How about starting a new kind of investment fund - globally connected but with conservative strategies

I’m looking to create a small group of say, 5-10 people, from all corners of the world, interested in asset management and valuation. Let’s say, we’re a bunch of 25-40 year old dudes and gals, deeply interested in fundamental and long term investment strategies, whom all have passion and love for interesting themselves in corporate strategies, new techniques and allocating to optimize a return to risk relationship among their assets.

With this group, we could have our own specialty  where we analyze and pitch a long term investment each, and present it to each other.

Let’s say that we one day have a Skype meeting where “Steve” from the United States pitches for his sector, Consumer Goods, and presents two companies we should have in our portfolio. After we’ve all agreed, it’s Naokis turn. Her specialty is Japanese robotics companies, and has been able to find two companies with a return on equity of 25%. We all agree that the one with the lowest P/B should be on the portfolio. 

Some of our portfolio and allocation savvy members like Erik from Sweden and Hanz from Germany optimize our assets and sends out the orderbook by linking to a Google portfolio. 

Time passes, some of us in the group invest according to the group portfolio and make new contacts - and voila ! We’ve created a new way to run a small investment fund! People could invest in our portfolio, which is run by people with passion, from all over the world, whom all believe in long-term, conservative investment strategies!

Pop me an email at hermes.cagn@gmail.com if you’re interested!

So need some financials in your portfolio? How bout’ em’ banks?

Some businesses are not DCF-friendly. Among them are material businesses which are more friends with a NAV-valuation function, and others depend on how much your cash your balance sheet is able to produce without doing anything at all. Such a business is known as a bank..A bank does not operate as the rest of the mortal companies. Never had the opportunity to really get my head into bank valuation, I started walking down the rough path and started evaluating banks on how good they were at upholding Basel II rules and measuring towards risk. The credit and operational risk part is quite easy to evaluate, but the market risk is basically impossible - even though the Basel Rules clearly states that Banks are forced to show all metrics, few do. Mainly I believe it’s because of internal value to risk modelling and its frailty. Even a big bank as Goldman Sachs can come across as “sluggish” when it comes to measuring risks. Mainly because risk-measurement is quite easy to poke holes through.

Banks also tend to differ in the way they report, as they lack cash-flow statements. A cash-flow statement is in general quite un-interesting and misguiding when it comes to a bank anyway. Mainly one focuses on the strange income and balance sheet. 

The income statement of a bank

“Top-line” or the row that usually holds the revenue figure for a normal company is a bit different for a bank. This part is just a net financial income row. It’s based upon a number of things such as interest rates and change in average debt volumes. Debt volumes consisting of debt TO companies and private people in the form of mortgages or common credit. After you’ve figured out what their net interest income is, slap on a couple of margins and work your way down to net profit in the usual way.

The balance sheet of a bank

This is one of the more unusual set-ups among businesses, but also the absolute most detailed one. Showing how much is in stinky bonds up to every penny saved in the coffee jars. But if you’re not interested in doing the Basel II dance, the one thing you’re going to be interested in here is the EQUITY side. Their own capital, and how much money they’re able to provide their investors with in realtion to return on equity and cost of capital.

Example valuation of U.S banks (Applicable to all banks)

Without too much consideration onto what the cost of capital is. Here’s my valuation of the bigger banks. I’ve tried the value of their return on equity and how far that is from the share price, and I’ve tried it the other way around, current valuation and how much they’d have to lift profits to make current valuation feasible. The “ACTION” row summaries the middle strategy.

Then I’ve set up a fictional bank portfolio buying the maybes and shorting the shit out of the negatives, getting myself into a 2x leverage. We’ll check back in a year to this post!

Kisses! /Lester

Do you know how much you’re paying for your stocks?

So what’s a value? Many times people know exactly what a value is when they’re buying an apartment or a house, investing in an education or the value of a job. People are extremely good at making those investments. Apartment hunters tend to understand exactly what they are ready to pay for a particular view, size and design. Getting an education is also an investment, and most people even leverage that investment (get a student loan) to get the return of knowledge and a better salary. Which leads us to the job! What you want to do, for a particular sum of money! Also an investment, which people are very good at making.

But how come most people lack the minimum talent when it comes to making proper equity investments? Usually, I believe that people have a hard time understanding what they’re paying for, and no idea or expectation on what to get back. Some try and look at old price changes in a stock, in some sort of hope that those same changes will occur again - most preferable at the exact time after they’ve bought the shares. 

But here’s a simple little move everybody can make, regarding get what you’re paying for. Learn what you pay for an asset, and what that asset should return. 

