Category Archives: Banking, Finance and Investing

Why Facebook and Linked In IPOs Might Scare Users

For some reason, I think I felt comfortable that my personal data was controlled by a small collection of private companies. Facebook, Google, Linked In are the big three that come to mind.

Linked in header image

Google has been public for several years and knows alot about me. And you. What web sites you browse, what you write in your emails, your preferences, your phone number, your personal details. The fact that they also know this about the rest of the world for some reason gave me comfort.

The fact that they also had hundreds of millions and now billions in search revenue also made me feel good. Would they bother jeopardising that in order to sell my data to people? I doubt it but maybe.

I’m also generally not too worried about it which helps.

That said, Linked In’s IPO and Facebook’s coming IPO have got me thinking. Linked In’s first day multiple of 300-600 times earnings implies that public shareholders either plan on making a lot more money than they currently are from these companies or that they love losing buckets of cash in the near term. Or that they’re speculating it will go up more like in the 1998-2001 internet boom.

What i’m wondering is what are they going to have to do to raise earnings in the manner they’ll need to to justify their valuation? Surely they’ll have to start making some decent money somehow?

Will Linked In start calling me and offering me jobs? Will Linked In or a post IPO Facebook sell my data to companies to advertise to me? I was less worried about these things with their private company CEOs at the healm and a smaller group of VC investors and rich Goldman Sachs clients as shareholders. But trading at multiple hundreds times current earnings, I’m not so sure. The profit growth has to come from somewhere.

With the post IPO Google, I not only didn’t think about much about this but I effectively didnt’ have a choice unless I wanted learn Chinese and try out Baidu.

With Facebook and Linked In I do have a choice. I guess less so with Facebook because it is a great tool for staying in touch with people. Linked In, however, I would happily ditch in a heartbeat if the concerns above worried me.

Luckily, they don’t worry me too much so i’m unlikely to leave these sites.

But I imagine there are millions of people out there that these concerns do worry. Will people use these sites the same way now that they’re publically owned? Should they? Will they do things differently? Are Linked In and Facebook less valuable as public companies at such high valuations?

Either way, Goldman Sachs who has already unloaded its Linked In shares and the pre IPO shareholders look likely to profit.

Users of Facebook and Linked in? I wonder.

My favourite parts of Warren Buffett’s 2011 Letter to Shareholders

Every year since 2008, i’ve been reading Warren Buffett’s letters to shareholders. They are an excellent source of investing and business intellect and usually pretty funny as well.

You can download the 2011 letter to shareholders or visit the letters archive.  Interesting quotes from this year’s letter are below:

Page 4, paragraph 1:

Don’t let that reality spook you. Throughout my lifetime, politicians and pundits have constantly moaned about terrifying problems facing America. Yet our citizens now live an astonishing six times better than when I was born. The prophets of doom have overlooked the all-important factor that is certain: Human potential is far from exhausted, and the American system for unleashing that potential – a system that has worked wonders for over two centuries despite frequent interruptions for recessions and even a Civil War – remains alive and effective.

Page 7, paragraph 3:
This “what-will-they-do-with-the-money” factor must always be evaluated along with the “what-do-we-have-now” calculation in order for us, or anybody, to arrive at a sensible estimate of a company’s intrinsic value. That’s because an outside investor stands by helplessly as management reinvests his share of the company’s earnings. If a CEO can be expected to do this job well, the reinvestment prospects add to the company’s current value; if the CEO’s talents or motives are suspect, today’s value must be discounted. The difference in outcome can be huge. A dollar of then-value in the hands of Sears Roebuck’s or Montgomery Ward’s CEOs in the late 1960s had a far different destiny than did a dollar entrusted to Sam Walton.

Page 7, second last paragraph:

Our second advantage relates to the allocation of the money our businesses earn. After meeting the needs of those businesses, we have very substantial sums left over. Most companies limit themselves to reinvesting funds within the industry in which they have been operating. That often restricts them, however, to a “universe” for capital allocation that is both tiny and quite inferior to what is available in the wider world. Competition for the few opportunities that are available tends to become fierce. The seller has the upper hand, as a girl might if she were the only female at a party attended by many boys. That lopsided situation would be great for the girl, but terrible for the boys.

Page 8, paragraph 2:

In addition to evaluating the attractions of one business against a host of others, we also measure businesses against opportunities available in  marketable securities, a comparison most managements don’t make. Often, businesses are priced ridiculously high against what can likely be earned from investments in stocks or bonds. At such moments, we buy securities and bide our time… We have been able to take money we earn from, say, See’s Candies or Business Wire (two of our best-run businesses, but also two offering limited reinvestment opportunities) and use it as part of the stake we needed to buy BNSF.

