another trap unexperienced value investors fall into.

Is Thor a good investment now?

I recently listened to an interview with Howard Marks and he put is very simply. When investing you have to look at where we are in the cycle now. Nobody can predict the future but you can see where we are now.

The first thing is to look at inventories, and those are high with dealers.

6 inventory correction

Let’s take a look at the industry.

8 industry

Even if there is no sign of a recession, just the small increase in interest rates will lower sales by 20%. If there is an economic slowdown or if interest rates increase further, I would expect sales to drop another 20% per year for a few years. Interest rates increased from 4% to 5% and already sales dropped.

7 interest rates

Source: FRED

Plus, an RV is really a luxury purchase, one that can be postponed easily and when the market contracts there is also a lot of inventory to be dealt with. RV dealers go bust, fire sales can make the environment very tough. From 2006 to 2009 sales dropped 60% for the industry. I think we are now in 2007 for the RV cycle, the peak has passed and the growth turned into a decline. Those who wanted an RV, probably bought one in the last 5 years as the conditions were perfect, long lasting economic growth, low interest rates on investments, high stock levels, a lot of money etc. It is really a discretionary purchase.

Then, they made a big acquisition in Europe at cycle peak too. The environment isn’t growing, there is a lot of competition from glamping or from mobile homes crated by the camping sites and I don’t see a positive for RV in Europe in the long term.

9 europe

For example, German tourists used to buy an RV and go to Croatia for the summer. However, now, RV space is replaced with small homes already there. It is more convenient, similar experience and you don’t have to do a thing.

10 camps

On the bigger picture you can see how more than half of the camping site has been closed with these kind of homes.

11 camsp

So, we are in a place where the trends in the industry in the US are negative but probably still above cycle average. The average in the US will be around 300k units sold, still 40% down from where we are now.

In Europe the average will be 160k and declining but we are now at 200k. Forget about growth in Europe.

In the US, the management discusses 77 million households camping and how they should all buy an RV.

12 promise

But they forget that 500k units per year sold quickly brings you to 5 million that saturates the market soon as not all campers want to own an RV.

Plus, consumer confidence is usually at its peak in the late part of the cycle. When it declines, RV sales erode.

13 consumer confidence

When RV sales erode you need to have strong financials and no debt. THO didn’t have any up till the Hymer acquisition.

14 debt

Now the company has about $3 billion in debt which should cost them $150 million in interest per year. If I take 2015 as the average cycle year, the cash flows have been $200 million which makes it just $50 million now.

15 average cycle

Conclusion

I don’t see growth in Europe as the market is changing fast. Trust me, Europe is not the place to go around with large RVs and travel.

The debt is a certainty, there is high risk of firing back and then things get ugly as those are getting now.

What would be an average cycle price value? Let’s say $3 to $5 per share in free cash flows leading to a valuation between $30 and $50 from a value perspective. Want to buy it with a margin of safety? Then we are looking at a price below $20. Am I crazy? It was trading there in 2011, 2009 and 2003.

The conclusion – look at the long term average in the cycle for the company, this will give you a good indication o the value and the investment potential with a margin of safety. Remember, where are we in the cycle now?

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To Buy or to Sell Stocks with Crash Coming? Doesn’t Matter for Value Investors – Buy Value

I received this very interesting comment from a subscriber as I bought my 5th stock for my lump sum portfolio which is now 50% invested. So, I invested 50% of my portfolio over the last 3 months that might surprise people scared of the upcoming crash or recession.

stock market crash

I have 3 points to answer this question:

  • I can’t predict the future, nobody can

Nobody knows what will happen with the market, we have the last two crashes in our mind that were close to 50%, but that doesn’t mean it will happen again. Nobody, and I mean nobody knows.

  • A recession is always around the corner

There are recession predictions for 2019 and 2020, but the same could had been said in 2018, 2017, 2016, 2015, 2014, 2013, 2012, 2011, and especially 2010 and 2009. There are many out there that have been waiting on the side-lines since 2009 or they just got in in the last few years. No need to mention the missed opportunities.

For example, my largest position in January 2018 was Nevsun Resources.

