The Time Has Come (the Walrus said) Archives

Get with ponz…

Those who remember “Happy Days” would of course remember The Fonz, the coolest dude around. For somebody who was supposed to be about 17 why did he always look to be aged about 30? Ah well, yankee crap.

I had an investment in Great Southern Limited. The timber planations company. That went bust.

NOW, it turns out according to todays Financial Review,  the company was telling a few porkies. They started paying out the proceeds of timber harvesting a few years back, and found the returns were not as good as claimed. So to keep the timber scheme investors happy, they “juiced up” the returns by boosting the payout to existing investors using the funds supplied by new investors.

This is what is known as a Ponzi Scheme, and it is as far as I know illegal.

The best known example is Bernie Madoff who MADE OFF with a few billion dollars in the US, and has just been jailed for about 160 light years.

One has to wonder: why did the Australian regulatory authorities not wise up to the local Ponzi Scheme being run by Great Southern and its management?

And why are they not currently being prosecuted?

These crooks should also be in prison.

In the meantime… I’ve just written out the official notification to serve on the wreckage, asking for my money back. I don’t expect to see it.

And I’ll do a post soon about how much the corporate vultures, otherwise known as Administrators, get paid. That’ll frighten ghosts and have children waking in the night screaming in terror.

I didn’t invest in a tax-driven timber scheme. Just a corporate bond. That actually makes me a creditor to them, not an investor. They owe me back my loan.

Here be a lesson: don’t invest in anything that derives its appeal and business model from a cunning tax planning arrangement. Shades of Baldrick: “I have a cunning plan, my lord”. Look how they always turned out.

Share options and start-ups

Todays Financial Review carries an article whining about the new tax rules on shares options.

A quick summary: The government have changed the tax rules so that shares granted are taxed on receipt, instead of when the shares are eventually sold.

Example (taken directly from the newspaper in another article): Suppose company X has little money and does not want to pay big salaries. So it gives it’s employees share options in the company. The option entitles the person to receive shares at a fixed price at some later date – usually provided certain performance targets are met. The assumption is that the shares will be worth more than is paid for them, and when sold the government gets its slice via capital gains tax and the employee cleans up. This compensates for a lousy salary.

[Just to muddy the waters, examples are being thrown around citing cases where employees receive shares, rather than options, to prove that there will in the long term be less tax paid. Gah. Keep the story consistent, please.]

The particular whinge is for start-ups who want to issue options rather than shares, and do this instead of salary – or in leiu of a larger salary.

The reason the government have changed the rules is simple – it’s a loophole. If an employee is paid in cash, then income tax is paid. If an empl0yee is paid in kind (school fees, house mortgage, etc) then Fringe Benefits tax is paid. So why should the issue of shares or options be any different?

Next… bear with me… Options.

The trouble with options is folk (and especially company directors) think they are somehow magical: they cost the company nothing but give great value to the employee. The ultimate Magic Pudding. The trouble with options is they are a RIGHT to do something at a later time. There is no obligation to exercise the right. (Suppose the share price tanks and is below the price at which the options can be used to buy shares… you’d hardly exercise the options if you could buy cheaper on the open market.) So placing a value on the options is difficult. If the market value rises, the options are worth something. If the market value falls, the options are just a bunch of junk.

So the effect of the changes to the tax law is to make it difficult or expensive to issue options, and doubly so because tax has to be paid up front for something of unknown future value.

Perhaps it’s a good time to get rid of the unscrupulous and immoral practice of issuing options!

If start-up companies REALLY want to give their employees some stake in the company with a future benefit through share sales, they can just fall back on the good old fashioned way. SELL THE EMPLOYEES THE SHARES! This is done all the time. It’s called a Capital Raising.

Furthermore, in a private company, or an unlisted public company – there is no open market, so the share price is whatever the parties agree it should be. There is plenty of scope for selling employees shares at an (agreed) low price. No options. No grant of free shares. No problem. Stop bloody whining.

Thanks for the memories, Sol

Over the years, having sworn never to have mobile phones, we’ve ended up with three of them in the house. All started their lives with Telstra, and today, finally the last of them has been shifted to another carrier.

For a long time, Telstra made sense. The coverage was the best, the infrastrcuture the biggest, and in many cases the competitors just used their stuff anyhow. We don’t use mobiles much, so we tend to try and go on plans with really long pre-payment periods. A year in advance is good if you can get it. Telstra’s plans seemed to gouge $30 a month, or every couple of months. The credit would accumulate because we didn’t use it. But miss a payment and you forfeit the lot.

So we’ve moved, because the dollars add up.

A week ago, the time had come to move the last phone off Telstra. The Oldest Sons phone. To do that we had to unlock the handset, and this is where the tale of madness and ANGRY began.

To unlock the handset, the Lady Of The House had to log into the web site. Trouble is, we use the web site about once a year, and she’d forgotten the password. No problem you cry, just play the game of answer the Seven Silly Questions From Hell and you get a new password. But with questions like “What is your mothers maiden name”, she was then bamboozled. When the account was set up 2 or 3 years ago – were the answers from HER point of view, or from OLDEST SONS point of view?

After getting the answers to the Seven Silly Questions From Hell wrong, the web account was locked out.

Solution – call the enquiries number. This she duly did, and after much waiting and 17 transfers, she had a nice chat to somebody who ran through the Seven Silly Questions From Hell and pretty much read out the answers. So much for checking identity. But, the web account could not be unlocked by the operator.

“It will automatically unlock in 3-4 hours”, she was informed.

That evening, another try resulting in the account still being locked.

More calls to operators, more transfers, and another half hour on the phone led to illuminating help such as “Oh, I can see you have been trying to log in a lot”.

“Well, yes. Your colleague said it would unlock in 3-4 hours.”

“Oh no, that’s not right, the account will take 3-4 days before it unlocks”, came the reply.

“What? 3-4 days? You have to be joking, right?”

“No. 3-4 days.”

“Well, all I want is to unlock the handset so its not locked to the Telstra network any more, can you help me do that?”

“No. Wait till the web services are unlocked and you can log in again.”

Grrrr. Right. Seething anger and burning resentment lit the room. If we could have harnessed this, we could have sent power back into the grid.

I provided tea and sympathy. She Who Must Be Obeyed would not be comforted:  ”The stupid jerks”, she fumed, “I’ll log a complaint.”

So she found the Telstra web site again, and went to the complaints form. Typed up a detailed description of what had transpired, and asked for a simple statement. Yea, verily, a mere clarification. “How long does it take to unlock the web account so I can log in again?”.

Submitting The Question That Shall Not Be Mentioned, the web system promptly came back with an error. A Parse Error. Clearly, the web system is broken. But who knows – maybe The Question That Shall Not Be Mentioned was submitted anyway?

And thus came back the answer, an email from the gods of Telstra. An email full of waffle cut-n-pasted from the Handbook Of Corporate Waffle, providing Yet Another Phone Number To Call For Customer Service In The Bowels Of Telsra. But not answering the question.

And thus began the email exchange. A reply was duly dispatched, stating that the answer provided by Providence and the Bountiful Gods Of Telstra was somewhat inadequate, seeing as it had not answered the question.

The email ping-pong continued for some days, each time new phone numbers being provided, and at no time giving an answer, to a question which had now assumed proportions akin the search by the ancient alchemists for the turning of water into wine, or the ponderings of the meaning of life. Only a number – you might think – only a number! But no, in the annals of Telstra, the Account Lockout Period is a closely guarded secret – transferred from one CEO to another, but only behind locked doors and when there  is a full moon.

And thus, a calm came upon the land, and the Family Of The Dump were silent and mollified, having temporarily given up on trying to tame the Telstra Dragon. Defeated, but not yet deterred, we quitely bided our time. We waited the allotted 3 to 4 days, and then some. Which brings us to today.

Today – The Lady Of The House spent another 2 hours on the phone, trying to report that the web site is broken. On each attempted “I’ll just transfer you”, she would shriek “No… I’ll NOT BE TRANSFERRED. Take down my complaint, you stupid and compliant oaf.” They didn’t like that much.

But today also, Providence and The Gods Of Telstra had deemed that the internet account woudl unlock. Like opening the Great Doors Of The Temple Of Doom, it was now possible to access the holiest of holys, The Telstra Account Site.

And so it was done that the handset could be unlocked from the Network Of the Omnipotent One, for the payment of a small fee. Strangely enough, Yet Another Phone Number In The Maw Of The Telstra Monster had to be called! But at no time did it actually ask for the credit card number, to which The Fee would be charged.

