Newsletter June 26, 2004


With this issue of the newsletter I introduce a new format to try and standardize the topic areas to address in each issue. In this issue I will address topics under each of the following headings.

  • Featured Industry Segment for Investment
  • Analyst’s Corner (Tips and tricks for analyzing stocks)
  • Trader’s Corner (Tips regarding trading strategies)
  • Politics and Business Editorial (who will you vote for…)

Featured Industry Segment for Investment

Peter Lynch author of the famed 1989 investment book “One Up on Wall Street“, counsels that ordinary investors can “beat the Street” by keeping their eyes open for new consumer service companies that consumers are beating a path to.

One consumer segment that I see as being “hot” is casual dining. Normally, the restaurant business is a great way to lose money. If you want to lose lots of money a good way to do so is to start your own independent restaurant. A banker I knew said that the percentage of money that his bank would lend to a an independent restaurant business was zero.

However, restaurant chains are a whole other matter. In my City chains like Montanas, Kelsey’s Swiss Chalet, Boston Pizza, Earls, East Side Marios, Red Lobster, Olive Garden, Tony Roma’s, Joey Tomatoes, and others all seem to be packed.

Some of these are national chains and some are small regional chains. They have a few things in common:

  • The atmosphere is casual
  • Staff are young, attractive, energetic and outgoing (they are hired for attitude first)
  • Prices are not rock bottom but are not outrageous
  • Portions are generous and there are refills of soft drinks and tea/coffee
  • Kids meals are very reasonably priced and include a drink and desert for one price
  • Service is fast, tables are turned over reasonably quickly
  • For the most part, reservations are not available (ties up tables)

My experience is that most households are eating out at these restaurants with sharply increasing frequency.

Young adults raised on McDonald’s have made the transition to these restaurants.

A number of other restaurants are on the way out. These include most independents which usually suffer from inconsistent quality and service, poor staff training, and poor staff attitudes. Buffet style restaurants are out as consumers want quality rather than quantity and gluttony. Fine dining is out because people really don’t want to go places that make them feel uncomfortable and offer small portions and high prices. A few very high end places will always remain but for the most part fine-dining is not a fine business.

For investors, not all restaurant chains will be good investments. But I believe that some very good, steady investments will be found in this segment.

Analyst’s Corner (Tips and tricks for analyzing stocks)

One of the hall-marks of a great company is that it has some competitive advantage that is very difficult or impossible for competitors to match and which allows it to make high returns on equity for a sustained or indefinite period.

The antitheses of a company with a competitive advantage is a company that sells an easily replicated commodity type product and for which there is no barriers to entry and no cost advantage.  Extremely pure versions of this may be rare but may include many retailers who sell the same products as their competitors. Every business that faces strong price competition, to the point where the adequacy of profits is imperiled, is to some degree the opposite of a company with a strong competitive advantage.

There are many different examples of strong competitive advantages. This can come from patent protection, proprietary and secret recipes, production process, a strong reputation for quality and service, a very low cost structure or other means.

For investors some of the best opportunities may lie in finding companies that have very strong competitive advantages but where the market has not recognized this fact.

It occurs to me that one source of hidden comparative advantage lies in a company’s culture and energy levels. Some companies are just constantly more on their toes and on their games than other companies.

As a simple example, I have had occasion to request an annual report and related data from at least 50 companies in the past few years. The response has ranged from almost instant to no response at all, or an incomplete response after two follow up emails or calls. It seems to me that the slow responders are not on their games and that the same attitude likely permeates their organization.

I had occasion to apply for an increase in an existing life insurance policy and it took over six months and several follow ups to get them to take my money. This company was not on its game.

Sadly, I have found American companies to be much more responsive than Canadian companies. For example, I have emailed the National Post’s editorial email address several times and never received the courtesy of a response. In contrast I called a senior columnist at Fortune Magazine and she called me back within 24 hours leaving messages on both my home and work voice mail. I attended Warren Buffett’s mega annual meeting in 2003 where just one American Express agent handles most of the trips booked through American Express. This young lady was amazingly responsive when I had to make a few calls to her. I emailed Hulbert’s financial digest in the U.S. and the owner and a staff member both got back to me within 24 hours. It seems clear to me that Americans have generally been trained to be more responsive than Canadians. I know of some companies that have a culture where top management keeps employees busy doing all kinds of internal projects and presentations for top (mis)managers while customer service is all but forgotten.

When you come across a company that seems particularly responsive and friendly to your needs and which exudes high energy then you may have found a company with a competitive advantage. If the share price does not yet reflect that, you may have found a strong value stock.

Traders Corner

In most takeover offer situations, it is reasonably clear that the offer will be accepted and there will be no increase to the offer price. In this case an investor holding the stock is faced with several choices:

1) Sell at the market which is typically a bit under the take-over price. This gets you your money faster for immediate redeployment.
2) Instruct your broker that you accept the offer. Now, you know the price you will get, but it will often be two to four weeks before you get the money.
3) Enter a sell order at some price above the market hoping that you will get a bit of a premium. If this does not work you may find that you will ultimately get the take-over price as the company will be legally allowed to force you to sell if they get over about 90% of the shares. The problem is your money can be tied up for some months.

