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Reproduced from  a private email by Mahesh Johari:

For most of the last 25 years we (as a nation) have been sold a story about investing in stocks for the long run.  Invest steadily, mindlessly, and over the long run stocks will earn almost 10% annual returns.  By the time this bear market has ended, this notion will be questioned by a great many.

I’ll give all of you a head start.

Let’s quickly review one of the greatest achievements of the past 15 years – the rise of the personal computer and the growth of the Internet.  During this time we saw two giants dominate this market – Intel (NASDAQ: INTC) and Microsoft (NASDAQ: MSFT).  They were the veritable Pippen & Jordan of the tech Bulls dynasty: nearly pure monopolists with gigantic profit margins, huge revenues, and fantastic cash flows.

Today, Intel’s share price closed at $12.08, the same level it was at when I turned 25 years old.  That was almost 12 1/2 years ago.  Let’s look at Intel closely and see what they have to show for this incredible run.

At the end of September in 1996, Intel’s share price was $12.08.  Adjusted for splits, there were 7.14 billion diluted shares outstanding.  The book value per diluted share was $2.09.

We could go into a brief academic debate about why I’m using book value instead of some other measure.  Book value is the accounting net worth of the company.  With some caveats, it is a reflection of value that takes into account all of what the company owns and all of its obligations.  The book value reflects the amount of capital the company has available to deploy productively in the course of business.

I use book value per share because one share of Intel essentially grants you ownership to that amount of book value.  If you simply hold that share, you could imagine that the value backing that share of Intel is growing by the same rate as the book value.  Book value is not influenced by the share price, which can fluctuate wildly with the market.

Compare it to your own situation.  If I asked how you have done financially over the last 12 years, I could look at your net worth 12 years ago, compare to what it is today, and have a pretty good idea of how you fared financially.  It’s the same idea.

Today, Intel’s book value is $6.80 per diluted share.  Over the last 12 1/2 years, it means that Intel has grown book value per diluted share at an annual rate of 9.94%.  Some of you will argue that I am not including dividends that were paid out.  Those dividends have totalled $2.25 over that time frame.  Including dividends, Intel generated annual rates of return of 12.50% over the last 12 1/2 years (assuming you didn’t reinvest the dividends).

That number sounds pretty good.  Until you realize that Intel was a near monopolist operating through one of the highest growth phases of their industry.  Think about that for a minute – a monopolist in a boom was only able to generate 12.50% per year in returns.  What does this imply for the 495 companies in the S&P 500 that are NOT monopolies, and are NOT going to be going through an incredible boom in demand?  A 10% annualized rate of return for the entire market suddenly sounds like a fantasy, doesn’t it?

So what the heck happened?  What about all those studies that touted how stocks would make 9-10% over long periods?  Is 12 1/2 years not long enough?

What happened is what always happens when people blindly follow historical statistics en masse.  The underlying behavioral model changes.  As naive shareholders piled in and stopped paying close attention to how the company was run, profits got transferred from shareholders to employees through stock options and bonuses.  Additional billions were blown on share buybacks at much higher prices.  Looking at the result after more than a decade of shareholder un-friendly behavior, it’s no wonder Intel’s results are mediocre.

The time to buy stocks for the long run will be when those that bought for the long run realize they have been fleeced.  When those people are so disgusted that they sell at low prices and the shareholder outrage forces companies to change their behavior – that is the time to buy stocks for the long run.  Price matters.  That’s how it has always been.

For those who like to check the numbers, I suggest the following:
Intel 2008 Annual 10-K:
http://idea.sec.gov/Archives/edgar/data/50863/000089161809000047/f50771e10vk.htm#301
Intel Q3 2006 10-Q:
http://idea.sec.gov/Archives/edgar/data/50863/0000050863-96-000040.txt
Intel splits (shown on chart):
http://finance.yahoo.com/q/bc?s=INTC&t=my

As a side note, if you actually bought that share of Intel in September of 1996, your rate of return was not 12.50% but 1.38% annually, assuming you didn’t reinvest dividends.  Ouch!

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There is a lot of spew about ‘behavioral economics’, the ‘behavior’ of markets, the psychology of markets, etc., and that ilk in pop media as well as ‘professional’ journals. All bring to mind that you can say almost anything if you don’t have to substantiate it. For the most part these type articles fill the vacuum left by disciples NOT having any scientific and empirical approaches to apply where needed. Most tell the reader little of value and almost all promise to understand the future enough to predict it. Yes, red flags all for those trying to figure what the heck is going on out there [in the world].

Niall Ferguson has written a book “The Ascent of Money” and, far from being a primer on Money 101 from this Harvard faculty member, his book is a set of deposits and balance statements on selected facts on loot, dinero, change, coin, or money and how it works with almost no relevance to the global financial meltdown (1-15-09).

So that you can appreciate the basis of what is going on out there financially and be entertained at the same time, I have enclosed the beautifully done PBS 2 hour documentary for online viewing. It is outstanding! Not in its profundity but in its scope. It was done (filmed, edited and packaged) before the death knell of current markets was sounded and it can’t possible live up to the expectations of those seeing it now through pauper’s glasses who are looking for THE ANSWER

The sections follow a sensible sequence: the history of money, trust, credit, bonds, stocks, insurance, real estate, globalization, hedge funds, computer models of investing, and “behavioral” finance. In reality the whole thing is about behavior; there is less focus on disciples of finance, economics, banking and risk management. See what you think. Let me know and I’ll respond to your thoughts and critiques.


http://www.pbs.org/wnet/ascentofmoney/featured/watch-full-program-the-ascent-of-money/24/

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