And thus, it came to pass, that by this evening the phone was freed from its tyranny, and transferred to the land of Vodafone, where an accumulation of Free Vodafone Minutes will likely see its cost drop to $50 a year. And have as parent a web site that works. And operators who answer questions , and make things work. All on  single number. Finally. After two weeks of pain and suffering.

————

There’s a bitter lesson for the next Telstra CEO in all this. Mr Sol, the current and outgoing CEO, takes great pride in reducing the number Telstra information systems, from something like 250, to about 20.

Trouble is, Sol, you forgot a couple of really important things. The staff don’t have a clue what’s going on. You changed things so fast you left the people behind. And you have so many toll-free customer service numbers that nobody has a clue which to call, when, and for what.

Oh – and your web site is still stuffed for logging a complaint!

I’ll be selling my Telstra shares. It’s no longer getting with the strength, it’s getting with the organisation that’s been F@#$ed.

Where has all the productivity growth gone?

Over on the Value Investing blog, James Carlisle asks “Where has all the productivity growth gone?”

Over the last 20 years or more we’ve been told that employee productivity – that is, us workers, has grown by something like 3% or more a year. Part of this has been due to productivity aids like automation, IT systems, removal of beaurocracy, less layers of management, and so on and on.

The commonly accepted wisdom is that IT systems (the PC on every desk, fuelled up with software from Mr Gates and others) have driven most of the gains.

I posted a long comment, which I reproduce below in slightly edited form, in which I argue that most of the gains are either illusory, delusional, or one-off in nature.

————-

I expect a great deal of the claimed productivity growth to be illusory – the product of the fevered imagings of managers, economists, and the salesmen for IT companies.

We can split an analysis into 3 main activities in the broader economy:
- Administration, support and services
- Design and development
- Manufacturing

Administration, support & services

In general, jobs like waiting tables, doing tax, purchasing paper clips for the office and so on have not changed a great deal. A waiter can only walk so fast, doing tax gets more complex not less (though spreadsheets help to even the score a bit here), and purchasing is still purchasing.

The methods of doing these things might have changed a little: waiters have point of sale computer systems – but these primarily remove error, they don’t get orders in a kitchen faster, they don’t get meals cooked faster. A purchase order is still a purchase order. The typing pools for those disappeared in the 1980s, so IT systems have done the work for over 20 years. Some suppliers now allow on-line orders – but hasn’t this just replaced the phone call?

So in all these parts of the economy, which I collectively lump together as “services”, productivity gains have been pretty small. There may have been some one-off gains back in the 1980’s, but since then there is not really a lot more left to wring out.

Product Design and development

Once upon a time, before the days of the PC on every desk – in other words prior to about 1990 for you young ‘uns, things got done. Smart folk designed washing machines and bits of electronics, and bridges and buildings. Sure it was all done on drawing boards with ink, and the clever guys stood around a blackboard arguing the merits of their ideas. Paper based design documents were slow and painful to produce, and kept to the bare essentials.

Now we have computer systems that make it easier and faster to write software, design electronics, and design bridges, buildings, widgets and what-not. We have CAD packages and software source management systems, electronic circuits can be designed using software that’s free on a $1000 PC instead of needing a mainframe in a room full of white coated keepers.

At the same time, though, the complexity has increased (compare a car or washing machine of today and 20 years ago). In addition, the ligitious nature of our society means that more needs to be taken into account, more documentation produced and archived in case of legal action.

So there have been huge productivity gains in all the product design activities, across all the disciplines, but these are again mainly one-off in nature and are counterbalanced by demands for the thingies being designed to do more.

Then there are the costs – you need systems and processes in place to backup the data, run the IT systems, archive documents, repair breakdowns, install data lines, service the UPS, and so on. There are now a whole range of essential service provision jobs that did not even exist 20 years ago, and they need to be paid for from something.

Let’s also mention email – something that didn’t exist years ago. Sure, it replaced the inter-office memo. But you generally only ever made a couple of copies, you didn’t send then to 10 or 20 people including the big boss fellas just to make the recipient look bad. Modern managers can receive 20 to 200 emails a day, and it’s very easy to spend 2, 3 or 4 hours every single day just reading and responding to email. The modern miracle of email with instant delivery has been one of the biggest productivity-destroyers in the history of the universe!

And with the PC and internet on every desk, now it’s very easy for people spend their day at work playing solitaire and reading the news sites. I personally don’t think design and development productivity has increased, overall, AT ALL in the last 20 years. The combination of easy goofing off, tools to remove drudgery, greater support costs, and greater demands all balance out.

Finally, and fundamentally, you can’t make people think or innovate faster in spite of books by Bill Gates. Ideas come about at the rate and times that ideas come about.

Manufacturing

There have been numerous gains over the years, with automation robots, and moving it all to low labour-cost countries. Sometimes the gains there are illusory too: for example, transport can eat up all the gains you made from a lower labour cost. And if that doesn’t stiff you, exchange rates can bite you instead.

But especially in manufacturing, any savings due to productivity drive competition. Competition allows one maker to offer a lower price and increase market share – and all manufacturers are forced to play a game descending the ever-decreasing spiral of  lower prices.

Here’s an example. I bought a dishwasher 20 years ago, and it cost me $1000 on discount. It died 2 years ago so I bought a replacement, which cost me $600 on discount. They both do exactly the same job, they are both base models without frills. In real terms the price paid for that dishwasher has more than halved in a period of about 15 to 17 years.

So any productivity gains in manufacture didn’t end up with the manufacturer, or their shareholders. Those gains materialised as lower prices and consumers took the benefit.

Conclusion

There have been big productivity gains in manufacture that go to consumers, small if any gains in design and development, and little or no real gains anywhere else.

I’m also deeply suspicious of those who claim general long term productivity gains, especially over the last 20 years. I get that Mandy Rice-Davies feeling: “well, he would say that, wouldn’t he”.

It’s all about the confidence, stupid

Groan, moan: it’s the end of the world! The banks are going to collapse and we’ll lose all our savings. Pull yer money out now and sock it under the mattress. Oh!! And we’ll all be murdered in our beds!

Endless stories of the worst financial crisis since 1929 are beginning to wear a bit thin.

Has the amount of MONEY in the world suddenly decreased? NO!

What’s happening right now comes from 3 things:

1. The dumbo yankees loaned a whole buncha money to a bunch of useless suckers who never had a chance of paying it back. These people bought houses and then could not meet the payments, so walked out. Banks left with empty houses is NOT a good look, especially if you can’t sell them to somebody else. A building industry that kept building in the face of evidence that the houses could not be paid for did not help.

2. Following on 1, the bankers left holding the derelect houses lost a bit ‘a repsect from the other bankers, so confidence in lending between bankers took a bit of a hit.

3. Following on from 2, the loss of confidence has led to a desire to be a bit more careful about loaning money to ANYBODY – and to demanding higher interest (the “risk premium”) for the privelige.

This sequence of steps leads to an economic contraction, and as confidence drops and the lack of confidence spreads, the money (which amount has not changed) ends up being stuffed in socks or kept under the metaphorical bed instead of circulating in the economy. Money that does not circulate has a big effect – a long time ago the effect of spending $1 was roughly calculated (I think by John Maynard Keynes) as creating about $2.50 of economic social activity. So withdrawing money from circulation sucks.

Somewhere along the way, the Irish Government decided to guarantee all bank deposits. This is fine for boosting local confidence and avoiding a run on the local banks. Oh damn! There is a downside: The smart money all promptly moves to where the guarnantee is. This is why government guarantees have suddenly sprung up in Europe, UK, USA and now here in the tin-pot great-brown land of OZ. If you want to keep capital in a country, you have to play the same games – sensible or otherwise – that everybody else is playing.

A lack of confidence has other symptoms: share markets fall. Share markets have an inherent higher risk than cash, a fact which is forgotten during boom times. But when confidence wanes, the money gets pulled out to stick in cash management or term deposits. The effect of many sellers and less buyers is the same as in any other market subject to such forces: prices fall. For the last 15 years, share market investors have known good times and rising share prices. Bad times, when they came, were brief. Compacency and an expectation of double-digit returns every year, forever, were the expected norm. Suddenly, these investors have seen the good times stop, and they are bailing out in droves – desperate to avoid further losses. Prices fall.

Funny thing about a share market loss: you only lose money when you sell.

