Investing Ideas

Here is a quote from Warren Buffett at the bottom of the Stock Market in October 1974.

Forbes : “How do you feel?”
Warren Buffett : “Like an oversexed guy in a whorehouse. Now is the time to invest and get rich.”

The US stock market has dropped 35% from its peak last year and the consumer recession is about to start and will last well into 09. Now is the time to start making your shopping list of stocks and to come up with prices that you dream you could buy those stocks at. You may very well get the chance to buy the investment of your dreams at a once in a lifetime price.

In Part 1 of my shopping list I want to list 25 companies I admire and would like to have in my portfolio. In subsequent posts I will detail what I like about the company and what I think its Intrinsic value is and what my dream price would be. I already hold some of these stocks (in bold) but i would like to buy more at the right price.

1. Berkshire Hathaway
2. Leucadia National
3. Brookfield Asset Management
4. Markel
5. Canadian Natural Resources
6. Chesapeake energy
7. General Electric
8. Johnson and Johnson
9. Pfizer
10. American Express
11. Coca Cola
12. Conoco Phillips
13. Proctor and Gamble
14. US Bancorp
15. Wells Fargo
16. J. P. Morgan
17. Goldman Sachs
18. Sears Holdings
19. Microsoft
20. Fastenal
21. CostCoI will edit this and add 4 more companies later

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Eddie Lampert has 3.5 billion in Sears Holdings. The merger between Sears and Kmart has gone well. Remember SHLD is not a retailer. SHLD is a holding company that happens to currently own 2 retailers. One thing i like about SHLD is Eddie Lampert is focussed on profitability and not on same store sales growth like most dumb retailers. Yes i know its the industry metric, I dont care. I want growth in profits and thats what Eddie delivers.

Here is a quote from the Sears Holdings message from the Chairman which hints at SHLD becoming a new Berkshire
“My goal is to see Sears Holdings become a great company whose greatness is sustainable for generations to come.”

Similarities between Eddie Lampert and Buffett.
Both started investing at an early age, have great long term records. Started a partnership/Investment Management companies at a young age with great long term returns. Both have virtually all of their net worth in these companies. Both have recieved special permission to delay filing their stock purchases. Both care about long term value and profitability.

What follows is pure conjecture. DO NOT MAKE ANY INVESTMENT DECISIONS BASED ON WHAT I PULL OUT OF MY HAT.

The long term future for SHLD.
Eddie Lampert will give away shares in SHLD to current ESL Management Partners.
SHLD becomes Eddie Lamperts version of Berkshire Hathaway.

SHLD in the near future
Rumors have been floating around that Eddie Lampert is prowling around for takeover targets. I don’t believe that the rumors about a Home Depot takeover have any substance. Id really like to see Eddie Lampert buy an insurance company like Progressive to manage its float. My candidate for companies that Eddie Lampert can takeover and turnaround OR companies with good Real Estate value which he can unlock are

• Gap Stores
• Radio Shack
• Pier 1 Imports
• Pep Boys
• Six Flags

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No question about it. The Dow and S&P have been going straight up for months. Not even a single triple digit down day.

• The Housing market is crashing - The market doesn’t care.
• Inflation is at the high end of the Feds comfort zone - Fed who? says Mr Market
• North Korea has nukes - Market shrugs it off.
• OPEC cuts oil production - So what says the market.
• Iran/Nigeria/Venezuela problems could spike oil prices - We got reserves.
• Amaranth collapse - Did something happen? Buy Buy Buy.
• Too much money chasing too few investment opportunities - Private Equity buying anything they can for an LBO
• High flying stocks and companies based on eyeball count are back. - Myspace, Facebook, YouTube and anything that’s Web 2.0
• Momentum funds are back - Lets chase the market, what a brilliant idea. NOT
• Mutual Fund Mondays are back - Retail investors chasing mutual funds that have already outperformed.

AND finally

• Frequent use of the scariest words in the investing: “This times its different because….” - Yea right, its different because people want to fool themselves into believing its different

So does that seem like a Goldilocks scenario? To me it seems like a Deja vu from 2000. A lot of people (who seem to live in a Toy story world) are convinced the markets are heading “to infinity and beyond”. Ok I’m exaggerating, but at the very least we need a 5% (600 points) correction to remove froth from the markets. An 8-10% correction would be better IMO.

