Newsletter May 29, 2010

InvestorsFriend Inc. Newsletter May 29, 2010

Do You Buy Shares in Companies or just Squiggles on a Chart that you hope will squiggle higher soon?

It appears that most investors, even large investors, don’t really think of “shares” as representing a part-ownership in a business.

After all, these investors are not hoping to make their money by holding their shares for many years and collecting dividends and benefiting from their fair share of the companies’ earnings.

These investors simply to hope that the shares will go up in price (the sooner the better) so they can sell at a profit. And they don’t seem really understand or even care about the reasons that the stock price might go up. They just want the price to go up and right now too.

And why do investors think that way?

Well, in part because it’s easier to think that way. It’s a lot easier to buy a stock based on a stock-price chart that seems to be rising than it is to think about or calculate or research how the stock’s price actually compares to its current and expected earnings.

It seem like at least 99% of commentary on financial television shows is about the trend of the stock price, not the fundamental value of the stock. You will rarely if ever see a chart of earnings per share growth.

When earnings are discussed, it is only as regards the very immediate reaction in the share price. The long-term trend in earnings is seldom mentioned. What about return on equity? it’s not a term you will hear very often even though it is at the essence of corporate valuation.

Ultimately it is a sort of group laziness that leads people to look for advice about a stock’s likely future price in the entrails or squiggles of a stock’s price history rather than looking at its earnings prospects or even its earnings history.

How should investors think about stocks?

Investors should think about stocks as what they are; ownership shares in corporations. Investors should think about the value of a share and its future price as being related to the future earnings and dividends of the corporation. They should think of themselves as share owners and company owners and not as mere share holders (the very term share holder seems to suggest it will be a temporary holding).

Is anyone Interested in the fundamental statistics of a stock such as the price to earnings ratio, the price to book value, and the dividend yield?

Well certainly some of us are, but we may be a small minority.

The other evening I was updating my valuation analysis for the Dow Jones Industrial Average (DJIA).

Bizarrely enough, I was unable to find the full Statistics for the Dow Jones Industrial Average on the Dow Jones Site itself. The Site requires users to register for a free password and I have one. Those Statistics have always been there in the past including P/E ratio (trailing and forward and based on both GAAP earnings and and adjusted earnings with negatives removed), and including Dividend Yield and Price to Book Value. And there is no indication that even under the paid section of the Dow Jones Site that these figures are there any longer. They are apparently just gone! Clicking fundamentals for the DJIA they give some fundamentals but the last update was some 15 months ago!

I then did some Google searching for the current DJIA P/E and yield did not really find what I wanted but did find enough to get by with for my update.

To me this is truly bizarre, the Dow Jones Industrial Average is one of the most watched stock indexes in the world. The change in the Dow is dutifully reported across the world in many thousands of newscasts and financial publications. Can it possibly be the case that there is not much interest any more in the earnings of the Dow that actually drive the level of the Dow? Is 100% of the focus these days on the level of the Dow with no real interest in the earnings that ultimately drive the level of the Dow. Has the whole investment world gone mad to the point where they think that the level of the Dow is really just a popularity contest? Yes, that does seem to be the case.

What are Some of the Implications of This?

Increasingly even institutional investors have drank the Kool-Aide of (so called) Technical Analysis. (It’s beyond me, what is “technical” about looking for patterns in squiggles).  They all study price charts looking for patterns instead of looking directly at the earnings and fundamentals of companies and stock market indexes. This means stocks will be increasingly mis-priced. There are and there will continue to be bargains and extremely over-priced stocks. There will be volatility. All of this is fantastic news for more intelligent investors willing to view stocks as part-ownership in businesses – who understand that stocks have values based on future earnings and that this value can be roughly estimated – and compared to the current price in the search for bargains.

What about market manipulation? Well bring it on! If it exists it too drives stocks away from their true values and creates opportunities.