It all highlights the difference between price and value: PRICE IS WHAT YOU PAY. VALUE IS WHAT YOU GET. During a panic, the sellers don’t care so much about price or value, they’re spooked and care only about getting out. Which seems like a good time to buy… when you can see the whites of their eyes and smell the fear!

Confidence will come back, the money will start to circulate again. But right now we also need the dumb-as-shit politicians to shut the hell up and stop whining, the journalists likewise. They are in danger of making the situation far worse by eroding confidence further and creating a self-fulfilling prophesy.

The Fund Damagers Cometh – again

I’ve previously had a spray at Fund Damagers. Today whilst confined indoors after being blessed by a visit from the Snot Fairy, I did the latest numbers.

My own investment, which carries no management fees, has given a total increase in portfolio value of a mere 10%. This is a difficult figure to do anything meaningful with because there are things there that have been bought anytime between 10 days and 10 years. In fact, I’ve lost a fortune in what I’ve been buying in the last 12 months. The downturn in stockmarkets has been pretty severe.

Nevertheless, let’s compare that with the returns from the 3 managed funds that I have invested in as well:

Fund 1: Increase in Funds Under Management: -24.8%

Fund 2: Increase in Funds Under Management: -33.75%

Fund 3: Increase in Funds Under Management: -2.36%

Yes, that’s right, the returns are ALL NEGATIVE.

All of the managed funds are now worth less than I paid. In all cases, I bought into those funds during 2002. You’d think that with the good times that have been, the funds would be streets ahead, even with the stock markets being down.

Now, will the Fund Managers Damagers give back any of those fees they have been using to buy their BMW’s? I don’t think so!

Fund Managers win irrespective of the market because they just charge a percentage of funds under their management. These fees will have fallen, but the point is: If I lose, they win. If I win, they win. Something is not right here.

Reason for buying a few managed funds: To set aside a few quid to pay the HECS fees should the chaps decide to go on to University. I’d have done better to have put the money in a term deposit.

I shudder to think what the superannuation statement will look like :(

Super idea… not!

Like many employees of big companies, lats year I took up the offer of buying shares in the employee share plan. Bear in mind, though, these are not Australian shares, they are for a large foreign company and are listed on a large foreign stock exchange. So DOING anything with the shares is difficult at best, but they are also locked away for 5 years anyhow. To add insult to injury, the price dropped 20% just after the allocation day.

Then the other day I got talking to my accountant. He pointed out, quite rightly, that this is madness.

The shares in the employee plan are paid for, by me, from my after-tax salary.

I could salary sacrifice a superannuation contribution from my pre-tax earnings and the benefit would be far greater.

For the sake of illustration:

- Lets assume I’m on the 40% marginal tax rate

- Lets assume I purchase $5000 in shares.

That $5000 comes from my after tax salary, so I had to earn $5000 / 0.6 = $8333.

And any earnings from those shares are also taxed at my marginal rate of 40%.

Now assume instead that I make a salary sacrifice into my super fund. The contribution tax is 15%.

So to get the same DOLLAR VALUE INVESTED, I need to salary sacrifice $5000 / 0.85 = $5882 (this puts $5000 after contributions tax into my super account).

And seeing as I did a salary sacrifice, my pre-tax income dropped by that $5882, meaning I don’t pay tax on any of that money. So my tax bill will reduce by 40% of $5882, or $2352.

Another way to look at it: I could instead contribute $8333 from my pre-tax earnings (the drop in my take-home would then be the same as buying the shares in the employee share plan). I’d lose 15% of that amount in contributions tax (leaving me with $7083 added to the fund). So my INVESTED VALUE is over $2000 MORE. Considering we started with the proposition of making a $5000 investment, the benefit of a pre-tax contribution to super is giving me $2000 more to invest!!

The effect of a salary sacrifice into super is dramatic: you pay less tax, the amount of money you can set aside for your dotage is significantly higher. For the rich folk on the higher tax rates, the effects are even more pronounced.

Looks like the employee share plan kind of sucks, really.

Banks ‘n Loans – Revisited

Duncan has a bit of a spray at banks raising their loan rates at greater than the increases being applied by the Reserve Bank.

But actually, if you look at both history and the current environment, its hardly surprising.

The History Lesson

Once upon a time, a long time ago, when knights were bold and maidens were fair… you get the idea. Anyhow, if you wanted a home loan you went to a bank. The banks raised funds from depositors and in wholesale markets (the money market and so on). The banks had to make their profit from the Spread - the difference between what they loaned money for, and what they paid depositors or on the wholesale market.

Then, a few years ago, along came deregulation and the emergence of the non-bank lenders. These guys ONLY raised wholesale money, either in the wholesale markets or by borrowing huge sums from a big bank and then slicing and dicing it into little chunks. The non-bank lenders also packaged mortgages into loan books and sold them off (called Securitising), leading to the stories of the mythical Belgian Dentists who earned a tidy income from owning a portfolio of Australian home loans.

The emergence of the non-bank lenders gave the banks serious competition. Over the last 15 years, the spread (that’s the difference between the loan and the deposit rates) has roughly halved.

And now folks… the Current Environment

Back in about August 2007, a bunch of clever dicks in the USA suddenly realised the Emporer had no clothes.

Until then, they had been making large numbers of home loans to people who could not pay. These were of an even lower standard than the Australian “low-doc” loans. These were to people who never had a hope in hell of paying. In the parlance, they were “sub-prime” loans. But the game was about making loans and collecting fees and to hell with tomorrow.

houseofcards.jpgTo help keep the merry-go-round spinning merrily, these loans were packaged (securitised, as above) and sold off all over the place. A bunch of even cleverer folks made managed funds out of packages of these crappy loans, and sold the funds. And on and on the game went. Some of these low quality loans were tucked and folded so many times they even became classed as high quality, such was the obscurity! Lots of yummy fees collected, but eventually the house of cards came a-falling down. Along the way, a few methaphors were mixed as well.

All it took was a bit of an economic slowdown in the USA, and those people who struggled to may their mortgages simply stopped paying. A lot just walked out of their homes. In that kind of environment, there are no buyers so house prices have tumbled, and an economic decline spiral has started. When the borrowers don’t pay, suddenly all those people with sub-prime loans, and funds, and what-not stop receiving an income and want to know why.

Poof! Like Merlin waving the magic wand, the light of realisation suddenly appears as people realise their “investment” was merely an illusion.

Like they have been in everything else, the politicians and leaders in the USA are completely incompetent – even if they knew what to do, they can’t fix this mess overnight. They allowed it to happen over a period of many years, and many years is what it will take to fix. At the moment they are in denial – just listen to President Bush.

In this environment, there is no confidence in any markets for anybody who wants to borrow money. There is still money available to borrowers, just a lot less of it, at much higher interest rates.

Because the lenders have generally departed, leaving only a cloud of dust and the sound of receding running shoes, the unravelling is spreading. Now, any company with large amounts of short term debt is considered suspect, irrespective of the assurances they give about having sources of funding lined up. (Witness the declines of Allco, ABC Learning, Asciano, RAMS and many many more). Funding is harder to get, and bankers are about the only sources left – and they are nervous.

So we’ve seen massive declines in the share market, as companies with large loans (called “highly geared”) have had to reassure investors that they can survive. They try, but it’s not working very well. The loss of confidence is contagious.

For the poor old home owner, the tables have turned. The non-bank lenders have no easy sources of funds – apart from our friends the big banks. They can’t borrow on the wholesale market – because there isn’t one for the likes of them. The only wholesale money market left is for the banks – big, solid, and dependable. And the rates being charged are higher.

The banks don’t source all the funds they loan out from depositors, much has to come from those wholesale markets. When the rates there go up, the banks only have two choices: absorb it, reducing returns to shareholders; or pass them on to customers, increasing their pain.

And that is why the banks are raising rates at greater than the rate set by the Reserve Bank.

Cos the money they are loaning out is costing them more.

Banks ‘n Loans

This has to be my quote of the week:

Warren Buffet in the Berkshire Hathaway annual report and letter to shareholders:

Some major financial institutions have, however, experienced staggering problems because they engaged in the “weakened lending practices” I described in last year’s letter. John Stumpf, CEO of Wells Fargo, aptly dissected the recent behavior of many lenders: “It is interesting that the industry has invented new ways to lose money when the old ways seemed to work just fine.

(My emphasis)

And this isn’t far behind:

Now let’s move to the gruesome. The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.