I have normally picked “door number two”. But on several occasions I have seen the shares subsequently trade somewhat above the take-over price. Recently I tendered my BW Technologies shares to the $36 offer price, for a nice gain. The company reports that it took up the offered shares on June 14, and I note that there was no trading that day. Trading in the few weeks after the takeover bid was made and up to June 14 was pretty well flat-lined at just under $36 as you would expect. However, YAHOO shows that the stock traded for two days after the takeover on June 15 and 16, and the price was mostly over $37 with one trade at $39.50.

I therefore was thinking that I had “left some money on the table” here and that maybe instead of tendering my shares I should have entered a sell order for about $37 to try and get a premium. However, in reviewing the trade data on YAHOO, I am not convinced that I had much chance of getting $37. There was only a very tiny volume of shares traded above $36. I am not really convinced that this is reliable data. I am perplexed too at why the stock had no trades on the takeover date, June 14, but apparently had some limited trading on June 15 and 16 and then must have been halted.

Based on this it still looks to me like the best option is to tender your shares to the offer, as long as the shares are not trading above the offer on the market. However, if the company should increase its offer, I assume (but I am not certain) that you would not get the higher price since you tendered at the lower price. Also you miss out on any chance to sell above the offer price, if for some reason the shares begin to trade above the offer price. So, if you are not in a hurry for the money perhaps you could enter a sell order somewhat above the offer and you might just get lucky.

I’m sorry that I can’t be more definitive here but there always seems to be a few mysteries in the market. I would be interested in reader insight on this topic and will report any feedback in the next newsletter.

Politics and Business Editorial

Investors will benefit from an understanding of how politics and business affect corporate profitability. Given the looming election on Monday, this topic will be unusually large this issue.

To cut to the chase regarding this election…I am voting conservative… because I think a conservative government will be in the best interest of myself and of most Canadians. Martin had a good run as finance minister under Chrétien, but now he must live with the Chrétien legacy. And Chrétien may not have been that bad but there were some real boondoggles and anyway it is truly time for a change.

  • We’ve Got it Pretty Good…

Notwithstanding the bleatings of over-zealous environmentalists and doomsayers, we have got it really good. We live in a country of staggering plenty and convenience compared to the world of even just 50 years ago.

When it comes to the basics, I think it is safe to say that well over 99% of Canadians live in warm safe houses with electricity, a telephone, television, and indoor plumbing. And a huge percentage also have dishwashers and multiple bathrooms.  Just 50 years ago many rural houses were heated with coal stoves and more than a few had no indoor plumbing. House fires were not uncommon in those days. Two-car families would have been a rarity.

The great majority of Canadians today live in houses where there is a car for each adult. (Certainly this is true in the vast suburbs, although perhaps not for apartment dwellers). People tend to live in houses with 50% more square footage of those they grew up in and with 50% fewer occupants. Houses are stuffed with electronics that were hardly imagined 50 years ago. For those with children a mini-van or SUV is almost obligatory just to haul home the booty from the mega grocery stores, Cosco, Home Depot etc. Anyone who claims that the standard of living is not rising steadily for the average Canadian has got their head in the sand or is looking at the small percentage of the population that, sadly, has not been able to fully participate in the economy.

  • Survival of the fittest versus equality and human dignity

Governments need to walk a fine line between ensuring people who work harder and smarter are rewarded with a higher standard of living but also insuring that the gap between the rich and the poor does not get too big.

I suspect that a completely free enterprise, survival-of-the fittest system will lead to the largest amount of goods and services being produced but would also lead to unconscionable disparities. Without free enterprise and reward for effort, people would work and produce less. Basically there would be a lot less “pie” to argue about dividing up. But this type of system can go too far. In the case of company executives and sports stars being paid in some cases well over $10 million per year, it may have already gone too far in those cases.

But changing to a “fairer” distribution of income is very dangerous since there may be a lot less “pie” to go around if we do that. The socialists among us argue that all humans have a “right” to basic food, clothing, shelter, and medical care. But they don’t seem to realize that if everyone were to avail themselves of that “right”, there would be no one left to work hard and produce the food, clothing, shelter and medical care.

I tend to think that our current system in most cases is in pretty good balance. I don’t want to pay taxes if the money is wasted. But I don’t mind paying reasonable taxes to support defense, certain public works, police and legal systems, supports to children’s education, assistance to low-income parents, public healthcare, support for those physically or mentally unable to work, world poverty elimination and similar worthy causes.

I see little evidence that taxes at this time are so high that people are cutting back on work and effort because “it’s not worth it”. Marginal income tax rates have been reduced and high income earners do get to keep a large share of each extra dollar earned.