3 nevsun

In January 2018 there were fears about China slowing down leading to a copper crisis etc., fears of a recession and market crash over the next two years with Ray Dalio saying there is a 70% chance for an U.S. recession. I would have been better in cash than investing in a copper miner, right?

Well, all depends on value, if you find it, even if a recession happens, your returns are delayed by a year to 3. The point is that if you buy value, you will survive those bad years and get ahead after the crash. So, I, as a selective investor, simply buy when I see value and when I am happy owning the business. It has rewarded me very well in the past no matter the possible crashes. And yes, I lost money in 2008, but it is not comparable to what I made from 2009 onward and from 2002 to 2008.

Index fund investors

For those who invest in index funds, just invest on a monthly basis, just dollar cost average and forget about stocks, don’t even think about it, you will get your returns whatever they will be, own your home, invest in another property, diversify and you will be well off. Your wealth doesn’t depend on the market, but mostly on you and you not doing stupid things like most did, I.e. selling in 2009 march.

3) Highest possible return long-term

I know if there is a recession my portfolio will get hit, but I also know that the highest possible return I will get is when I buy value when I see it. So, in good years I will have great returns, in a bad year, I don’t know how I will do. There is a nice passage in the book Margin of safety by Seth Klarman discussing how when you buy value, real value, it often offers downside protection as it is already depressed in price and the price can’t go much lower. All my current 5 stocks trade below book value, mostly tangible book value, have high earnings yield and potential. So whatever happens, I am a happy owner, owning assets and that gives me a margin of safety.

To explain in an easy way what margin of safety investing is, I’ll make the next video article apple.

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Stock Market Crash, Economic Collapse, Rigged Markets? How to invest rationally!

Good day fellow investors,

Last week I made the news on the topic how one should focus on the businesses he invests in and not so much on the macroeconomics.

I’ve got this interesting email discussing how I am missing many points:

Underlying factors that affect the metrics you used in your article:

  1. The role of the ESF in market ‘rigging’. – U.S. Treasury’s Exchange Stabilization Fund
  2. Stock buybacks from the new tax code (fudging the numbers you are working with).
  3. The key role the central banks are playing by keeping interest rates artificially depressed, thus not exposing the true cost of debt servicing.
  4. The sheer number of Zombie companies and historic high levels of BBB bonds.

Plus, how I should contact Peter Schiff, Gregory Mannerino and I would get quickly to 100k subscribers!

All the above is all correct, if I make a business analysis, I get 2k views, if I put stock market crash in the title, I get 4 times more views.

1 views

And in this article, I really want to put the topics of market rigging, buybacks, low interest rates, zombie companies into an investing perspective because I think there is a big difference between investing and protecting yourself from something that might happen but doesn’t have to happen.

2 keynes

When it comes to investing, the key is to achieve the best risk reward return and always remain solvent, no matter how irrational the market might seem.

Contents

Stock Market Fear and Irrationality

THE MAIN QUESTION IS HOW TO INVEST?

Market rigging!

Stock buybacks from the new tax code (fudging the numbers you are working with)

Artificially depressed interest rates

Corporate credit, zombie companies, government debt

How to invest keeping the risks in mind

THE MAIN QUESTION IS HOW TO INVEST?

One should think about HOW TO GET BOTH; good returns from businesses and protection from what might happen while taking advantage of possible market rigging. That is what I focus on and the message of this article is to try to give more balance to the possibly predominant message on YouTube regarding Stock market Crashes and Economic collapses etc.

We as investors have to focus on how to get the best risk reward return to reach our financial goals. Let’s say that gold explodes in 2034, I bet you that 98% of all those invested in gold at the moment, would not have the patience to wait till then to realize profits. That is one, plus, by 2034, if you have $1k now and you get a 15% return because you understand the market;

You know it is rigged,

You know buybacks are strong,

You know interest rates will remain low, or inflationary due to the huge debt,

You stay away from zombie companies, buy those that will do even better when the competition dissolves!

Your 1k become 8k thanks to the power of compounding, earnings and dividends that you don’t get if you buy insurance. Actually, insurance is a cost.

Let me put the things into perspective!

Market rigging!

The market has been rigged since ever – it is in the interest of most politicians, policy makers and people that stocks go up, pensions go up, everybody has more money, more confidence, spends more and even wages go up a bit – so it is in the interest of the current economies that markets go up, collaterals go down, and everybody is pushing for it to go up.