The airline industry’s demand for capital ever since that first flight has been insatiable. Investors have poured money into a bottomless pit, attracted by growth when they should have been repelled by it.

:)

Eddy all fall down go boom

Today shares in ABC Learning (Australia’s biggest operator of child-care centres) took a dive. Reason: the company is loaded with debt, and at the moment any company with lots of debt is suddenly on the nose and the shares are sold down.

Only a few months ago, ABC Learning was one of the stars, could do no wrong, onward and upward forever.

A few observations:

- Hedge Funds seem to be indulging in blatant market manipulation by finding companies where the management have a lot of shares secured against borrowed money (”on margin”), then by clever buying and selling they can trigger a “margin call” resulting in a forced sale by said management. The forced sale drives the price down further, the Hedge Fund can buy at the lower price and make a tidy profit – especially if using short selling. Sooner or later this kind of market manipulation will have to be examined and probably outlawed, because not all market players are equal. Those who have a lot of money can screw those who don’t, and those in the know on the strategy win while the little guys lose. Once this was called insider trading, now there is nobody on the inside, merely somebody on the outside who can change the market dynamic so radically they might as well be on the inside.

- Large amounts of debt have always carried a higher risk. A benign environment has meant that companies and individuals have got away with it for so long that when the environment changes they are like rabbits in the headlights: confused and wondering where it all went wrong, just before being smashed into little bits. That said, though, careful use of debt has had a useful place for a long time, and will continue to do so. There seems to be a degree of market overreaction at the moment.

- (and finally) I’ve always been a bit suspicious of ABC Learning. They have grown very rapidly in a fairly capital intensive business (all that real estate… unless its leased) and (probably worse) they have a very high dependence on the government subsidies for child care. For a big owner of ABC Learning shares, a change in government policy is all that stands between a nice dividend, and wondering how to put bread on the table. That level of dependence on government largesse has always left me feeling a bit underwhelmed.

Who knows where the credit crunch will take us, and how many more companies will suffer terrible falls in share prices. And who knows how many companies will be so badly hit that they end up being broken up and sold off at bargain prices, where the shareholders get next to nothing. Such is the way of market upsets. All a good argument for having a diversified portfolio of carefully run companies.

Fund Damagers

It’s probably no secret (just go read some of the “Pages” off on the right hand side, about money and investing) that I’m no great fan of Fund Managers.

Fund Damagers is what I normally call them, a bunch of blood-sucking leaches.

There are a rare few who don’t, but most – the majority – of managed funds charge a management fee. This fee is usually structured as a percentage of funds under management. Some add a performance fee.

The effect of these fees is that the fund manager gets paid out of your money, even if they make your investment go backwards, because they take a percentage of funds under management. And in the good times they still take that fee, as well as helping themselves to a portion of the “outperformance”.

The net effect of this is that the chaps from the fund manager get to drive a new Beemer each year, because you and I pay for it come what may.

So…

In spite of my dislike of Fund Damagers, 5 years ago I tipped some money into 3 managed funds. I did this to build a fund for the children’s education – figuring that I’ll try and invest my own money for my future but in case I screw it up, I’ll rely on the much-lauded, much applauded fund managers to safely handle a few quid to pay the kids HECS fees when they need it.

Measuring fund managers performance in good times is a pointless exercise, because even a dead donkey can make money in a rising market. Measuring fund managers performance in bad times sorts out the wheat from the chaff.

Now, 5 years after investing with those funds, we are in the midst of the current market meltdown, so its a good time to reflect on their performance.

Each fund was bought at the same time – 5 years ago, all within about a 3 or 4 month period.

Each fund is set up so that the fund distributions are reinvested.

So how have our funds gone?

  Fund 1 Fund 2 Fund 3
Amount Invested $3330 $3853 $9504
Current Value $3274 $4443 $9439

The amount invested includes the distributions from the funds over the 5 years, so the original amounts were less. However, I pay tax on the distributions and the tax paid is not included here.

What this shows is that the fund managers, over 5 years, have gone backwards in 2 of the 3 cases. When the tax I pay is taken into account, they have all gone backwards.

Thank you, Fund Damagers!

I thought it appropriate to remark on the performance, because it’s the time of year when the Fund Managers evaluate their performance and go on an orgy of self-congratulation about how well they have done, and hand out awards for the best performing fund in the last year.

Perhaps they should look at total return over a longer period!

Buffettisms, 2007

From this years letter to shareholders by Warren Buffett, CEO of Berkshire Hathaway…

Regarding directors of companies:

… many directors who are now deemed independent by various authorities and observers are far from that, relying heavily as they do on directors’ fees to maintain their standard of living. These payments, which come in many forms, often range between $150,000 and $250,000 annually, compensation that may approach or even exceed all other income of the “independent” director. And – surprise, surprise – director compensation has soared in recent years, pushed up by recommendations from corporate America’s favorite consultant, Ratchet, Ratchet and Bingo. (The name may be phony, but the action it conveys is not.)

Regarding the size of the corporate office (this from a company with revenue of over US$80 billion!):

Our federal return last year, we should add, ran to 9,386 pages. To handle this filing, state and foreign tax returns, a myriad of SEC requirements, and all of the other matters involved in running Berkshire, we have gone all the way up to 19 employees at World Headquarters.

This crew occupies 9,708 square feet of space, and Charlie – at World Headquarters West in Los Angeles – uses another 655 square feet. Our home-office payroll, including benefits and counting both locations, totaled $3,531,978 last year. We’re careful when spending your money.

(By the way, 655 square feet is 60 square metres, or roughly an office 7 x 8 metres. And 9708 square feet is 900 square metres, or roughly 30 x 30 metres, which is NOT MUCH to fit 19 staff into.)

Further on executive pay at companies:

CEO perks at one company are quickly copied elsewhere. “All the other kids have one” may seem a thought too juvenile to use as a rationale in the boardroom. But consultants employ precisely this argument, phrased more elegantly of course, when they make recommendations to comp committees.

You can find the full 36 page letter to shareholders here. Every year it makes good reading, and should be mandatory for boards and CEOs everywhere, for it candour, honesty and simplicity of presentation.

Woz this ‘ere Future Fund all ’bout then, dudes?

A couple of colleagues have been asking questions about Howard and Costello’s Future Fund. They were under the impression that it is some bucket of money set aside for the public good at some time in the future.

Well… chaps…, it’s nothing of the sort.

In short, the Future Fund is a bucket of money to be managed for the purpose of paying the Commonwealth Government unfunded Superannuation.

Gosh, that’s a mouthful. Before you all go to sleep from boredom, WozzItAwlMean?

  • The Commonwealth Government is the Feds. That’s the mob what’s in Canberra.
  • The Superannuation is the wodge of money paid to retired employees of the Federal Government. Superannuation pensions and lump sum super payouts.
  • The UNFUNDED part comes about because some (but by no means all) employees of the Government have a special type of super scheme called a “defined benefit” scheme – whereby they get a certain amount of money irrespective of how much they tipped in. More below.

Now for some more breakdown, details and analysis.

Who gets the benefit, and how, and why?

The money held by the Future Fund will be used to pay pensions and lump sum super payouts to former public servants, judges, and politicians who are in defined-benefit super schemes.

Erk – lost you again?

Public servants employed after about 1989 are not in a defined benefit scheme. In about 1989 or thereabouts, the old CSS (Commonwealth Super Scheme) was terminated for new entrants. From that time new employees are forced to join the PSS. The PSS the new super scheme, and it is a contribution scheme just like most private companies run.

Those in the PSS just get out of super what they put in, so new public servants after about 1989 are PSS members. Those PSS members do not, never have, and can never create an unfunded superannuation drain for the Federal Government.

The number of members of the old CSS is ever declining as those already retired die. There are many members and former employees (like me, for example) who have kept our CSS benefits. Imagine a 20 year-old in 1989 who stayed in the CSS. Now they are about 40. In another 20 years or so they will retire and take a benefit (payout).

Why did many stay in the CSS? Simply, the CSS benefits are defined as a multiple of your final average salary plus contributions made, so its a good deal! This is the unfunded part. The portion not paid by the members earnings has to come from somewhere, and that somewhere is government taxes.

So is the unfunded liability a big nasty problem waiting to bite the Government?

No. Never was, and because the number of people who need to be paid under the old schemes is declining, it will become progressively less and less a problem in future.