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The video games industry is one of the fastest growing industries in the world. Its the creation of a new form of interactive entertainment. The industry is growing rapidly and will soon be bigger than the movie industry.

The “King of games”.
For years Nintendo was the king of video games, every competitor that challenged it was summarily demolished. The NES and SNES (Famicom in Japan) made Nintendo a synonym for video games. Their high quality in-house games and memorable characters like Mario, Zelda, StarFox, DonkeyKong started franchises that still sell games by the millions. Nintendo also introduced quality control of third party developers to made sure that customers had great games to play. As the video games industry took off competitors introduced competing consoles like Sega MegaDrive/Genesis, 3DO, Atari Jaguar, Sega Saturn, but they all failed because they didn’t have the games to back up the hardware.

The new kid on the block.
It was not until the PlayStation launch in 1994 by Sony that Nintendo faced its first true competition. The PlayStation was first to market. Sony introduced the CD format which had 10 times the capacity of a Nintendo cartridge which gave game developers creative freedom they never had on 32MB cartridges. The PlayStation was much easier to program than the N64 which helped Sony attract a lot of third party developers to PlayStation. When Nintendo released it Nintendo 64(N64), Sony already had a stranglehold on the market. What Sony saw was the creation of a new form of entertainment. The PSX has gone on to sell 100 Million units over 11 years and the PS2 surpassed that number in 7 years.

Two is company, three is a crowd.
Microsoft got its taste of the video game industry when it developed the operating system and development tools for the Sega Dreamcast. The growing video games market seemed to threaten the PC market which generated most of Microsoft’s revenue. The XBox was also a chance for for Microsoft to diversify it’s revenue stream, it joined the console wars in 2001.

What next?
The Next-gen Console wars are upon us. The competitors are Microsoft, Sony, Nintendo. The victor will receive control over a hundered million households.

Console Manufacturers
The money is made not in the hardware sales, usually consoles are sold at a loss. The profits flow in from licensing deals with software developers who want to publish games for the console. The more games that get developed and sold the higher the profit for the console manufacturer. The number of games developed and sold is directly proportional to the number of units sold.

Sony PS3 (SNE): The PS3 is a difficult release for Sony. Game developers like consoles to be positioned exclusively for gaming and not as media units. Selling a console as a media unit means game developers have no idea how many units were purchased for the purpose of gaming. Another risk factor for Sony is the price point, usually consoles sell for around $299-$399 at launch. At launch the PS3 will sell for $599-$699, agreed that it has a Blu-Ray player but the price is twice the XBox360. Sony lost the VHS v/s Betamax wars and is trying to win the HD-DVD v/s Blu-Ray wars. I’m afraid Sony may win the Hi-Def wars but lose the console wars.

Microsoft XBOX 360 (MSFT): First out of the block its projected to have 10 million units shipped before PS3 or Nintendo Wii make it to market. Improved production lines mean it will be able to cut prices when the new consoles launch, further improving unit sales.

Nintendo Wii (NTDOY): The new unique controller with motion detectors will provide a unique gaming experience. The Nintendo image of high quality kids friendly games will sell units to pre-teen audiences. Nintendo’s gaming franchises will also help sell a lot of consoles, especially in Japan. It wont win the console wars but it will be extremely profitable. Unlike Microsoft and Sony, Nintendo doesn’t depend on third party developers. It has the best game development unit in the world. The company can release a Mario, Zelda or Pokemon game and sell 5-7 million consoles.

Microsoft and Sony will sell more consoles but the video game revenues are a small part for both companies. As a pure play on video games Nintendo wins. Even without the console market Nintendo would do fine because its Game-Boy dominates the handheld market. The PSP isn’t even worth mentioning

Game Developers
As consoles improve independent game developers are closing down. Better hardware mean the customer expects better looking games. They want games that look as good as movies. The production costs of games are skyrocketing, with some games costing as much to develop as blockbuster movies. This has led to significant consolidation in the industry. The only companies that will survive are the big publishers.

Electronic Arts (ERTS): EA has excellent sports franchises which lets them publish sports games with minor tweaks every year that sell millions. It also controls franchises like The Sims, Battlefield, Medal of Honor etcetra that are million unit sellers. The best part about EA’s business is that it develops all games for all consoles, so it doesn’t matter which hardware manufacturer wins EA get its software sales.

