Newsletter November 24, 2001

November 24, 2001 Newsletter

Scroll down and Ignore the shaded bit here which is very dated and no longer applicable.

Updates:

Enbridge – returns to the Site as a Buy
Sino-Forest – Maintaining the Strong Buy rating but only for a long-term investment
Boardwalk – should eventually rise with its rents, good value
Stantec – Great company, but seems near full value
Pason Systems Inc. – Raised to a strong Buy on increased earnings and share price decline. Some short term risk due to energy patch decline in drilling but excellent long term value.
Loblaw – Weak Sell / hold – great company but seems over-priced.

For members only:

CAE – My analysis would say don’t buy at the recent price of $11.35

Research for sale:

Last week, for the first time, I offered a new research report for sale. The response was very encouraging. I don’t have anything new for sale yet, as I prefer to wait until I have a new “strong buy” company. If you have not already purchased the report and are interested in doing so, link to For Sale.

Be assured that most of my research will continue to be posted free of charge. My main goal at this point is to continue to build the membership.

Companies and Cows:

I divide companies into three cow categories.

1. Cash Cow companies. These pay a very good dividend but may not grow much in value. Like a Dairy cow, you have to feed it, but it gives off a steady stream of milk.

2. Growing Cow Companies. These don’t give off any immediate pay-out but you expect fast growth. Like a beef calf, you have to feed it, it does not give any daily return of milk, but eventually it fattens up and you sell it to market. This includes also research and early stage companies.

3. Sick Cow Companies. Companies stuck in poor industries. For various reasons like cheap imports or stiff competition or poor management, these companies pay little or no dividend and generally shrink in value over time. These are the turn-arounds that don’t. These companies are typically whining for the government to protect them from imports or otherwise give subsidies. Like a very sick cow that keeps on eating but refuses to ever die. It just keeps costing you money. This of course, is the type of company to avoid like the plague.

Types of Companies:

In terms of companies I demand either good current profits or a demonstration of very strong growth. If a company can give neither profits nor growth, I want nothing to do it. The one possible exception is an early stage research type company. These may have no sales yet. So, they can’t demonstrate profit or growth. Fundamental Value analysis is essentially useless on these stocks (except perhaps for checking if the company has enough cash to avoid bankruptcy). I leave these companies to other analysts since I have no particular ability to analyse them

POINTS TO PONDER

How much money is “in” the Market ?

I have money “in” the market and so do you, right? Well, actually the money that we paid for stocks on the market actually went immediately to the seller (less commissions), it’s not really “in” the market.

The answer to how much money is “in” the market, is zero, the market is a trading room, not a bank, it holds no money.

Cash on the Side-Lines?

I hear a lot about money “on the side lines” or “in money market funds”. The theory is that if this money comes into equities then it will drive the market up. Well, maybe it will.

But consider that if that money is used to buy stocks, then the sellers of those stocks will end up with that same cash (less commissions). The money goes “through” the market not “into” it. The money comes out the other side. Presumably the sellers of the stock now have cash and will want to spend it to get back into stocks. Some will find stock prices too high and will hang onto the cash or spend it elsewhere, others will buy stocks. So we will have another (but reduced) round of increased stock prices as some of the original stock sellers bid for new stocks to replace their equity position.

It seems like a virtuous circle, the same money changing hands through the market a number of times with stock prices being bid higher each time. The commissions paid to brokers and the higher stock prices act as friction to insure that the same money cannot slosh back and forth through the market forever. The ripples quickly die down.

To the extent that some investors have money on the side lines in money market fund, another group of investors are short the same amount of cash (less commissions) that they would have received had that sideline money gone into equity funds and been used to purchase equities from other investors. In total it’s hard to see where there is really any net extra cash on the sidelines through this process.

But, some of that sideline cash would have gone directly to companies (rather than to other investors) through share sales and IPOs. To my way of thinking, it is the reduction in IPOs and company share offerings that represents the only true net cash on the sidelines.

Even if there is cash on the sidelines, I don’t think it will have that much impact on share prices when it is switched to equities. In the long term stocks trade based on the value of expected earnings not based on supply and demand or scarcity value like some Gretsky rookie card.

How the Stock Market creates and destroys wealth in an instant.

Imagine there are 10 million shares of company XYZ which last traded at $10. The holders of these shares have a total of $10 x 10 million = $100 million in wealth tied up in these shares. Now imagine that on a certain trading day just 1000 of these shares happen to trade hands at $12.00. The total trade is 1000 x 12. = $12,000. Now the holders of $100 million shares can look at their monthly statements or computer screens and see that their shares¬† are “worth” $12. Their total wealth is now $12 x 10 million = $120 million.

Look at what has happened, a $12,000 trade has boosted the price to $12., and created $20 million in wealth! So where is this pot of money? The truth is it is nowhere, it was created out of thin air. Since the stock traded at $12, the theory is that the present owners of the 10 million shares “could” get an extra $20 million if they sold their shares at $12 instead of at the previous days $10. But that ‘s a hypothetical transaction.¬† The extra $20 million exists only on paper. If the company is truly worth the $12, then we have no problem, but if the rise to $12 was the result of some false rumor or false expectation then the stock is not really worth the $12. and will soon fall.

This example is a bit extreme, but a similar phenomena happens every day on the market. A small number of shares trade hands, and sometimes the stock price rises substantially, and this sets the price that we all use to count our wealth for the total number of shares. A $100,000 in trades can easily create millions in new wealth.

There’s nothing sinister about this, it’s just how the market works.

It works the same way on the way down. A small volume of shares trading at a lower price can wipe out millions and even billions in wealth. The money literally disappears back to where it came from which is thin air. A few people get out by selling their shares, but only if other people buy their shares for real cash. When a company with 100 million shares suffers a price decline from of just $1.00, $100 million in wealth literally disappears from the economy.

Radio commentators report that investors withdrew their money from the oil sector last week. Well maybe a few did, but they were replaced by those who bought their shares. In aggregate, investors as a population cannot withdraw money from a sector and when stock prices rise, new money (or wealth) is created out of thin air and when stock prices fall wealth is destroyed and disappears.

It may sound magical on the way up and brutal and sinister on the way down but this is how the market works.

The only real money that goes into a sector is when the money goes directly to the company in a share sale by the company. Real money comes out of a company when it pays dividends.

Trading shares in the market causes real money to change hands and causes the creation and destruction of paper wealth. The paper wealth can be exchanged for real money at the trading price of the shares, which constantly changes up and down, creating and destroying staggeringly large gobs of paper wealth. The paper wealth far exceeds by thousands of times, the daily real money flow through the market that is used to value the paper wealth.

It all sounds rather scary, but as long as we avoid cases where the stock market price is well above the “true” value of the company based on it’s true earnings potential, we should be okay. It’s fine to hold wealth created out of thin air, but under-pinned by a solid company, but we must avoid cases of wealth created from thin air and supported by nothing more than hot air.

Next Newsletter:

For next time I hope to research and find a new Strong Buy company.

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Regards and thanks for your interest,

Shawn Allen
Editor
investment-picks.com
(now investorsfriend.com)