The important points to remember here are that:

  • The CSS had been running for many, many years and the amounts paid out were always manageable. The term “unfunded” is technically accurate but used effectively to create an emotional feeling of a bad, evil, never-ending drain.
  • One group of major beneficiaries of unfunded super systems are politicians, who have a different super scheme to public servants. Pollies are not in the CSS or PSS, they are in something different again. It was very generous until Mark Latham got some changes. As far as I know it is still a defined benefit scheme, its just less generous than it was. (I may be corrected on this point – it may have changed to an accumulation scheme).

Pretty much every economist, commentator, analyst or scribe who has looked at the Commonwealth superannuation liability has concluded that the Future Fund is not needed. Remember – the amounts that need to be paid out have been in decline for nearly 20 years and will continue to decline.

So why has it been set up?

The reasons are partly political and partly financial.

Let’s start with the financial, and move on to the more contentious part.

Part the first: It all comes down to Bonds.

A Bond is a financial thingy whereby you loan your money to the issuer of the bond for a fixed period(usually some number of years), and in return you are paid interest. At the end of the term the original money is repaid. Notice that bonds do not pay back more at the end to compensate for inflation.

Once upon a time, Governments used to fund major works, or just day to day expenditure, by issuing Government Bonds.

Because Governments rarely go bankrupt, the risk associated with a Government Bond is considered to be so low as to be negligible.

This has created a method of benchmarking financial products, and evaluating financial risk.

You simply compare against the 10-year Government Bond rate, which is considered to be a risk-free rate.

Therefore, anything paying less is silly, might as well buy Government Bonds. Anything paying more by definition has a higher risk.

Now the fun starts…

Mr Howard and Costello have run such large Government surpluses in the last few years that they are very close to paying off all of the Commonwealth Government debt.

This creates a conundrum for the financial markets – how to you price debt, and risk, and investments, when you have no Government Bond rate to compare against?

Solution: Don’t use all those surpluses to pay of debt, dump it somewhere else instead. But where, oh where?

Part the second: Politically, Howard and Cossie have the imagination of small dead ferrets*. The dosh could be spent on all manner of nation building:

  • Fancy a high speed rail system between Syderney, Melbourne and Canberra?
  • How about lower cost education?
  • Why not build some humungous pipelines from far north Queensland, heading south, to bring cheap water to the masses instead of expensive desalination plants?

And I’m sure you can dream up a few more.

But sadly, the powers that be in Canberra don’t want to spend anything on building a legacy for the future of the country. One has to wonder why.

So with all this money sloshing around there are two things that matter. Handing out tax cuts before each election (makes for a good poll result), and making DAMN SURE that if Labor get elected, they can’t get hold of it.

Suddenly, after months of hand-wringing by the financial sooth-sayers, the light-bulb moment occurred, something like this:

TING! (thats the light bulb turning on – use your imagination)

PC: Let’s make a fund, a special fund, where we can say the Government doesn’t really have the money any more. Let’s tip it all in there. Let’s invest it!

TING! (the second)

PC: Let’s use it to pay for super… all those aged evil public servants sucking at the public teat, we can palm them off and blame them for having to do this! And (shh) those pollies on their big post-parliamentary pensions. What a neat way of funding them!

JH: And look, it means it’s special money. Labor will get crucified if they try to raid it! Woo-hoo!

PC: And wow – now we still have Government Bonds and the financial marketeers can sleep easy.

JH: Noice one!

(Howard and Cossie give high-fives and sail happily off into the sunset)

———

* Small dead ferrets – with thanks to my uni fried Geoff who used this term whenever he possibly could.

Interesting market – at last

The share market has finally started to get interesting.

For that last 2 years its been pretty much month on month rises, where any turkey can make money buying and flogging a bit later.

Now it has finally started to get intesting again. Some prices are not rising so much any more, some are falling, some just bouncing around a bit. Companies have been reporting big profits and their prices have been going down instead of up.

This is a market I kind of like… When others are losing confidence and driving prices down, it’s a time that I’m beginning to get interesting in buying.

I’ve recently bought a few shares in a company that I’ve been watching for 6 years. That’s a long wait for the price to enter a zone I consider reasonable!

Now I’ve noticed that some of the listed property and infrastructure trusts are selling for less than their asset backing – most have been selling at a premium for the last few years. Why would you pay $1.20 for $1.00 of value? Finally tere seem to be a few cases that seem more like paying $0.80 for $1.00 of value. That’s interesting!

At last! Nice!

American express… why?

I received yet another unsolicted offer for a credit card yesterday.

Today’s turn is from American Express, where by their amazing good graces I’ve been “pre-approved” for a Gold Card with a A$50,000 limit, and no annual fees, ever.

It looks vaguely tempting – the intersest rate is lower than the card I have at the moment.

Then… thinking… but I don’t pay any interest on my current card because I pay it off in full every month anyhow. And I don’t pay fees on it. And it only has a small credit limit ($2K?) to force me to stay disciplined.

What on earth would I want a credit card with a $50K limit for?

If I were stupid enough to spend that much, there is no magic puddling to pay it off, I’d still be a wage slave for years, even with their 12% interest rate.

I guess these things are attractive to some people, but I think I’ll keep going the boring old-fashioned way and just save up for the (few) things I want rather than using credit.

But that brings up the next questions:

How do these people know my address?

Where did they get it from?

How do they get some idea of my salary to offer me a “pre-approved” card?

How do I make them go away forever?

Build your own financial fortress

A good simple article from “The Intelligent Investor” magazine.

Build your own financial fortress.

Worth a read.

A dead donkey can make money in a rising market

I’ve just been doing a periodic grinding of the numbers for the family fortune (ha ha, cries of hysteric laughter). This being the small amount we’ve managed to stash in the share market over the last 15 years or so.

I’m using a marvellous magical software program that tracks shares owned, dividends received, and changes in market value. Based on the calculations done by this thing, the family fortune has delivered some interesting returns:

Total Return (since inception): 50%

1 -Year return: 26.9%

The total return figure is a bit hard to get the head around. It’s the total income received + the total change in market value, calculated for each share since original purchase. It does not include things that have been sold where a capital gain or loss has been made, so its a bit misleading. It is not an annualised compounding rate of return (which is harder to calculate but a much more interesting number).

Of more interest is the 1 year figure, especially seeing as not all this years dividends have been come in yet. The figure of nearly 27% means that the investments + change in market value for the last year have returned… yes, 27%. This includes the results from the investment decisions that bombed badly.

These results are not gained using anything clever. No options, no contracts for difference, no warrants, no short selling. Just buy and hold, based on reading the newspaper and subscribing to one of the market tip-sheets.

On this last point, I often disagree with the tip-sheet, but it does make interesting reading and helps to give some idea of a thought process to use.

Has your managed fund returned 27% in the last year? And if it came close, how much did you pay in fees to keep the fund damagers in their BMWs?

Has your clever trading strategy returned 27% for a typical hands-on amount of work of under an hour a month?

These kind of return figures are both exciting and frightening. They are exciting because it’s nice to see the investments grow, and it vindicates the thought process used in making the investments.

The returns are frightening because it leads to complacency – an expectation that this will happen each and every year (it won’t!).

More generally, the fact that such returns are available leads to the current rash of “investment” touts who push greedy unsuspecting mugs into markets they don’t really understand.

When markets are rising, making a good number is easy. When markets fall, which they inevitably will, many will lose their nerve… and their shirts… or more. There will yet be much wailing and gnashing of teeth!

Personal Finance Software #3

After getting quite grumpy, they emailed me back to say they would send my request on to the software developers :)

I had to get quite nasty, though…


Read the rest of this entry »

Software technical support reply?

No reply from the technical support people selling that software…

If I don’t get a reply soon, I’ll switch to phase 2, which involves writing letters to their Chairman and CEO. It’s easy to find this information for an Australian listed company.

Personal Finance Software (again)

I’ve just bought an upgrade to the latest version of some personal financial management software.

I can’t name names for fear of being sued for defamation (but send me an email if you want to know what it is).

The new version gives different results in reports to the old version.

The old version gives correct results for short term and long term gains in capital gains reports, and makes preparing that part of a tax return quite easy.

The new version gets the short term / long term split wrong under some circumstances. The result is that depending on the transactions, you might end up paying too much or too little tax. [Come audit time, the ATO take a pretty dim view on people who understate their income, so a bad calculation by this program ain't a good thing!]

So far my experience in reporting this as a bug to their technical support has not been fruitful, to put it mildly. A nastygram has now been despatched.

I’ll post further updates as they happen.

In the meantime I’m planning my strategy for when their technical support tell me for the second time to either naff off or pay $4.90 per minute to ring them.