Page 9, paragraph 3:

GEICO also jump-started my net worth because, soon after meeting Davy, I made the stock 75% of my $9,800 investment portfolio. (Even so, I felt over-diversified.)

Page 14, paragraph 4:

A housing recovery will probably begin within a year or so. In any event, it is certain to occur at somepoint… At Berkshire, our time horizon is forever.

Page 16, 3rd last paragraph:

Our borrowers get in trouble when they lose their jobs, have health problems, get divorced, etc. The recession has hit them hard. But they want to stay in their homes, and generally they borrowed sensible amounts in relation to their income. In addition, we were keeping the originated mortgages for our own account, which means we were not securitizing or otherwise reselling them. If we were stupid in our lending, we were going to pay the price. That concentrates the mind.

If home buyers throughout the country had behaved like our buyers, America would not have had the crisis that it did. Our approach was simply to get a meaningful down-payment and gear fixed monthly payments to a sensible percentage of income.

Home ownership makes sense for most Americans, particularly at today’s lower prices and bargain interest rates. All things considered, the third best investment I ever made was the purchase of my home, though I would have made far more money had I instead rented and used the purchase money to buy stocks.

But a house can be a nightmare if the buyer’s eyes are bigger than his wallet and if a lender – often protected by a government guarantee – facilitates his fantasy. Our country’s social goal should not be to put families into the house of their dreams, but rather to put them into a house they can afford.

Page 18, paragraph 2:

Even before higher rates come about, furthermore, we could get lucky and find an opportunity to use some of our cash hoard at decent returns. That day can’t come too soon for me: To update Aesop, a girl in a convertible is worth five in the phone book.

Page 18, paragraph 5:

Within ten years, I would expect that $376 million to double. By the end of that period, I wouldn’t be surprised to see our share of Coke’s annual earnings exceed 100% of what we paid for the investment. Time is the friend of the wonderful business.

Page 18 to 19:

It’s easy to identify many investment managers with great recent records. But past results, though important, do not suffice when prospective performance is being judged. How the record has been achieved is crucial, as is the manager’s understanding of – and sensitivity to – risk (which in no way should be measured by beta, the choice of too many academics). In respect to the risk criterion, we were looking for someone with a hard-to-evaluate skill: the ability to anticipate the effects of economic scenarios not previously observed.

The hedge-fund world has witnessed some terrible behavior by general partners who have received huge payouts on the upside and who then, when bad results occurred, have walked away rich, with their limited partners losing back their earlier gains. Sometimes these same general partners thereafter quickly started another fund so that they could immediately participate in future profits without having to overcome their past losses. Investors who put money with such managers should be labeled patsies, not partners.

Page 19, paragraph 3:

Over time, we may add one or two investment managers if we find the right individuals. Should we do that, we will probably have 80% of each manager’s performance compensation be dependent on his or her own portfolio and 20% on that of the other manager(s). We want a compensation system that pays off big for individual success but that also fosters cooperation, not competition.

Page 21, paragraph 1:

We have that flexibility because realized gains or losses on investments go into the net income figure, whereas unrealized gains (and, in most cases, losses) are excluded. For example, imagine that Berkshire had a $10 billion increase in unrealized gains in a given year and concurrently had $1 billion of realized losses. Our net income – which would count only the loss – would be reported as less than our operating income. If we had meanwhile realized gains in the previous year, headlines might proclaim that our earnings were down X% when in reality our business might be much improved. If we really thought net income important, we could regularly feed realized gains into it simply because we have a huge amount of unrealized gains upon which to draw. Rest assured, though, that Charlie and I have never sold a security because of the effect a sale would have on the net income we were soon to report. We both have a deep disgust for “game playing” with numbers, a practice that was rampant throughout corporate America in the 1990s and still persists, though it occurs less frequently and less blatantly than it used to.

Page 21, final paragraph

Part of the appeal of Black-Scholes to auditors and regulators is that it produces a precise number. Charlie and I can’t supply one of those. We believe the true liability of our contracts to be far lower than that calculated by Black-Scholes, but we can’t come up with an exact figure – anymore than we can come up with a precise value for GEICO, BNSF, or for Berkshire Hathaway itself. Our inability to pinpoint a number doesn’t bother us: We would rather be approximately right than precisely wrong.

…(I always love explanations of that kind: The Flat Earth Society probably views a ship’s circling of the globe as an annoying, but inconsequential, anomaly.). You can be highly successful as an investor without having the slightest ability to value an option. What students should be learning is how to value a business. That’s what investing is all about.

Page 24, paragraph 2:

Furthermore, not a dime of cash has left Berkshire for dividends or share repurchases during the past 40 years. Instead, we have retained all of our earnings to strengthen our business, a reinforcement now running about $1 billion per month. Our net worth has thus increased from $48 million to $157 billion during those four decades and our intrinsic value has grown far more. No other American corporation has come close to building up its financial strength in this unrelenting way.