Take advantage of it.

On silver markets, gold markets, there are many speculators that make it look crazy and rigged because there is no rationality there. You can’t eat gold; no dividend and it doesn’t grow. In the 1980-s the Hunt brothers tried to rig the silver market. They owned 30% of global silver but regulations broke them.

Silver price:

silver price

Stock buybacks from the new tax code (fudging the numbers you are working with)

4 smart

Source: Reuters

$940 billion of buybacks expected in 2019, that is 3% of the market.

There will be ups and downs, but some buybacks are smart if made below book value, or replacement value or intrinsic value, and those values are in the eye of the beholder.

5 bubyacks

Source: Yardeni

Try to find buybacks that increase your value, your ownership and avoid those that destroy shareholder value. Compare many stocks and you will find the difference.

Artificially depressed interest rates

As long as it works, it does good in the short term while it is uncertain for the long term – again, as an investor you have to understand the game and play it wisely. The tide could change with a big inflation, but that is why I invest in businesses that would do well if there is inflation but that also do well in this environment. I get dividends, I get growth, expansion etc.

6 rate

Source: FRED

Corporate credit, zombie companies, government debt

Governments and corporations have increased their leverage as low interest rates allowed for lower borrowing costs. US government debt quadrupled in the last 20 years.

government debt

Source: FRED

However, this situation can be solved with inflation for the government and with bailouts for corporations. Plus, when zombie corporations finally fail, the environment will be healhier for good businesses. I’ll talk more about that in the next article discussing Archer Daniel Midlands (NYSE: ADM) where the CEO actually hopes for higher rates to limit the competition.

How to invest keeping the risks in mind

Now, what I just said, doesn’t mean I completely disregard it, I’m not stupid, I am not invested in companies that would go bankrupt in case interest rates go up, I am looking for both, both good businesses, that offer business returns and protection in case of any kind of crisis.

You have three options to invest your money!

The first option is to focus on protection: gold, put options, Treasuries (if you can call them protection). The second option is to focus on businesses, growth, business returns and investments.

Your $1k becomes $8k in 15 years with a 15% yearly return. If you own gold, and the dollar loses 50% of its value, you are at $2k, no dividends, no business, a lot of stress because you depend on what others are willing to pay, not on actual value.

I must say I did a lot of research on macro, especially when I was writing articles on a daily basis three years ago as that was my job, but my conclusion is, that one should be smart and take advantage of what is going on and not bet on something happening because it is logical to happen.

The situation was crazy in 2009, and many sold what they had fearing the macro voices, I was buying businesses in 2009, nice 5 baggers for me.

2 gdx

I took a loan 4 years ago, bought a house, and it was probably the best risk reward investment in my life. Fearing a crash would have me being without huge gains over the last 10 years.

The third investing option is to have it both. For example, a company I was heavily invested in 2018 was Nevsun Resources, a copper miner with a promising project in Serbia. However, what the market disregarded was that 30% of revenue from the project were from gold, not just copper. So, you can buy investments that give you a business return but also protection just in case some of the above mentioned risks materialize. I am now exposed to silver with my portfolio, but if you would take a look at my portfolio, you would never imagine it has a silver call option in it. That is because I like it both; give me business growth and give me the insurance part for free.

Think about it, although so rational, I reiterate my question, is it and will it actually be profitable to be scared or you should simply see how to get the best out of it all?

To put things into perspective, don’t focus on what should rationally happen due to text books or chicken littles, but put probabilities onto every conclusion. What will happen in the future is probably something unknown, be ready for it by investing in both.

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Prepare For A Currency Collapse

Good day fellow investors,

in the news last Friday, we discussed the earnings of various companies and how a long-term investor should approach those, check the video out if you haven’t. As promised, today we will discuss the economic environment, the FED’s shift in gears and how one should think about long-term investing in relation to what might happen.

I’ll explain how:

  • we are most probably going for a global currency collapse, that will happen sooner or later,
  • the economy doesn’t have to collapse, and
  • how stocks might better than other things.

