Newsletter May 13, 2007

InvestorsFriend Inc. Newsletter May 13, 2007

Free Stock Report on Tim Hortons

Our Stock Reports are a paid service and have proven to be extremely valuable to our paid subscribers. In fairness to our paid subscribers, it is extremely seldom that we give any free sample reports of our current stock picks.

We are making a rare exception right now and are giving you a link to our report on Tim Hortons.

Last Summer we thought Tim Hortons was worthy of buying at around $28. At that time we said “Tim Hortons is a very strong company. It is not bargain priced, but this may be a case where it is worth paying the price to hold a high quality company.”

Now Tim Hortons as moved up to about $35 and we think the same logic applies. It does not look particularly cheap but it’s probably worth paying the price to hold such a high quality company.

Anyone who lives in Canada would surely not be surprised to know that the company is making a lot of money. The stock price already reflects that profitability. It is therefore very unlikely that the stock will double in price anytime soon. On the other hand it seems relatively certain that the company is going to grow over the years and then eventually within five to seven years it is quite plausible that the stock price will double.  And it seems very unlikely that the stock price will be lower in several years then it is now. So that is a pretty good risk / reward profile.

My view is that it is a good idea for most investors in Canada to own some Tim Hortons stock. If nothing else it will put a big smile on your face every time you pass one of their locations and see those long line-ups.

Click to access your free report on Tim Hortons

Are You Gettin’ Enough? (Return that is)

It’s useful to think about how much return you can expect from investing in stocks.

It’s a mathematical fact that the average investor cannot expect to earn more than average return of the overall stock market. It’s sad but true, we can’t all be above average, and in fact only 50% can possibly be above average and we should expect fully 50% of investors to be below average. But the news gets worse. After all of the costs associated with investing (brokers fees, bid ask spreads earned by market makers, and money management fees of all types), the average investor will under-perform the market by an amount equal to the average percentage of all such fees and costs. Therefore it is a mathematical fact that on a dollar-weighted basis more than 50% of all investors must and do under-perform the market average in any given year.

So… if you have been earning as much as or more than the market averages over the years, then you are in the lucky minority and are getting more than your fair share out of the market.

If you have been under-performing the market average by more than a couple percentage points then you are not getting your fair share out of the stock market.

If you want to reliably get a higher than average return most years then you need to be following investment practices or investment advice which is using better than average techniques to select stocks.

Personally, over the past seven years in a row, I have gotten quite used to getting significantly higher than average returns. I plan to keep it up and to keep sharing my stock selections with our paid subscribers. I can’t, of course, make any guarantees about the future, but I see no reason to think that the techniques that I have been using will not continue to work. Frankly, I don’t expect to beat the market every year, but I do expect to beat it on average over the years.

Asset Allocation

“Asset Allocation” is the fancy term that the investment industry uses when they discuss how much of investments should be “allocated” to the “asset classes” of stocks, bonds and short-term deposits.

Increasingly the investment industry – supported by academic studies – recommends a balanced approach where your money is spread around and you don’t put all your dollars into one basket.

Personally, I did not take the balanced approach and instead have been close to 100% in stocks ever since I started investing. Maybe I was just lucky but the fact is that this approach has served me exceedingly well. Each dollar that I have ever invested has more than tripled to $3.35 in a dollar-weighted average of less than eight years. This is far better than I would have done using a balanced approach.

Despite the “go-balanced” mantra of the investment industry, it is no surprise at all that my 100% stock approach did better than a balanced approach. In fact it is well accepted that over the long run stocks have done better than balanced approaches.

But a 100% stock approach is certainly not suitable for everyone. Stocks can be highly volatile. It’s not a suitable approach when the money is needed in less than about ten years or when a person is not prepared to accept volatility.

I have done the math myself and graphed out the historical results to the point where I am comfortable with a 100% stocks approach, at least most of the time. I would however lighten up on stocks if I thought that the markets were significantly over-priced. And as my portfolio grows larger I may at times (as I did temporarily earlier this year) reduce my stock exposure to avoid the risk of short-term volatility.