#1: What something actually costs - price-to-book:

The price to book is a simple and common ratio in equity analysis. It’s simple to figure out, and easy to understand. Basically, the book value is the value of the assets a company holds, less it’s debt. So, if a company would go bankrupt, and had to sell everything to repay all the loans and get out of everything, this is the money it would have left. Basically, the size of its equity on the balance sheet. An example most people would understand is the apartment example; Assume that you wanted to buy a studio apartment in Stockholm, Sweden. Here you need about 2,3 million SEK, or $350.000. That’s maybe not “walking-around” money for most people, so you’re going to have to finance a small part yourself, and then take out a mortage loan from a bank. So lets say that you borrow 75% of that value, $262.500, and the rest you use your own saved little nest egg of $87.500. So what’s the picture now? Well, your total assets are $350.000, your debt is $262.500, and your equity is $87.500 - thus your book value is $87.500. Let’s say that you tell your friends that you’re going to let them buy a piece of you, and give them, I don’t know, a dividend of your yearly sallary. You consist of 100 shares, and you offer them an issue in you for $1000 a share. That means that they are paying 1.14 (1000/(87.500/100)) in price to book for you! If they said; “Noo, Lester, that’s way too much, I’m going to offer $700 for a share in you”, then they don’t believe that you or your assets will be able to perform so well, and you’re even in fact worth less than what you have! Sad :/ (Ex. Most airline companies trade below 1.00 in P/B, but we’ll get to why that is). 

So here are a couple of book values and price to book for some of the biggest US companies: 

image

#2 Return on equity (ROE) 

That’s the last column you’ve got there on the right, the Return on Equity column. It’s simply the net income over equity. The higher that is, the higher the price to book should be right? The equity that returns a lot, should have a high value, yes?

Lets compare:

This graph shows something interesting; a strong positive relationship between the book-value and the return on equity. That’s why an airline company might have a P/B below 1.00 (i.e, very low / negative return on equity - diminishing asset value size).

As you also can see from this graph, the two companies with the biggest anomalies are General Motors and Nike. Imagine that with the Return on Equity General Motors has, it should be valued at around 3.00 in price to book. The equity size wont change that much, so the price has to change as to get closer to a proper price to book-value. So according to this graph, the share price should be three times higher (imagining that they’d hold their ROE). And looking at Nike, they’re trading at about the same ROE as GM, but five times the book-value. So a fair quick estimate is that one should sell Nike to buy GM. 

Keep in min though that I made this analysis in about 10 minutes. Far more insight is needed to figure out a long term ROE and a stable book value. But this is a simple way to start out when trying to become a proper investor as opposed to headless chicken running around on the trading floor…KNOW WHAT YOU’RE PAYING FOR!! <- Can’t stress that enough.

TheShareholder.org: Apple, Time Travel and Shoes

theshareholder:

Seeing as how there is a lot of Dr. Who fandom around the Internet, I thought I would pass along a little advice to time travelers. If you find yourself travelling back to today’s date 32 years ago (December 12, 1980), you’ll find yourself presented with the IPO of Apple Computer. In that…

I’ve followed this guy for a while, and since there are not many of us out there nowadays, I’m glad to see another actual investor there. Looking for value, and being an owner of a corporation rather than a “trader”.

However, in relation to this post - it’s harder than one thinks to find these companies that can act this way in the face of current market conditions. Later years for example, I’ve become allergic to internet start-ups, even though a Spotify IPO, if they had a positive cash flow and a good enough price would turn me on somewhat, I still would not touch it due to the volatility in operating results for online services. I’d probably require a price lower than 1 in the price-to-book ratio for me to even dare.

But if you, TheShareholder reads this, what would you say is one of the more interesting and may I say “radical” segments to start looking for the 20-30 year blockbusters? For example, do you believe that old media (i.e New York Times type companies) ever makes a comeback, when they figure out how to get paid for their work, and re-take the landscape once again? Or would you be a wee bit more conservative in this quest?

Mathematical illiteracy is a problem in this business. If you don’t know how something as elemental as multivariate differentiation works. Maybe a teller position might be something for you?

Dokdo or Takeshima? Foreign investor view

Dokdo or Takeshima. What I just said there means nothing to most of us here in Europe or the United States, but it means a lot to the Japanese, if not more to the Koreans, whom have had a hard time dealing with land ownership for a while now with the North Koreans. Dokdo is the Korean name, and Takeshima is the Japanese name for two islets in the East Sea, claimed by the Japanese to be part of Japan, and by the the Koreans to be part of Korea. This article, for the sake of not being biased will go by the western name, Liancourt Rocks (named after the french ship, Le Liancourt, who rammed the islets in 1849, trying to sail through the thick fog the area is known for..) 

Both powers, Korea and Japan are claiming ownership through various historical reasons (It’s even said that North Korea supports South Korea in its claim). But the underlying reason is far more important, since the Liancourt Rocks stands on top of possible massive gas reserves, that could make Korea independent in gas demand for the coming 30 years, and Japan, only about 10 years. So depending on which the pendulum of world powers swing, commodity funds investing in local basic material and gas companies will be on the radar. But who can utilize the technology to pump the gas in the most cost-efficient way, that does not put the rich fishing grounds at risk? Will foreign investments be allowed to such an extent that most people can gain from this? … 

According to the Korean energy institute, the Liancourt Rocks would, as mentioned, make Korea independent from gas imports for the coming 30 years. Making a “quickie” valuation and looking at the gas demand in Korea, they consume about 42 000 mcm a year, with a yearly growth of around 4 to 5 percent. With that growth, the mentioned 30 year demand implies that the Liancourt Rocks hold some 2.400.000 mcm in untapped gas deposits. And lets say that natural gas prices hold average levels of today the coming years ($250 per mcm), the Liancourt rocks are worth about half a billion USD, in “today’s” money in only gas deposits. That’s like Korea getting another Hankook Tire company (by looking at market cap). 