Sadly, one area where taxes do create a large dis-incentive to work is for people on low incomes. Those on Welfare may be reluctant to earn a few dollars because it will often be taken off their benefits, dollar-for-dollar. For families earning between about $25,000 and $45,000 total marginal tax rates including loss of child tax benefits, GST credits and other programs are criminally high. (I am talking about effective marginal tax and benefit loss rates often over 60% and sometimes 100%). It is really true for these people that it is very hard to get ahead. In some cases it can be almost futile to bother to try to earn more money since a huge percentage of any extra will be lost due to extra taxes and reductions in government benefits. This is criminally stupid and needs to be changed.

So in this respect, I do have a social conscience but I also think that in some areas we need more free enterprise and more reward for initiative.

  • User Fees

I am in favor of more user fees (but they must be offset them with reductions in general tax levies). We all like to get something for nothing. But deep down we know that “free” goods and services from the government are not really free – someone is paying. And most free items will be wasted to some extent. People water their lawns less when they have to pay for it…

I would love to see gasoline taxes dedicated strictly to the costs of maintaining roads, the costs, if any, of dealing with exhaust pollution and even to the costs of subsidizing mass transit. When someone else takes the bus, there is more room on the road for my car and I am willing to subsidize mass transit in order to reduce road congestion. (Call me selfish, but remember selfish free enterprise is what drives our economy and creates our world of plenty). Also I use the Bus as my emergency system when my car is in the shop. Therefore I should indeed be subsiding the existence of the bus. Once all these costs are included in gasoline taxes, we will essentially be paying what I call a “fully compensatory” fee to drive our cars. Under that system I then think it is no one’s business if some people are driving huge gas guzzlers because they will be fully compensating the world for the costs they impose in roads, pollution and congestion of roads.

Private Schools – Right now in most provinces, private schools receive some funding per student from the province to represent the costs that the government would have paid if the kid was in the public school system. This seems logical but could lead to the neglect of public schools if the rich and powerful no longer send their kids to public school. The neglect will be due to loss of economies of scale and due to loss of political leverage. My view is private schools should get no provincial funding at all. Make it fully user pay.

Private Health Care – We will and should have more private medical clinics. It ought to be a fundamental right of people with money to purchase any medical care that the public system can not provide. But again, absolutely no government money should subsidize private clinics. But the public system should be free to pay for patients to attend private clinics if that is cost effective for the public system.

  • Leisure Time

It is well known that the predictions in the 1960’s were that by the 2000’s, people would be spending a lot more time on leisure and a lot less time working. In fact, what has happened is that people are spending a lot more money on leisure but probably less time.

People are actually mostly working harder and longer and that is because there is a lot more goods and services available that we all want. In the 60’s people got along without or mostly without cell phones, multiple televisions, movie rentals, SUVs, expensive vacations, designer cloths, frequent restaurant meals, fast food, home computers, internet connections, professional day-care, expensive hair cuts, tutoring for kids, income tax software, computer games, newer drugs and medical procedures, cosmetic surgery, cosmetic dentistry, 2000 square-foot multi-bath homes, and many other things that many of us deem essential today.

People are willing to work harder and longer to enjoy all of these new products and services. And people are willing to spend huge amounts of money on leisure and travel.

We now live in a world where the average women’s hair appointment (and some men’s cuts too) costs more than a low-end kids bicycle or a low-end DVD player. Any appliance costing less than about $200 is pretty much a throw-away if it breaks since repairs cost so much compared to mass-produced products. There are thousands of examples of strange pricing discrepancies. Products are often commodities and some of them seem ridiculously cheap. Meanwhile services like lawyers and dentist costs and even hair cuts have gone through the roof.

The implication for investors is to try and avoid companies that are making commodity products unless you are investing in the low-cost producer. There may be much better opportunities to make money in service companies.

  • Freedom?

Despite living in a land of plenty and general freedom it is shocking to realize how many unjustifiable restrictions we live with. It is illegal for Canadian cable T.V. companies to provide the music channel MTV to Canadians (sounds like something a communist government would enact). It is illegal for wheat, chicken, or dairy farmers to sell their produce on the free market. Private broadcasting stations are forced by law to meet Canadian content rules. Private medical care is often illegal. There are probably thousands of examples of needless restrictions on freedom which have nothing to do with safety or other valid reasons, and everything to do with protecting the incomes of some special interest group or other.

  • Election Day

It seems to me that the Conservatives are most likely to be the party that will make some minor improvements in terms of rewarding initiatives and safeguarding freedoms. But let’s face it, there is really not all that much difference between the parties, for the most part I expect business as usual.

On election night, after the results are in, watch for versions of the following moronic comment… Canadians decided that they wanted a (liberal/conservative) government but they decided that they did not want a (majority/minority) government and they decided to put in some NDP members to balance out the house… Such statements are made every election and imply that Canadians have gotten together and colluded with their votes and “decided” how many conservatives and how many liberals. The truth is that individuals cast their votes and the result is just what “falls out”. It’s not possible for Canadians “decide” they want and therefore install a certain party, individuals decide who to vote for and then the collective result just happens. This is a minor point but moronic comments bug me.