Recently I completed extensive data analysis that led to two short articles that demonstrated the past average superiority of returns for a stocks-only approach based on U.S. data for all possible 30-year savings and 30-year retirement periods since 1926. Over the years I have written over 100 investment articles for this Site. These latest two are two of the most important articles I have ever written. These are available as free bonus reports to our paid subscribers.

At his recent huge investor conference in Omaha, Warren Buffett gave the following response when asked how he would invest money that was not needed for 20years: “I don’t believe in having 60% of this and 30% of that – and if I had to invest for 20 years, I would buy stocks”.

The question is should we believe Buffett, generally acknowledged to be the world’s most successful investor in history and a man of extremely high integrity, intelligence and common sense. Or should we believe the investment industry and the academics?

My money is on Buffett, if you agree I will see in the stock market!

Non-GAAP should not be Non-Sense

GAAP stands for Generally Accepted Accounting Principles. A corporation’s financial statements must be prepared in accordance with GAAP.

Many companies report non-GAAP earnings results as a supplement to earnings reported on their financial statements. It’s legitimate to ask why investors would need non-GAAP figures. After all, the GAAP earnings best reflect earnings in the eyes of the accounting profession and its regulators. However, the goal of what GAAP earnings is trying to present can often differ from the goal of what an investor is trying to understand.

An investor typically is trying to figure out if the value of a stock is justified by its earnings. GAAP earnings in any particular year are often impacted by certain unusual items that are not expected to recur in future. If an investor is looking at the Price /Earnings (P/E) ratio of a company this only makes sense if the earnings are representative of a “normal” year.

Non-GAAP earnings provided by management can be very useful. Ideally they would represent earnings in a normal year. Or they might remove an expense that is required for GAAP purposes but which management believes is not in substance an expense. (For example there are certain intangible items that are very much like goodwill. GAAP does not require the amortizing of goodwill but may require that assets that are very much like goodwill be amortized).

Sadly, I must warn investors that some companies are totally abusing the concept of non-GAAP earnings.

One of the companies that I follow indicated the following:

Net income on a U.S. GAAP basis was $54.8 million. Net income on a non-GAAP basis was $93 million excluding; 1. $1.7 million of amortization of acquisition-related intangible assets, 2. $18 million of stock-based compensation expense, and 3. $26.9 million of restructuring charges.

I have grave concerns with this and consider it to be a an abuse of the concept of providing non-GAAP or adjusted earnings.

First I have a minor quibble with the use of “net income on a non-GAAP basis was $93 million. In my view, they should say net income would have been $93 million if not for… or they could say adjusted net income was $93 million. They should be careful not to imply that the $93 million was in fact the net income.

But my bigger concern is with their presentation of a net income figure that adds back $18 million in stock-based compensation expenses – as if it were not an expense. (I have no issue at all with adding back the amortization of intangibles, or the presumably one-time restructuring charges.)

Companies fought long and hard against including the cost of stock options as an expense. But they LOST that fight. As Warren Buffett said (roughly quoted), if options are not compensation, what in the world are they?, if compensation is not an expense what is it? and if expenses do not long belong on the income statement, where in the world do they belong?

This company justified adding back the stock-related compensation, as if it were not a real expense, by explaining that the expense was unrelated to operational performance in any particular period and not under the control of management. If these items are “lumpy” it would be legitimate to adjust back to a normal level for the period. But to ignore these expenses in a figure labeled “net income” is nonsensical.

Having lost the battle over expensing these items, this company is apparently nevertheless still trying to fool investors into thinking that stock-related compensation is not an expense. Worse yet, they have probably fooled themselves and their Board members. And given that they think options and stock grants are not an expense they appear to have have pretty much handed this out like so much candy.

The point is that what they presented as non-GAAP is, in my opinion, non-Sense.

Investors should be wary of managers that get too aggressive in presenting non-GAAP or adjusted earnings. It reminds of 1999 and 2000, when companies like Nortel were reporting profits on an “ex-items” basis and asking us to ignore losses on the GAAP income statement. It turned out the accountants were right about the losses and the “ex-items” profits were ex-reality.


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Shawn Allen, President
InvestorsFriend Inc.

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