Konami (KNM): The company that created the Dance Dance Revolution craze (I’m sure you’ve seen kids dancing on the floor-mats) has a lot of franchises like Metal Gear, Bomberman and Silent Hill, each of which will be made into multiple games for various consoles. The company posses a brand recognition in Japan that ensures its games will be blockbusters.

I like the consistency in earnings of Konami over EA. The majority of Konami’s revenue comes from console games but Konami also has some Arcade, Toy, Mobile and Casino gaming exposure that helps it weather the downturns in the industry at the end of each console generation.

Others: I do not like any of the other game manufacturers like Activision(ATVI), THQ(THQI), Atari (ATAR) and Taketwo(TTWO). They dont have the size, financial strength or game library/franchises that EA and Konami have. The one company i would love to own is Blizzard (Vivendi), too bad its not an individual company

Services
The only ones i know of are Shanda(SNDA), Netease(NTES) and The9 (NCTY). The companies provide services for On-line gaming and on-line communities. They’re just too risky.

Retail
Wal-mart and Best-Buy sell a lot of consoles and video games but there is only one company that is exclusively a video game retailer.

GameStop(GME): is the world’s largest video game retailer. The company operates 4,500+ retail stores throughout the United States, Austria, Australia, Canada, Denmark, Finland, Germany, Italy, Ireland, New Zealand, Norway, Puerto Rico, Spain, Sweden, Switzerland and the United Kingdom. To GameStop it doesn’t matter who wins the console wars and it doesn’t matter which game developer get the next blockbuster franchise. If the industry grows GameStop will mint money.

Best way to invest in video games : GameStop(GME)
Alternative : Nintendo (NTDOY)

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So you’re invested in dollars? You heard on TV or someone told you that the dollar is losing value. Is this true? Yes. The reason is simple. The US trade deficit for the last 12 months is 800 Billion, thats the annual GDP of countriles like Brazil or India. You want to know how to invest to protect against the dollar’s decline? If you want to protect yourself against the dollars decline the simple answer is to invest internationally. There are lots of ways to invest internationally and I will look at each of them.

Currencies: When the US dollar goes down, it reduces in value compared to other currencies. So an easy way to protect against the decline is to invest in foreign currencies. This is an option i do not like because investing and trading foreign currencies is extremely risky. The other reason is buying currencies is a short term hedge, once the dollar declines the trade is over. You get one time returns on the actual decline but that’s all. Investing in companies is a better way to go as i’ll explain later.

A series of new Trusts have started trading on the NYSE that allow people to own various currencies. I dislike investing in currencies and would never recommend them. They are extremely risky. I just included them for completness.

• Euro Currency (FXE)
• British Pound Sterling (FXB)
• Canadian Dollar (FXC)
• Australian Dollar (FXA)
• Swiss Franc (FXF)
• Swedish Krona (FXS)
• Mexican Peso (FXM)

Two mutual fund families have started new funds that protect against the falling dollar. These are professionally managed but still risky especially high risk is the Direxion Dollar Bear which seeks daily invstment returns of 2.5x the inverse of the dollar.

• ProFunds Falling U.S. Dollar Investor
• ProFunds Falling U.S. Dollar Service
• Rydex Dynamic Weakening Dollar A
• Rydex Dynamic Weakening Dollar C
• Rydex Dynamic Weakening Dollar H
• Direxion Dollar Bear 2.5X Inv

Why Companies over currency?
A declining dollar helps US/Foreign companies that have a lot of international sales. This is because they earn the same amount in international currencies but when its converted into US dollars they earn a lot in dollar terms. Lets take Coca-Cola in a hypothetical example.

If the company recieves the same 20 P/E in 2007 as it did in 2006 the stock should rise to $50.20. If the US$ drops by 20% the international profits would be reported as $2.11 instead of $1.76 and the company would be valued at $57.23 thats a 14% increase because of the drop in the US$. Every subsequent year that the dollar remains at the lower level the company would report higher EPS by 14% so you benefit every year that you hold the stock over a 1 time benefit in owning a foreign currency.

US Multinational Companies: The best bet is to look for large multinational companies which do business in all major international markets. When the dollar declines these companies will recieve major increases in EPS.