Just before we start, I wish to thank you all for the great reviews on Amazon, we are in the company of greatness on the Amazon best seller list, with Nobel prize winners like Shiller, legendary investors like Lynch and great trading books like Market Wizards. I thank you all for your support.

18 books

The FED’s pause

Let’s start with the news, the last two weeks were filled with crucial news that is important to systematize and put it into context.

The key piece of information is the FED’s pause and change in rhetoric.

We can say the FED capitulated! The committee will be patient with rate hikes and adjust for whatever might happen.

2 the fed

3 new territory

Source: FOMC

Prior to the FED’s change in heart, there was this expectation that we are in for a global slowdown. After the FED changed its rhetoric, said they will pause to keep the economy up, stocks rallied after the bad end of the previous year.

So, a decline of 15% in the S&P 500 and a 100 basis points increase in the cost of borrowing for the US government, led the FED to stop with raising rates.

19 5 year trasury

Source: FRED

However, the FED capitulating means that the economy isn’t doing good at all because it cannot sustain small hikes!

6 end of cycle

Source: FRED

It is simple, corporations are too leveraged. US corporate debt has almost doubled over the last 10 years. The situation is similar across the globe.

7 coprorate debt

Source: FRED

Governments are too leveraged. Budget deficits are piling all over the place.

8 budet deficit

Source: FRED

Same situation across most of the modern world.

Now, you can tighten interest rates, but that will increase the cost of borrowing for governments, that will consequently force them to borrow more as no politician is going to save money and not spend.

Given the FED, ECB, BOJ and others are ready to do whatever it takes to keep things as those are, the only thing they know how to do is to give more of the same medicine, thus more debt.

NOW, let me make this simple – Q4 2018 – people were selling because of the FED, the economic data was good!

Q1 2019, people are buying because of the FED, the economic data is not that good!

2 truck orders

Source: Wolfstreet

3 italy recession

Source: Reuters

4 germany gdp

Germany

Source: The Independent

My conclusion is that there will be no more tightening, no more normalization because, over the last 10 years, politicians and central banks have seen that interest rates can be low and they are now like junkies on low interest rates.20 trump

Source: Twitter

How to invest and what to expect

I am looking at the data, I look at the FED’s and the politicians’ behaviour and I am thinking;

1) There will be more money printing, much more

The last recession unveiled a tool that hadn’t been really used before, it unveiled the possibility to use central banks’ balance sheets to help the economy. Before 2009, Central banks’ balance sheets had been mostly flat. After 2009, an explosion of money printing is what followed.

9 balance sheet

Source: FRED

We have already seen that governments and corporations went on a borrowing spree to take advantage of the low rates. As it is normal with both governments and corporations, there is never the intention to pay back the debt, their only goal is to make money on the spread between what they are earning from the capital used and the interest rate they have to pay. For example, Apple can borrow at an interest rate of 3% on a 10 year bond, if they use that capital and make 5% on it, they make a lot of money. Debt repayment? Don’t joke, you might kill someone with unstoppable laughter.

With governments, it is even worse. US interest expenditures had been stable as interest rates had been declining and stood low. However, as the FED started tightening, US interest expenditures exploded and given the current budged deficit, higher rates would make the payments unbearable. The usual definition of a Ponzi scheme is when one has to borrow just to pay the interest on the debt.

If interest rates increase by just another 100 or 200 basis points (1 or 2%), the interest payments of the US governments would make most of the budget’s deficit and would force the government to borrow to pay interest expenses.

10 government payments trasury

Source: FRED

What does this mean for the long-term? Well, the FED can control rates until a certain moment, at some point it all breaks down like a house of cards. Interest rates go up because who wants to lend money to a government or corporation that is borrowing just to pay the interest, inflation creeps in as people want to spend their money and the FED has to hike to stop the inflation while still printing to save the economy.

2) Be a debt owner, not a debt holder

Debt holders are the suckers, thus all diversified portfolios like my friend’s portfolio with an investment bank is, will see their values erode. Do you know that in the 1970s, bonds were called certificates of confiscation as inflation would eat up most of their yield?

news portfolio

Source: $13 Million Dollar Portfolio Analysis

Or, any other pension fund in the world will be in trouble too. While working in the Netherlands I did have a pension fund, ABP, where the top investments are government bonds, of course.