By being so cautious in respect to leverage, we penalize our returns by a minor amount. Having loads of liquidity, though, lets us sleep well. Moreover, during the episodes of financial chaos that occasionally erupt in our economy, we will be equipped both financially and emotionally to play offense while others scramble for survival. That’s what allowed us to invest $15.6 billion in 25 days of panic following the Lehman bankruptcy in 2008.

Michael Lewitt Video on the US Government Stimulus

HCM Market Letter author Michael Lewitt comments on the US Government stimulus efforts.

I’ve been reading Michael’s articles for about 3 years and it is good to see him finally getting some more publicity as a result of publishing his new book The Death of Capital.

Other Comments from the December market letter include:

  1. Bad policy in the US will ensure the that boom and bust cycle will continue
  2. The US economy showing signs of improvement but not as much as might be expected following a recession. The data is also not as positive as it is being seen by the markets
  3. Europe (and the Euro) is in trouble with Spain Portugal, Greece, Ireland Belgium and Italy the most vulnerable
  4. China boom to end at some point unless “they are unlike every other growing economy in the history of the world” –  People trusting numbers coming out from China are not wise.
  5. He also gives a range of investment recommendations at the end of the article that are worth reading.

Michael Burry’s 4 Must Read Investing Books

The Big Short by Michael Lewis featured the stories of the first individuals to bet against the US housing market before the 07/08 financial crisis. Michael Burry was said to be the first to do so.

Not only was Michael (Mike) Burry said to have been one of the first to do so, he was also one of the most dogmatic in his approach.

Michael Burry - Scion Capital - The Big Short
Michael Burry's 4 must read investment books

Originally a doctor, Michael Burry spent countless hours learning to be a stock market investor by writing a stock market blog and investing himself  throughout the late 90’s and early 00’s. By the end of decade, he would be the instigator of billions of dollars of bets against the US housing market.

An intriguing character in the book who also turned an original $100,000 in his Scion Capital hedge fund into hundreds of millions, I spent some time trying to find excerpts from his early blog and forum posts.

One of the excerpts (including the 4 books he recommends to all those new to investing) is below:

Re: books

To get started, I’d suggest the following four books:

If you read these books thoroughly and in that order and never touch another book, you’ll have all you need to know. Another book you might want to consider is Value Investing made easy by Janet Lowe – a quick read. I have a fairly extensive listing of books on my site, with my reviews of them, and links to purchase them at amazon [Michael Burry’s site no longer live].

My problem is I’ve read way too much. One book stated, “If you’re not a voracious reader, you’ll probably never be a great investor.” But sometimes I wish I had a more focused knowledge base so that my investment strategy wouldn’t get all cluttered up.

Re: Security Analysis (Graham and Dodd) you can get a lot of the same info in a more accessible format elsewhere, but everyone says that Buffett’s favorite version is the 1951 edition. Yes there are differences, and the current version has a lot of non-Graham like stuff in it.

Good Investing,Mike

For a full list of his comments and posts, you can visit this Michael Burry profile on Silicon Investor.

Renting Vs Buying Property – 10 Factors that should Influence your decision

Renting vs buying a house or apartment

As a twenty-something year old living in Sydney in 2010, it would be nice to know whether I should buy or rent the apartment (or house) I live in.

Many people from my parents’ generation would say buy a house now and watch it grow in value. And perhaps it really is this simple; it was for them.

That said, not many of my friends can afford to buy property in Sydney, and for the ones that can, many still choose not to. Is it overpriced? Is it a change in attitudes? do we get more value out of flexibility? Is renting good value?

I’ve told myself that one day I would sit down and do some calculations and figure out which is better for me. After just completing this process, at least to some extent, I still have no idea which is better. But I do understand more of the factors that influence it and to what extent.

The first thing I learnt is that some calculations turned out to be many calculations. The second is that there are so many variables in my solution that I can only know for sure which is the better option for me if I am able to predict the future. And after reading The Black Swan recently, I’m not very comfortable with my ability to predict the future.

A useful tool to help you choose between renting and buying

After spending hours trying to create a spreadsheet myself, I’ve found a very useful tool made by the NY Times to help with this analysis (a screenshot is here). In the example screenshot, I compared buying a $450,000 apartment versus paying $1,200 a month in rent and investing the leftover cash at 7% over a 30 year period. I also assumed that both house prices and rental prices will increase by 5% each year on average. As you can see under this scenario, renting remains financially better than buying for the full 30 years (a full list of assumptions are here).

Now, if only it were that simple. Unfortunately, the assumed variables in the above example are not so simple at all.

What if house prices don’t keep rising?

We don’t know that house prices will increase at 5% per annum for the next thirty years (many would argue Australian house prices are due for a correction). Regardless of the answer to this and despite plenty of research, I personally have no idea. But I still need to make the best decision I can with the information that I have.