• Coca-Cola(KO) - 70% International
• Johnson & Johnson(JNJ) - 45% International
• Proctor & Gamble(PG) - 40%+ International
• Citigroup(C) - 43% International
• PepsiCo(PEP) - 35% International
• News Corp(NWS)

International Stocks: International Multinationals have the same earnings increase benefit as US multinationals and an added benefit for international stocks is their assets may also get higher value.

• Cadbury Schweppes (CSG)
• Siemens (SI)
• Toyota (TM)
• Sony (SNE)
• ING Group (ING)

Commodities: The last way to play the decline in the dollar is to bet on commodities. Since commodity prices are set in US$ terms they rise in relative value when the dollar declines. All commodities traded in dollars should increase in value if the dollar declines. Companies in the energy, metals and mining industry should perform well.

• Integrated Oil - Exxon Mobile(XOM), Conoco Phillips(COP), PetroChina(PTR).
• Independent Oil and Gas - Encana(ECA), Suncor(SU), Chesapeake Energy(CHK), Devon(DVN), Canadian Natural Resources(CNQ).
• Metals and Mining - Anglo American (AAUK), Rio Tinto (RTP), BHP Billiton (BHP)

Mutual Funds : For anyone that would prefer an International mutual fund (Which is the safest way to play the dollar decline). I list my favourite International Funds.

• Julius Baer International Equity (BJBIX)
• First Eagle Global (SGENX)
• Dodge and Cox International(DODFX)
• Oakmark International(OAKIX)

Note: I would stay away from international stocks that get most of their earnings in US dollars. If you find an international stock that gets most of its earnings from the US market. Since the company is paid in USD When the dollar declines the revenue of that company will drop while their costs will remain the same.

Conflicts : I own shares of Chesapeake Energy

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Google is the king of search engines but its kingdom under attack. The invaders are Microsoft’s Windows Live, Yahoo and the newly renamed kid on the block Ask.com.

Google’s advantage: At one time most search engines used to display a list of pages containing the search words without ordering the results by importance. The results were like searching for a needle in a bale of hay instead of a haystack, better but still a pain in rear. Then along came Google and its page rankings, the hay was gone. It has taken years for Yahoo, MSN and Ask.com to realise the importance of ordering results by importance and developing the infrastructure and algorithms to provide results comparable to Google.

Search by definition is imprecise since the search engine has no clue what you’re really thinking about. If you type in Apple are you searching for the Fruit or the Company? The search engine has no idea, neither do the advertisers. The only person that knows is you. Google still returns better results but the difference is negligible.

Yahoo: Losing to Google
Lets get this one out of the way. Yahoo is getting its ass handed to it on a plate by Google. Its losing to Google in every aspect from search, functionality, user experience and on the financial side too.

Microsoft: The threat from Vista
The Microsoft threat is not from its search engine but from Internet Explorer 7. Here is a quote from the Internet Explorer features page

“Internet Explorer 7 brings your favorite web search providers to you. With the built-in search box, you can search the web at any time without having to open a search provider page. You can display search results in a separate tab, and then open the results in other tabs to quickly compare sites and find the information you want. You can even customize your search by setting your favorite search provider as the default.“

As most of you have probably guessed the “default search provider” is Windows Live. What a surprise. So every installation of Vista is potentially a lost user for other search engines. Most users wont bother to change search engines if the default one gives results that are good enough. Search engines can negotiate deals with PC manufacturers to get their search engine set at the default. This will cost money since HP, Dell, Sony wont be providing the service for free. Any future re-installs on these computers from a retail copy of Vista will reset the default back to Windows Live.

Easy to access was another minor advantage that Google had. Type in Google and hit Ctrl+Enter to go to the Google site was easier than “search.msn.com”. Now you just need to type in “live” and hit Ctrl+Enter to get to the Microsoft engine.

Ask.com: A better user experience
Search engines are no longer about getting users a relevant result. All search engines do that. Engines need to differentiate themselves by providing unique features and assisting their users manage the results. Ask.com has done a phenomenal job of differentiating itself. Personally I love the binoculars which give a quick view of the site in a pop-up. I also like the “Narrow your Search”, “Expand your Search” and “Related Names” sidebars. Ask.com also has a nice feature (probably from when it was called AskJeeves.com” where you can ask a question and it will try to answer the question along with providing search results. For all of these reasons Ask.com is the fastest growing search

Conclusion: Google is a good company with good earnings and growth but its dominance is under threat from Microsoft and Ask.com. I prefer IACI for its Ask.com search engine which has a better user experience and is growing faster than Google. While Google is a one trick pony IACI has a diversified economic float and a brilliant CEO in Barry Diller.