11 pension funds

Source: ABP – Dutch pension fund

3) Stocks might do well

However, the situation gets tricky with stocks as those are businesses and businesses, the good ones can transfer price increases, i.e. inflation to customers. A good example is the Argentinian stock market. From February 2008 the Argentinian stock market increased 17 times.

12 argentina

And you thought the S&P 500 did well?!?

However, the Argentinian Peso did almost the opposite against the dollar.

13 peso

So, prepare for a currency collapse down the road. It might happen tomorrow, it might happen in 2029. Whenever it happens, if you are not prepared, you are the sucker and you might lose it all.

4) The world will continue spinning

People often forget that the world will go on, the currency environment might be different but emails will still be sent. The cost might be different.

A good illustrative example is a normal postal stamp in Italy. The price in 1958 was 25 lire while in 1998 was 800 lire.

16 italy 2

The current price is EUR 0.95, thus 2000 lire. So, over 60 years, the price of sending a letter in Italy increased 100 times.

17 current price

The problem is that it will not be linear, it will be explosive so that will take many by surprise most. What to do? Well invest in great businesses, we will talk about one tomorrow, Disney, you can invest in commodities, we will talk about that on Monday with zinc, Glencore, Teck, Anglo American and you can make money on inflation, or at least stay protected as we discussed in the video on inflation this week.

My focus now is on businesses we can’t live without. That will give me protection over the long term, looking at margins of safety and healthy business returns.

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InterContinental Hotels Group Stock Analysis – Overview, Valuation And Investment Approach

  • A company that has seen its ordinary dividend increase 11% CAGR over the last 15 years, must be something special and well worth watching.
  • Asset light businesses are taking over the world due to their high margins and high returns on capital.
  • However, you have to buy them at a fair price. We discuss the expected investing return in relation to the stock price.

InterContinental Hotels Group (NYSE: IHG , LSE: IHG) is a stock that did very well over the past 10 years.

IHG stock price chart

The reasons for such a good performance lie in the high levels of free cash flows the company has been able to generate, its dedication to rewarding shareholders, ordinary dividend growth, industry tailwinds and many special dividends asset sales.

Given the asset light business model and positive long term industry trends, one could assume the growth to continue in the future. The free cash flows are used not only to reward shareholders, but also reinvested with a high return on capital. This is a characteristic only great businesses have. To quote Charlie Munger:

It’s obvious that if a company generates high returns on capital and reinvests at high returns, it will do well. But this wouldn’t sell books, so there’s a lot of twaddle and fuzzy concepts that have been introduced that don’t add much.

In light of the above, I have analyzed the company and summarized my findings in the video.

Video content:

1:10 Company overview – business model, strategy, debt, shareholder orientation

7:12 The industry

8:00 Investment perspective and strategy

If you like this approach to investing; focused on great businesses but patient for opportunistic entry points, please check my Stock Market Research Platform.

Brexit – An Objective Investing Perspective

  • Politics aside, it is important to have a clear investing perspective on how can our portfolio positions be affected by Brexit.
  • For now, markets are pricing in more pain for Europe, than Britain.
  • There are some stocks that should be avoided and some that shouldn’t be impacted at all, on the contrary.

Brexit is a very hot topic in Europe nowadays. However, it is important to separate your investing perspective from whatever might be your political views. I sit down with Niche Masters Fund with head investment manager, Peter Barklin, and discuss his very interesting, objective investing perspective, on the potential implications of Brexit for us as investors.

Just as an interesting note from the video, European stocks (VGK) (IEUR) have been hit harder than UK stocks (EWU). This shows that the Brexit isn’t just all bad for Britain and that we must carefully weigh the pros and cons.

Video content:

0:00 Introduction
1:40 Brexit for investors
3:27 What to own
5:08 Brexit benefits
7:04 Brexit and Europe
10:05 Portfolio positioning
11:29 Brexit risk perspective

Enjoy the video.

www.nichemastersfund.com

Sven Carlin Research Platform: https://sven-carlin-research-platform.teachable.com/

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Stock Market News – The FED, Interest Rates and How to Invest

Good day fellow investors,

The news this week was all about the FED as the FED’s chairman made a speech and their meeting minutes came out on Wednesday. The market reacted extremely positively to the news and new rhetoric.

