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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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Reproduced with permission from a private e-mail from Mahesh Johari

Some quick commentary only today.  The stimulus bill that just passed the House contains a “Buy American” clause, which forces materials purchased using funds from the stimulus package to come from American manufacturers.

Intuitively, this sounds both logical and appealing.  If we’re spending our taxpayer dollars, obviously we want those dollars to be spread throughout our economy.  It makes no sense to pass an economic stimulus package that sends our money to China.  So why not mandate that?

Unfortunately it’s not that simple.  The “Buy American” clause has great political appeal but will do nothing but defer job losses and prolong the overall process of adjustment that we are experiencing.

Here’s why: Let’s imagine (for example) a steel manufacturer in the U.S.  The manufacturer is unable to compete globally because their cost structure is too high.  They are facing the prospect of downsizing, of shuttering excess capacity, of laying off workers.  But wait! Here comes the stimulus package to save the day!

Now this uncompetitive sloth of a firm has a new lifeline.  They can sell their overpriced product to the stimulus package.  They can delay downsizing, cost cuts, and layoffs.  So as long as the stimulus package is around, they can keep being inefficient.  Meanwhile their international competitors are becoming ever more efficient, adjusting themselves to true market conditions.  The competitors are getting better.

When the stimulus package expires, the firm will be right back where it began: uncompetitive and burdened with an unsustainable cost structure.  Then what?  Of course the layoffs will come, the downsizing, etc.  Everything that should have happened will happen, just a year or two later.  The part of the stimulus used to overpay for those American materials will essentially have been used for zero long term benefit.  The overall economic adjustment process will be prolonged.

This type of waste why we have to be very careful when it comes to government spending.  Government spending packages tend to waste a lot of money.  Resources that are wasted produce no long term economic benefit.

So what should we do?  We don’t want companies to willy-nilly send our stimulus dollars to China.  Well, at least not when they can get the same stuff in the United States.

As long as we are creating websites and transparency, let’s go all the way!    We could require any purchases of commodity materials from international vendors to be subject to a domestic competitive bid first.  For example, if Caterpillar feels their most economical source for steel is based in Australia, let’s require them to accept competitive bids from American firms BEFORE they are allowed to place the order to the Australian firm.  If we keep the process open and transparent, it will bring the best American firms out to compete at peak efficiency – a very desirable outcome.

We have to be very careful here.  Subsidizing inefficiency is not the path to prosperity.

Related Blog/News Posts (add by Russ not email author, just for further reading):

CNN on Limbaugh and Obama Package

Perfect Storm?

Retailers on the Ropes

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The answer isn’t so simple.  That’s the theme of this entire blog lately, eh?!

Check out this fun, interactive and very detailed piece from T. Gray.

Stock Market Returns by Presidential Party.

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I was recently told, “War time was not the time to question the existence of God”

Just like the America’s intelligencia tolerated slavery and bigotry in our history, I sometimes get the inkling that we tolerate the hate and superstitions of organized and unorganized religion and its blurring influences because there is never a good time to take on ignorance, mysticism and bigotry.

When the economy is going good, I hear “Thank God” exclaimed on the market floor.

For some, there is never a good time to question the existence of God.

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