Derivatives

For all you investors and wanna-be investors out there, be like Elmer Fudd: be vewy vewy careful… of derivatives.

Derivatives can make you a profit, but you need a great deal of skill and time to do so. You also need to be happy to carry high levels of risk, and to wear very large losses.

What is a derivative? Anything that’s not a hard, tangible asset. Examples that quickly spring to mind: options and contracts for difference (CFDs).

For fear of legal action I cannot mention the names of companies touting “schemes” to make you rich by trading in derivatives.

Instead I’ll quote some wise words from Warren Buffet in his 2004 annual letter to shareholders:

Though derivative instruments are purported to be highly liquid and … we have had the benefit of a benign market while liquidating ours … Like Hell, derivative trading is easy to enter but difficult to leave. (Other similarities come to mind as well.)

The real test of the earning power of a derivatives operation is what it achieves after operating for an extended period in a no-growth mode. You only learn who has been swimming naked when the tide goes out.”

In the Australian market in the last couple of years, a dead donkey could show a profit. The real test (as above) is to look at performance when markets are flat or falling.

——–

Warren Buffet is Chairman and CEO of Berkshire Hathaway, Inc, and one of the worlds richest people. He built his fortune (and that of his shareholders) purely by careful investment in the share market.

A virtuous circle

Been thinking a bit about investing and borrowing.

Using a margin loan to buy shares, the shares bought are used as security for the loan. It’s much like buying a house – the house can be sold to pay off the loan. With a margin loan, the shares can be sold to pay off the debt.

Typically, margin loans are used at gearing levels that involve what I think is too high a level of risk. For example, at 70% gearing you would have some value of shares where 70% is paid for with borrowed money, and 30% with real money. Many margin loans allow gearing of 70% to 75% depending on the shares in the portfolio. Strangely, many lenders seem to encourage these crazy levels of gearing.
It can all come unstuck if there is a sudden fall in the market. The effect of a fall is the value of the shares drops, but the debt is the same. This means the gearing ratio goes up. Then you might get your friendly banker ringing with a “Margin Call” – which means you have 24 hrs to stump up the cash or they will start selling shares. Of course the sale is at the prevailing market rate – and if the market has fallen you are looking at taking some nasty losses.

It is much safer to keep the gearing ratio quite a bit lower – 30% to 40% is my threshold for a sufficient margin of safety (if you do the maths, about 35% gearing will let you survive about a 50% fall in the market).

——-

There seem to be two common approaches to borrowing to buy a house to live in:

1. Pay off the loan as fast as you can to make it go away; and

2. Don’t bother to pay it off because the money is cheap.

All fair enough in their own way, depending on what your goals are and your degree of comfort with debt.

When it comes to investing, the same two approaches seem to apply.

In the first case, the idea is that you pay off the debt (if you took any on at all) and live off the earnings.

In the second case, the idea is that the asset appreciates in value at a sufficient rate that you don’t ever worry about the debt (essentially – the rate of growth of asset value is greater than the interest rate). Then, live off drawing down equity – ie make the debt bigger – when you want cash.

——-

Here is another, though slightly more complex idea – mainly aimed at margin loans for shares. Just a new twist on an old idea.

Use debt as a source of funds for opportunistic buying, but keep it under control:

- Buy shares in companies you have loads of faith in, when they have a scandal or fall on (short lived) bad times.

- Pay some of the debt down from salary or earnings from the shares bought, so that there is more debt available the next time an opportunity comes up.

- Aim in the long term to have a retirement fund that might have some associated debt – just not enough to worry about.

- Keep the gearing ratio low.

The nice thing about this approach is that the incremental cash cost of using it is very small.

Time for a worked example: suppose I have no cash but I do have a some assets, and a margin loan with low gearing. Then I see Kick-ass Consolidated shares going for a good price, and giving (say) a dividend yield of about 5%.

If I have to use cash – tough – I lose because I don’t have any.

But if I buy using debt, I’ll pay about 8% interest on the borrowings. If I get a 5% dividend yield, fully franked, that is an equivalent interest rate of 7%. So the dividends are paying the debt for me, and the cost to me (to prevent the debt from rising) is the difference in interest rates: 1%.

This is a pretty neat deal: If I can buy an asset, and use the cash flow from the asset to pay the debt used to buy it, then I only have to make up the difference. If I can find that 1% of the purchase price, then paying the interest on the loan means you get the capital growth of the asset for 1% down. Potentially this is a very big return. I need to pay that 1% forever, though!

$10,000 purchase of Kick-ass Consolidated – all bought on debt.

Return is $500 per year + franking credits, effectively $700 per year.

Interest on the loan is $800 per year.

So to control $10,000 worth of Kick-ass, I only need to find $100 per year.

Now suppose that I can find (say) 20% of the cost price… lets use some numbers:

I buy $10,000 worth of kick-ass, using debt.

Results as before…

Now I get $2000 from Uncle Freddies inheritence, and pay that straight off the debt.

Return is still $700 per year.

Interest cost is now $8000 * 0.08 = $640 per year.

I can now do nothing and the asset will eventually pay off the debt entirely. Compound interest works in my favour, and the reduction in the loan gets faster each year.

Once the debt is reduced a little, I can go buy something else. The debt goes up, as does the income, and the first asset is helping pay for the second.

And so on, and so on…

Trouble with the above approach is that it is using a very high level of gearing (80%), so I’m at risk of a margin call if the price falls.

If instead you were to reverse the figures, ($2K debt, $8K cash) then the interest charges are well and truly covered, the likelihood of a margin call is dramatically reduced, and when you get the opportunity you have plenty of equity cover already in place to take advantage of opportunities that crop up.

Low to moderate gearing thus forms a low risk, cash-flow positive virtuous circle, where the more you own, the more cash you generate, so the more you can buy.

The kicker is that if you are very patient, and buy quality assets on bad news, you stand a better chance of getting some very nice capital growth thrown in as well.

And with the share market – time in the market is very important. The sooner you start, the better off you will be.

The thing that requires the greatest discipline is patience – it is far better to buy nothing, than to buy something that is too expensive.

Comments welcome!

HomeTrader

For about the last 3-4 years, each weekend the Financial Review has carried a large full page advertisement from HomeTrader, touting their courses on how to make a motza by trading shares.

About 3 weeks ago these stopped appearing. Instead, a small advertisement has been run. This is an apology, stating that the figures quoted in the advertisements were not actually obtained by people trading shares. Instead they were trading “Contracts for Difference” – a newer kind of derivative.

Derivatives like contracts for difference (and options) are highly leveraged and really only suitable for people with a sophisticated understanding of financial markets. They carry a very large potential downside…

Just remember for anything that seems too good to be true… it probably is.

————-

EDIT 16-Jan-06: In the interests of fairness:

Following an exchange of emails with the operators of HomeTrader, I have modified the above post to remove a statement of personal opinion.

The operators of HomeTrader have requested that I remove this post completely.

The operators have also pointed out that their full-page advertisements are now being run again (which is true because I have seen them in the Financial Review). This presumably means they have done whatever they needed to do to make ASIC happy.

My adding this statement does not represent my giving of investment advice. I am not licensed by ASIC or anybody else to provide such advice. I neither endorse or criticise HomeTrader, or any other share market advisory or trading systems or advisers.

The PLW AGM

A happy coincidence saw me with too much leave accumulated with the consequent pressure from HR to use it up, and the Annual General Meeting of Peter Lehmann Wines.

So, yesterday was a day off work to attend the AGM.

Peter Lehmann Wines was a publicly listed company which my family and I had bought shares in during the original float about 12 years ago. It’s been a spectacular performer, with a 10 year average annual shareholder return of about 14%.

About 2 years ago a large foreign company launched a takeover bid, the ensuing fight eventually saw a partial takeover by the Swiss-based Hess group.

The company went from being owned by a few big players and many small South Australian individuals, to being 85% owned by Hess, 10% by the Lehmann family, and the remaining 5% is owned by about 430 small shareholders. Trade in the shares was very small, so now it is an unlisted public company.

We have tried to get to the AGM for the last 5 years or so – the formal meeting is always over quickly and we get to take a look around OUR company. Not to mention, the spread for lunch was always fantastic.

Yesterday saw us driving off to the Barossa Valley, admiring the farms and crops in the countryside on the way there.