1 s&P 500

Up 1.55% on Monday, 2.3% on Wednesday.

Something very important it that we have to always do is to differentiate between the FED’s rhetoric and what they will actually do. As we have seen this week, what the FED says has a big impact on markets and changes the economic environment.

So, the FED must be very careful about what and when it says something. Let’s give a quick overview of what has been said and what has been done and then discuss and explain the implications of it.

The topics:

  • Powell’s dovish speech
  • FED’s meeting minutes
  • Economic data
  • Investment risk reward outlook

On October 3 2018, Powell said the following:

we’re a long way from neutral at this point, probably.

This week he said this:

interest rates are “just below” a range of estimates of the so-called neutral level

And this is very important for asset values and the economy! Let me explain:

Everything starts in the economy based on where interest rates are.

2 20 years interest rates

Source: FRED

Why is this so important for the economy and asset prices? Well, first about the economy. People have unfortunately already a lot of debt, be it student debt, mortgages, car loans or credit card loans. Now, if interest rates go up, debt becomes more expensive and consequently interest payments rise and there is less money available for spending.

For example, I have plotted the 30-year mortgage interest rate against the FED’s funds rate.

3 mortgage rate

Source: FRED

You can see how if follows the FED’s rate but what is important is that since the FED started increasing rates, the 30-years mortgage rate went from 3.5% to the current 5%. This means that the cost of a mortgage increased 42% which is huge.

The following chart shows how closely correlated those things are.

4 mortgage rate

Source: FRED

Now, why are Powell’s words so important. Because he now said the neutral rate will be closer to the current level of 2% than what was previously expected, closer to 4%. That 2% difference in the normal rate, makes the difference between a 5% mortgage and a 7% mortgage which is an enormous deal as people have more money to spend elsewhere and the economy doesn’t suffer.

Why did Powell change his rhetoric? Economic data

A look at the FED’s minutes show how they are watching what is going on and allowing for flexibility.

Concern on debt, leveraged loans.

11 debt

The last economic date has been showing weakness signals and therefore the FED changed their rhetoric not to lead the economy into a recession immediately as they usually did in the past. To say it again, when the FED increased rates, usually a recession followed.

The economic data came from various sources.

Home prices have slowed down in growth.

6 home growth

Source: WSJ

Why is this so important, because the economy is based on debt and asset prices going up, a decline in home prices would quickly lead to a 2009 situation.

But, perhaps the most significant information related to the economy is the following.

GM is cutting jobs in order to prepare for a slowdown in the cycle. You can do whatever you want but you can’t fight market cycles.

closing

Even the extremely bullish IMF downgraded its global outlook.

7 global downgrade

Source: Bloomberg

Also, something that summarizes an economy, are business equipment orders, not growing despite the tax cuts and stimulus.

8 equipment orders

Source: Bloomberg

How to invest in this environment?

Now, with everybody yelling that the FED will start the next recession, the FED is changing its policy to not be the one starting a new recession, what happen in the past will not be the next trigger, it is always something new.

Nevertheless, by lowering the normal rate, the FED is going along with the populist policies across the globe as you cannot be the only idiot tightening. So, things will be going along as they are going until they stop going and currencies go to hell. Be careful when owning bonds and business that cannot transfer price increases to customers and business that are alive just because of low interest rates.

For example, car manufacturers in Europe that can borrow at 0%:-)

I am investing in commodities, good businesses that will survive cycles and inflation.

On the economy

It is clear that it is so dependent on stimulus, both fiscal and monetary and that is how it is. One day, the FED and politicians will lose control because they are not allowing for a natural cyclical economy A recession is good as it eradicates the bad. However, bankruptcies are at historical lows.

9 us bankruptcies

Source: Trading Economics

Lower interest rates will make it easier to pay off debt, but we are just postponing the inevitable and making it harder down the road. One day, inflation will knock on our doors, be ready, be hedged and have a long-term mortgage again if the opportunity knocks with a 3.5% 30 year mortgage.

Keep reading, we will simply continue with what we do on this blog, looking for great businesses that are going to do well no matter what happens in the economy and we are going to look for value across the globe and buy when we find it but we will always keep in mind the risks out there.

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