Conflicts : I own shares of Microsoft and IAC/Interactive Corp

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Heres a question. What will be the richest countries in the world in a few decades? If you answered any of the following USA, UK, Germany, Japan you got it wrong. Try again. Did you think it was China, India, Brazil, Russia? Wrong again.

Where does wealth come from?
Wealth comes from natural resources which can be harvested and sold to those who want them. Wealth also comes from material that can be changed into something more valuable through proper application of knowledge, skill, labor and equipment. So we have 2 ways to generate wealth. Harvesting natural resources and improving resources thru knowledge and labor. With world population bursting at the seams there is an ever increasing availability of people and labor. Natural resources on the other hand are finite.

What makes a country wealthy?
If a country consumes everything it produces it creates no wealth. If a country consumes more than it produces its poor. Only countries that have a surplus are wealthy. You may feel that China fits the bill since it has a trade surplus with most countries. China has an extremely large population that is currently living on basic necessities. As the population starts to become more consumer oriented more of their manufacturing and production will be used to satisfy internal needs. The countries that I feel are the richest are Australia and Canada.

Why these 2 countries?
Lets look at some Figures first

USA - Population 300 Million - Area 9.6 Million sq kms.
Canada - Population 32 Million - Area 9.9 Million sq kms.
Australia - Population 20 million - Area 7.7 Million sq kms.

These two countries have extremely large land masses with barely the population of 2 major american cities. Furthermore Canada and Australia are developed countries with good infrastructure and stable governments unlike the middle east and africa. Geographically Canada’s proximity to the US and Australia’s relative proximity to China gives both these countries major customers that need natural resources.

How to invest?
A simple way to get exposure to these countries is to use an ETF.
IShare MSCI Australia (EWA)
IShare MSCI Canada (EWC)

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“Water water everywhere but not a drop to drink”

Seventy Five percent of the world surface is covered in water but 97% is salt or otherwise undrinkable. Another two percent of water is held in Glaciers and Polar ice caps. One, just ONE percent of the water on this Blue planet is usable for drinking, household use, agriculture, construction, manufacturing etc. Shocked? It gets worse. Water consumption is increrasing at 2.5 times the population growth. By 2025 two-thirds of the world population will live in water stressed conditions.

What are people supposed to do? Stop drinking water? Stop bathing? Stop agriculture, construction and industry? NO the answer lies in more efficient use of water, better distribution, purification, filtering and increasing the water supply. The companies that deal with water in any form will show good steady growth over the next few decades.

My Personal opinion is that since this is a very long term bet and there are no stand out companies that i can think of the best way to play this would be to invest in PowerShares Water Resource Portfolio (PHO) . If you prefer to invest in individual companies over Mutual Funds or ETFs my favourites are Aqua America, SUEZ, and Veolia Environnement. I have included a list of companies that form the Palisades Water Index.

• Calgon Carbon Corporation (filtration)
• Consolidated Water (water utility)
• Insituform Technologies (pipeline installation and repair)
• Companhia de Saneamento Basico do Estado de Sao Paulo (water and wastewater utility)
• Pentair, Inc NYSE (pumps, motors, filtration, water tanks)
• Southwest Water
• California Water
• Pall Corporation (filtration)
• Watts Water Technologies (valves)
• Amer States Water
• Aqua America
• Millipore Corporation (filtration)
• United Utilities
• ITT Industries (pumps)
• Franklin Electric (pumps and motors)
• Nalco Holding
• Layne Christensen
• Danaher
• Idexx Laboratories
• Lindsay Manufacturing (center pivot irrigation systems)
• Badger Meter (flowmeters)
• Synagro Tech
• Veolia Environnement
• Tetra Tech
• Urs Corp
• Valmont Industries (center pivot irrigation systems)
• Itron
• Flowserve (pumps)
• SUEZ-ADR
• Ashland, Inc.
• Idex
• Roper Industries (appliances, pumps, industrial controls)
• Emerson Electric (pump motors and flowmeters)
• Siemens-Ads
• General Electric (appliances, motors)
• 3M

Conflicts: I do not own shares in any of the companies or funds listed.

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