By-the-way, the companies you own shares in don’t think of you as owners either. I occasionally email a company and I always indicate if I am a share owner (I use the term share owner not share holder). Often the response concludes with  the thoughtless and insincere looking line “Thank you for your interest in (company name)”. That bugs me.  I feel like writing back and pointing out that I am not some outsider merely “interested” in the company, I am an owner. I feel like then thanking them for being part of our company’s “hired help”. But hey, if investors don’t think of themselves as owning anything more than a squiggly line on a chart that might go up in price, I guess why should these companies think of investors as being actual owners?

If you are interested in selecting shares of companies to buy (based on earnings and value, and not based on squiggle analysis) you can access our Stock Picks for a nominal cost by clicking this link.

Or, if your prefer to invest in Exchange Traded Funds – again based on earnings and not on squiggles – you can access, free of charge, our Summary Table of Canadian Exchanges Traded Funds. This is the most useful reference document for Canadian Exchange Traded Funds that we know of – we have not seen anyone else even attempt the job.

Has the World Consumed Beyond its Means and Used Debt to do it?

There can be no doubt that many individuals have consumed well beyond what their incomes would allow and they did it by going into debt. Paying back that debt can be expected require a period of consuming well below what their incomes would allow.

Many commentators have stated that in affect the United States as whole has used debt to live beyond its means. Citizens a a whole have done it and so has the U.S. government, they say. And not just the United States, other guilty countries include, they say, Japan, the United Kingdom, Greece, Ireland, Italy, Spain, Portugal and others. A whole world of debt.

But that leads to the question:

Is it possible for the entire world to be in a net debt position?

It seems obvious that the answer is no, the world as a whole can’t be in a net debt position. After all, no money has been borrowed from sources off this planet. Clearly every dollar owed by an individual or a corporation or a country is owed to some other individual, corporation or country. And it nets to zero.

That does not mean it’s not a problem, but it would be a bigger problem if somehow the whole world was in debt on a net basis to the Martians or something.

Another related question is:

Is it possible that the world has been consuming more than it’s really capable of producing and paying for? More houses, cars, food, energy , and entertainment than it’s capable of paying for?

Although it seems like a lot of commentators assume the answer is yes, in reality the question almost answers itself. Of course the world did not consume more than it produced. Countries can do that by importing, but the world as a whole is not importing anything (except sunshine, which is free).

It is however, possible that the world was consuming more that it is capable of sustainably producing in the, long run.

For example, it is clear that some of what we produce and enjoy comes from the use (or exploitation, if you prefer a more loaded term) of non-renewal fossil fuels.  So we can consider the use of non-renewable fossil fuel and other non-renewable to be a large check mark under the column of unsustainability.

When it comes to cars and food and entertainment we pretty much consume as we produce and so that looks sustainable.

What about all the buildings and roads and power plants and power distribution and communication networks? With all of those it seems clear that the world as a whole consumes less of those than we produce each year. We continually invest in additional and improved houses and roads and power plants and distribution networks of all kinds every year. We could stop investing and just consume what we have and let these things “run into the ground”. But we don’t. We invest more than we consume every year.

According to statistics Canada data, in Canada, some 21% of GDP is plowed back into investing as opposed to consuming each year. That seems like a huge rate of “savings” that never gets talked about.

Overall, I would argue that the condition of the world as a place for humans to live is improving year after year and has been for thousands of years, with no end in sight. Even on a per-capita basis this is the case. The average quality of life on this planet has never been better and is on track to continue getting better every year. Human investment in long-lived improvements and knowledge and technology is the reason.

From this point of view any notion that the world as a whole is in debt and has borrowed from the future, that it is exploiting its resources without investing for the future, and that our children will be forced to pay back our collective debts is utter nonsense.

Today is in fact the best time in history to be born, and tomorrow will be even better.

And it’s a darn fine time to be an investor too!

END

Shawn Allen, President
InvestorsFriend Inc.

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