But it’s not that easy. Extracting the gas is not as simple as fiddeling a straw down there. The gas under the rocks is known as methane hydrates (frozen gas) and it is not yet possible to extract it in commercial quantities and use it as fuel. So the focus has to be on which country will be able to produce the technology. So we’ve got to look at the biggest gas producing companies in each country and the size of  their R&D budget, as to figure out who’s got the most means in figuring out how to transform the methane hydrates into usable material.

Japan will obviously be the strongest when it comes to the number of companies that are able to take the challenge of the gas. Since Korea only has one publicly traded company in that industry, namely Korea Gas Corp. The other two, E1 Gas and Korea National Gas, are both privately held. E1 is a subsidiary to the Chaebol LS-Group, making the exposure to the gas field too small, and the Korea National Oil Company is owned by the Korean government (I think). Japan on the other hand has Inpex and JAPEX, both publicly traded. But Korea tends to have a lot of cards hidden up their sleeves… 

Regarding how much they push into research and development, it’s all over the place. Including exploration expenses, Korea Gas, whom only trades oil and gas today, only has had to push in about 1-2 percent of sales into those costs, whereas JAPEX smashes in 15-19 percent! JAPEX even has a clear strategy communicated regarding development in producing liquid fuel out of methane hydrates. Find it here, with maps and all!

It seems however, that Japan is the most efficient country out of a shareholder viewpoint, as they already have operations set up, which seem to be plug and play in regard to the exploration of methane hydrates under the Liancourt rocks. But at the same time, we don’t know how much the Korean government has hidden under their coat. Korea can create a Chaebol out of thin air from its government portfolio. Privately held corporations in Korea might already have a strategy for production of frozen gas deposits, we just don’t know it yet, and once fields are available, companies like Korea National Oil might become publicly traded to attract foreign capital. But that’s a big “might”. 

The historic viewpoints are way too difficult and equal to compare for me. Either you’d go by US military maps, in favor of Japan, or by a bunch of post war treaties done here in Europe, in favor of Korea. If I had a gun to my head, I’d personally go by the European treaties, like the one held in Potsdam, Germany. Not trying to be the colonial European drawing lines on the map, but it’s a way better consensus than just one country’s military maps. 

Sorry if I offended anyone, but I’m a descendant from culture like this: 

Solution: 

Share the rights to the gas field 50/50. Liancourt consists of two main “rocks” in similar size. How about picking one?.. I don’t know. Invest in JAPEX if it goes to Japan, keep an eye out for other solutions the Korean government provides if it goes to Korea (Korea Gas Corp. does not seem ready by themselves to handle the fields)

A fair way to figure out the value of gold

I’ve been keeping a small part of my portfolio in Gold ETFs. It’s a good idea since you hedge yourself against a number of inflationary outcomes with gold. The valuation of an asset, that does not pay dividends or produce cash flow, the only thing to do is to sow together a demand function on a number of variables, and create a simple equilibrium priced regression model

Variable #1: 10yr US. Bond Rates

The US bond rate does provide the biggest effect on the gold price of all of the assets. Big in size of the price, and also the biggest statistical significance. The effect it gives is of course negative. The higher the interest rate, the higher the gold price. And with bond and commodity markets changing to be massive, so does their interconnection. An rate increase from 2 percent to 3 percent in a ten year government bond, gives a predicted drop in the gold price of $395. I know, I know, you should have made logarithmic interpretations of the dependent and independent variables as to show elastic differences and making the model more general so others can use it… But most people won’t understand that, and it’s an easier interpretation to view it in actual change of dollars (not as solid of a model though)

Variable #2: Ernst & Young Bank Confidence index

You can find that here, on the Ernst&Young webpage. This is an interesting variable since the less confidence one has in the banking industry, you want to hide your money in gold. However, it has quite a low significance. And the effect is rather small. As the index moves up by say, 10 points (on a quarter), the gold price is going to drop by about $25.

Variable #3: ISM index

Or the industrial manufacturing index. Which is the only variable that provides a positive effect on the gold price. Not that big either though, but has a high significance. One point up in that index, would provide a positive move in the gold price by $15. 

The current prediction the model is making is that gold should be worth at the time about $1,703, (It’s trading at $1,722) which is quite accurate. But what would it be worth if we return to “normal” market conditions again? Will it drop to $350/oz again? Probably not. The model predicts a a gold price of about $945 on a stable economy, with a US bond rate of 3.50%, an ISM index of 53.5 and an E&Y financial confidence of 85.0.

So now you might ask I’m holding something I predict is going to drop in value? Well, as I’m predicting the shares I’m holding are going to be worth more, this asset has to go down to account for a stronger economy. I only hold it to ensure myself that if shit hits the fan and the economy goes completely down the drain, that I at least on an asset bound to increase in value under such circumstances. 

Here’s a clip of my model in excel. You’re not going to be able to read it, but there are some nice graphs there and a picture of gold which is nice I guess.