The meeting was a much smaller affair than it used to be – about 50 shareholders turned up (it used to be about 400). There cannot be too many public companies that have Annual Meetings of shareholders like this:

. The meeting did not start until the Lehmanns arrived – and fair enough to show the founder some respect

. How many company AGMs have the major shareholders dog walking amongst the other assembled shareholders?

. How many companies have the (acting) Chairman making jokes with the other directors and shareholders?

It was a simple meeting, over with quickly, the company is trading well in difficult times, and there were “light refreshments” after.

Light Refreshments, Barossa style, means local produce: a locally smoked and cured ham, Mettwurst, salad, fruit, pie, bread and of course German cake. And not to mention – the company wine is available – whatever you want, as much as you want.

After the light lunch (stomach groaning), I’d hate to see a heavy meal!

Some stand-outs in the food department from this and previous years:

. Linkes make really good authentic Mettwurst and still smoke and cure hams the old-fashioned way. The Linkes ham is THE BEST I’ve ever eaten.

. Try and get some Zimmys Barossa pickled onion relish…. Mmmm. Same for their Beetroot relish!!

. The Barossa bakeries do really good bread and some of the best German cake you will ever find:

- Try the Apex Bakery in Tanunda for bread and German cake (Streuzel) made the old-fashioned slow-rise way

- Linkes bakery in Nuriootpa does a really good bienenstich (the Australian corruption calls this a Beesting)

After lunch and a quick zip into Rockfords to try & buy a bit more wine (the sparkling Black Shiraz is one of the best ever) it was time to rush home and collect the kids from school.

We are so incredibly fortunate to have such a luxury of good food and wine, readily available. Sometimes it takes a trip out of the city to find the really good stuff that is grown or made the old-fashioned way , but it is there if you go searching.

——–

Shameless plugs: If you go to the Barossa, make sure you visit Peter Lehmann wines, if only to take a walk through the gardens. But buy some wine, it’s one of the few places to give 13 bottles with every dozen purchased. But also track down some decent bread, Streuzel, relishes & chutneys, and so on. It’s worth the effort.

Investing and Speculating

Investing and speculating… two highly loaded terms.

“Investing” carries with it a tone of gentrified dignity.

“Speculating” has a feel of the gambler or the spiv.

You will find frequent mention of “investors”, often in the financial pages of the newspapers, and frequently in those large advertisements trying to entice you into paying the ransom of a minor principalilty to go on “a home trading investment course”, with sure-fire rules where nobody loses and everybody makes a motza on the markets. Yawn. Yeah, right.

A speculator does not know much, or care much, about what they tip their money into. In today, out tomorrow, don’t worry what it is, just find a bigger mug. Buy low, sell high ( yeah – like the bottom and top are SOOOOOO obvious).

Every share trader is a speculator. If they try to convince you they are an investor, consider gently correcting them, but walk away.

The investor has a different mind-set. Investors are in for the long haul, thinking carefully, listening, evaluating, and placing their money somewhere with a heart-felt conviction. Investors don’t have stop-loss orders, don’t worry about the price in the markets going up and down. Investors make their decisions, tip in their money, and don’t worry, happy in the knowledge that by doing nothing their wisely chosen purchases will rise in value over a long, long period of time.

A specualtor is a gambler. An investor is a thinker.

Wanna know why so many speculators call themselves investors? Go back to the start… “investor” sounds good. Speculator sounds a bit dodgy…

Telstra yet again

A really good short article by Stephen Mayne appeared in the Crikey emails this week (no URL to link to, sadly, so I’ve got to quote lumps of it).

After yesterday’s doom and gloom profit warning from Telstra, does anyone really think the government has a hope in hell of getting T3 away at the budgeted price of $5.25 a share? Terry McCrann got it absolutely right in today’s News Ltd tabloids when he wrote: “The core reality of and challenge for Telstra as a business is actually very simple. It’s a fabulous 20th century monopoly living in the 21st century.”

Here’s a table of Telstra’s PSTN (the old fixed-line business) revenue over the past 5 years, including a projection for the current year based on comments made by CFO John Stanhope predicting a 6.8% drop in 2005-06, following the unprecedented 3.4% fall in 2004-05:

2001-02: $7,755m
2002-03: $7,916m
2003-04: $7,984m
2004-05: $7,709m
2005-06: $7,185m (f)

Telstra has long used its fixed-line business for gouging to keep its already fat profit margins high, but those two ACCC-approved increases in monthly line-rental charges now look absolutely disastrous. Customers are leaving in their tens of thousands.

We’ve got 3 fixed lines in the old Crikey bunker which cost us $90 a month in rental fees. We’ve just cancelled one this morning on reading that everyone else is sick of being ripped off and is going without. Why don’t you try the same? Mobiles are so cheap these days that you don’t really need a landline.

Whilst Telstra is enjoying good growth in mobile and broadband revenue, these are subject to intense competitive pressures which don’t allow for the same monopoly profits that flow from the rapidly declining fixed-line business.

At last glance, the telco’s share price was languishing at $4.76, down 9c. Several major analysts have downgraded their outlook on the stock and Merrill Lynch has slapped it with a rare sell recommendation.

Knowing all this, who’s going to pay $5.25 a share for a slice of a declining business? The government will do well to get $4.50 a share which is only $29 billion and then you’ve got the billions that will be diverted to improve services in the bush and the shares that will be put directly into the Future Fund. With Telstra contributing $2 billion-plus to the Federal budget in recent years, Peter Costello is facing a black hole from T3 process.

With so many Australian investors still upset about being dudded on T2 at $7.40 a share, the government and its army of highly-paid advisors will have their work cut out getting T3 away. Even if it does get Senate approval, will the government sell at any price?

Then again, if the regulatory framework is as light-handed as it is in the banking sector, T3 could be a good buy if a fully privatised goes hell for leather slashing costs, withdrawing regional services and jacking up prices where it has market power.

After all, the Howard Government sold a majority stake in the Commonwealth Bank for just over $10 a share in 1996 and then did nothing as it abandoned the bush and gouged the bejeezers out of its customer base. The CBA is now pushing $50, but it’s hard to imagine Telstra shares being sold for $5 and then rising by 500% to $25 over the following 10 years.

Sadly, Telstra’s glory days are behind it and the government is about to attempt selling a flea-blown dog to a sceptical public. Buyer beware if the final sale price begins with a 5.

I’d add that as the same time as this is going on, the government is hell-bent on adding more regulation to Telstra, and deliberately setting out to cripple its business. Some of this is called “accounting transparency” – jargon for telling your competitors exactly what your costs AND MARGINS are so they can undercut easily. Some is plain old pork-barrelling, and some is just pig-headed political ideology.

Mr Howard and Mr Costello: I’ll walk over hot coals barefoot before I buy another Telstra share from thieves the likes of you.

Would you ever sell a million dollar house?

A reader (thanks Zac) posed a question in the context of a separate post, but I’ll repeat it here, out of context, and then go on to discuss it:

Why sell a million dollar house so you can rent? Especially if you are going to be renting something that is not going to be competitively priced or in good physical condition

So, the question is, would you ever sell a million dollar house? (Let’s ignore the second part of the question).

Answer: It depends.

Let us assume that the current property market prevails, so rental returns are about 2% to 4% (which is crazy but that is what a speculative bubble creates).

Let us assume that we can invest the proceeds of selling the house and get a return of about 10%. This is not unreasonable – there are a number of shares you can buy on the stock exchange which will give a dividend yield of about 5.5% to 6% fully franked. This is an effective equivalent interest rate of 7.7% to 8.4%. By paying attention and buying carefully, a long term capital gain of a further 1.5 to 3% is quite achievable.

So, if I sold my million dollar house, rented it back, and invested the sale proceeds, I would probably pay out (based on the rental yield – lets assume 4%) about $40,000 per year in rent (well… it was a million dollar house!).

My million dollars invested is returning about $77,000 to $84,000 in cash and cash equivalents, and a few more dollars in capital gains.

So, my house when sold generates an income that covers the rent with money left over. And there is another benefit… I don’t get to pay the council rates any more – the landlord does!

Now, assume I don’t want to live in a million dollar house any more, I’m happy with ordinary suburbia, paying (say) $400 a week. That gets me a pretty flashy house in Adelaide… That means I’m paying $20,800 per year in rent and I am even better off.

Now, before you question if this really happens, the answer is a resounding yes.

I know somebody who figured all this out, and sold their house in order to rent for the rest of his life. He was able to get a far higher rate of return by taking the capital value of the house and investing it.