Suppose that house prices stay at the same level they are now for the next 30 years, based on these assumptions, the tool tells us that If you stay in your home for 30 years, renting is better. It will cost you $887,567 less than buying, an average saving of $29,586 each year.

Renting vs Buying (House prices constant)

What if I can’t produce 7% on my investments?

The nice thing about simple graphs like the one above is that they are often not so simple. If you can’t manage to invest the money that you save by choosing to rent at 7% per annum (though some stock market experts might call this a conservative expectation) , things can start to look less peachy for renters. Keeping house prices increasing at our initial assumption of 5%, but changing your investment returns per annum by just 2% to 5%, buying takes the lead after 30 years for the first time in this analysis.

If you stay in your home for 30 years, buying is better. It will cost you $494,992 less than renting, an average saving of $16,500 each year.

The flipside of this point is that if you can produce returns in excess of 7%, things starts to swing very quickly in favour of renting. At 10% per annum on your investment returns, If you stay in your home for 30 years, renting is better. It will cost you $1,446,552 less than buying, an average saving of $48,218 each year.

Without taking a view on this myself, for those of you thinking that achieving 10% returns on the stock market year on year is easy, consider that half of the return of the US stock market over the past 50 years was associated with just 10 days with the greatest daily change (The Black Swan, Ch 17).

Renting Vs Buying with 10% investment returns

What Other factors affect the decision to buy or rent a house or apartment?

As you can probably tell by now, deciding whether to rent or buy is going to depend on your opinion on a number of factors, most of which you probably have little idea about. And that’s from a financial perspective only.

During my analysis, other factors (this is not an exhaustive list) that can have a big impact included:

  1. Rental Prices (if rental prices rise by less than 5% a year, renting becomes even more appealing)
  2. Interest rates (6% interest on $450,000 is $27,000 that you’re giving to a bank in the first year)
  3. Strata fees (just watch $1,000-3,000 a quarter decimate your choice to buy that sleek apartment in Elizabeth Bay)
  4. Down Payment Value (the amount your ready to part with now will make a difference to where you are 30 years later)
  5. House or Apartment Improvements and Maintenance (whilst maintenance and improvements can have different effects, the more you spend when buying the worse off you are unless it adds value to your house or apartment)
  6. Selling and Buying costs (both negatively impact buying versus renting)
  7. Your Marginal Tax rate (this is again situation dependant but the more tax your paying the better off you are where you can claim that tax, as such buying can work out better)

So should you rent or should you buy?

What all this analysis has led to for me is knowing that I’m going to have make some educated bets and be ready to change them if necessary. Some of these bets include what I think about the future of house prices, rental prices, and how I think I’ll go investing my own money.

At least for the moment, i’m not going to buy property in Sydney. This by no means implies it won’t work out for those that do choose to buy. I can see a scarcity of houses in Sydney continue to push prices up for decades to come.

Sydney property prices near the city (or preferably in it) for a 1 bedroom place seem nothing short of crazy (unless i want to own 38 square metres in an apartment complex on Oxford St). That’s not saying they might not get more crazy and make many people profit in the process.

The place where I live is a much nicer place than I would get if I bought a $300,000 – $450,000 place in a similar suburb (my share of the 2 bedroom place close to the city is $350 pw) . Buying a place in Sydney seems only to be an option to me if I am ready to live in it since rental yields of 2-5% really don’t excite me (I feel my money is safer in my Virgin Saver account). If I want to travel for an extended period of time, buying doesn’t give me that flexibility either.

One other factor I think about is the end game. At the end of 30 years, I either have a house that I own or (hopefully) a pile of cash and some investing skills. From a financial perspective only, I’d take the cash and investing skills over the 2-5% yields per annum that are common at the moment in the property market. That said, maybe in 30 years or before then, I’ll want a house for me or me and my family to grow old in. The trick for me here is to realise that if I do want a house at some point, I might have said pile of cash to buy it with if I can manage to invest well until then.

As for investing my own money, if anything, this analysis has shown me that if I am going to follow the renting path, I do have to focus on investing my money as wisely as I can. To do so, I’ll be focusing on investing in things I can understand and that appeal to me (I outlined an approach this in my article Successful Investing, Worldly Wisdom and Your Circle of Competence). This will hopefully be in my own business.

Whether you should rent or buy will come down to analysis of all these factors. The main points I want to get across in this article is that it is not as simple as some think (though that doesn’t mean that what you would have chosen won’t end up working anyway) and that you need to spend some time thinking about these factors before and after making your choice.

For those that want to go even further that the NY Times tool, check out this one. In terms of disclosure, my friend Max has informed me that I should let people know that I work for a company that recommends stocks on the ASX.