I also know a landlord who bought a house from somebody who was happy to rent, because the capital could be used to generate income.

Next: what if the figures change – what if rents are higher and other investment returns are lower? In that case, the results will be different and it may not be worthwhile. That is why the answer is “it depends”.

Assets and Liabilities

No doubt you have all filled out forms at some time or other (especially when asking for a loan), which require you to list your assets and liabilities.

The standard definition is something like this:

Asset: Something you can sell to raise money.

Liability: Something you owe.

This is very simple, easy to understand, and in my opinion misleading.

Using this definition, a car is an asset, so is a house. A loan is a liability.

I’d like to turn this on its head and present a more business-like definition (accountants and economists, stop reading now before you get annoyed.)

Asset: Something that returns you an income.

Liability: Something that costs money to keep and maintain.

This definition helps to put purchase decisions into perspective.

Here are 3 simple examples:

CAR.

Classic definition: Asset.
My definition: Liability.

Reason: A car costs an up-front amount to purchase, and then you never stop spending. You have to feed it on petrol, service it, get it repaired, and it declines in value over time. With very rare exceptions you can never sell a car for more than you paid for it.

A car does not only cost the up-front purchase price and the ongoing cost. It also has the opportunity cost (the price you pay because you could not use that money for something else).

It is easy to show (in a subsequent post) that the opportunity cost can far exceed your wildest expectations, and make the cost of owning a car something truly horrifying.

In our modern society you probably have no choice in owning a car. So, if it is a necessary evil and you understand the economics, you can make an informed choice.

Buy a car that is:
- sufficient but not luxurious;
- does not cost an arm and a leg to run;
- is going to last you a long time (and better, a long, long, long time).

HOUSE.

Classic definition: Asset.
My definition: Probably an Asset, could be a Liability.

Reason:

Like a car, a house costs an up-front amount to purchase. Unlike a car (which is frequently but not always necessary), everybody needs to live somewhere. Therefore a house is a necessity. However, you have a choice, you could pay “dead money” in rent, or you could buy.

In some cases, you are better off renting, in other cases you should buy.

If your house appreciates in value, you probably have an asset. In general, all houses appreciate given a sufficiently long period of time. However, houses need maintenance to stop them falling apart. They need repairs, painting, cleaning. These all cost. In that sense, they are a liability.

If you can use your house to generate additional income, its status as an asset improves.

For example, if you use equity in your house to buy other income producingassets, then your house is more clearly an asset. But if you use equity in your house to go on a fancy holiday (as many people in Australia are doing), your house is more likely to be a liability.

A house is not clear-cut. It very much depends on where it is, what it’s value will do, and how you handle any borrowings associated with it.

MARKETABLE INVESTMENT.

This category covers shares, bonds, investment property, etc.

Classic definition: Asset.
My definition: Usually an Asset, occasionally a Liability.

Reason:

Mostly these assets pay an income stream (dividends, rent, etc). This makes them an asset. Mostly they are set up with the objective of returning something to their owners.

A share that pays a dividend is an asset – until the company goes bust, then it’s worthless.

A share that pays no dividend is only an asset if the value (and over time, the market price) goes up and up. A company that pays no dividends, and does not grow its value over time is plainly a liability.

If you can sell shares for less than you paid, does that owning those shares a liability? (Probably).

The various financial instruments available are usually assets if they pay an income stream, but even then you need to look carefully. If they pay no income stream, look very very carefully.

If they pay an income stream that depletes your capital over time (due to value lost to inflation and taxes), you may actually have a liability.

Sometimes shares, bonds, or rental property can be liabilities. Look, think and question before accepting conventional wisdom.

So what do I do with my Financial Freedom Fund?

Invest it!

Sounds easy doesn’t it.

This is where the hard work starts, and where we get controversial.

Remember, you have to beat tax and inflation. If tax takes (say) 50% of the return, and inflation is running at 3% per year, then you need to get a return of at least 6% or you go backwards.

Don’t worry about short term returns – quarter by quarter is meaningless. Year by year is nearly meaningless. You need to look at time periods of 5 to 10 years, and let the magic of compound interest work for you.

(As an aside – assume you can get 10% per year and ignore tax. Then after 10 years, compounding means for every $1 you start with you have 1.1^10 = $2.60. And 10% is a pretty lousy return. Aim higher. A lot higher.)

Real Estate & Houses

Some invest by buying rental property (the devotees of Jan Somers, and others). Personally, I don’t go much on this. It involves maintenance and tenants, and other nasty hands-on things. And over the last few years the capital gains have been good but the rental returns, lousy. The capital gains are likely to have a pause for about the next 5 years.

Those who want to flame me about my attitude to rental housing – don’t bother. If that’s what turns you on, then go for it. But, do your research… house prices cannot rise at faster than inflation forever. It stands to reason that nobody could afford to buy if that happened. Do your research, and you will find that house prices tend to go in cycles – roughly 10 years long, characterised by big rises for 2-3 years, followed by about 5-7 years of being pretty flat.

Personally, I don’t want to spend $200K to $350K a pop to buy houses that could take a long time to offload. And to start you need a lot of equity in your own home, or a lot of savings.

Managed Funds

There are plenty of these about, and more every week.

Watch out! Most managed funds are professionally managed by fund managers. I call them fund damagers because they always make money even when you don’t – most take a percentage of the funds under management, not a percentage of the gain they get you. A nice little earner if you are in the business.

Managed funds generally have a low cost of entry so you can tip your money in when you have only $1000, or maybe $2000 depending on the fund.

Most of them let you tip in regular extra contributions – great for set and forget.

If you put money into a managed fund, you want to aim for a return of at least 15% per annum averaged over a 10 year period. A cash or capital stable fund is secure but gives lousy returns. If you are young, take a few risks.

Most importantly, most managed funds charge an exit fee as well as an entry fee. So having chosen, stick with it. If you always chase the high performers you will lose through the fees you pay. Constantly moving from one fund to another is known as “churn”, and its another nice little earner for the fund managers.

Choose carefully, choose a few different funds, tip in regularly, and don’t worry too much about short term performance.

Never, ever, put all your money in one place or under one manager. There is safety in spreading it around a bit.

(A controversial point here: Diversity is sometimes known as “di-worsity”. The best investors in the world have consistently made superior returns through holding concentrated portfolios. However, these guys do this all day, every day. If you and I can’t manage that, then diversity will deliver worse returns than the best in world, but it also lowers risk. The choice is yours.)

Shares, bonds, and marketable securities

If you want to buy a few shares, make sure you do your research first. If you don’t know where to start, buy some books. Don’t just buy one book, buy 5 or 6. You need many points of view.

Treat trading schemes with suspicion. Treat technical analysis with suspicion. (Technical analysis is the business of looking at historical trends, plotting price charts, and reading the tea leaves).

Be careful of financial advisors, especially those that want to cream off some of your money by cute things like “rebalancing” your portfolio on a regular basis.

You can sign up with an Internet broker for nothing, and buying and selling is cheap. You can start investing with $500 if you want. I’d suggest waiting till you have about $1000 before getting going.

Don’t buy anything just because you know it. Buy because you understand it. Find out what companies do, who there management are, how they treat their employees. Find it their profits are consistent or up and down. Find if they pay a dividend. See if they look expensive of cheap. Think and look before investing. Remember – it’s your money!

If a company looks cheap – see if you can find why. Have they declared a profit warning? Are they in trouble? Maybe they really are overlooked and present a bargain. Maybe not.

If a company looks expensive – see if you can find out why. Are they a good consistent performer, where today’s poor dividend will be nice earner in 5 year? Or are they in the middle of dot-com style speculative lunacy?

Look at the poor performers, and find the names of the senior management. Remember them. See if they keep popping up. There are some companies I will never invest in because of who is in management and on the board. If I post those names here I’ll get sued for defamation – sorry – you will have to do your own research.

Never follow the herd. The herd are often like sheep – sticking together, running in the same direction, and never thinking for themselves.

This sounds hard. It is hard. But the cost of entry is low, and the potential returns are high. You need discipline, patience, confidence and research.

Finally – there is nothing like concentrating the mind by having real money on the line.

Listed Investment Companies

If everything above sounds too hard, or unattractive, look at the Listed Investment Companies.

There are at least two on the ASX that have been going for more than 50 years.

Both of those two have a highly diversified portfolio, pay reasonable dividends (and have been growing dividends for 50 years) and have very low management costs – typically less than 0.1 % of funds under management (no, that is not a misprint – and compare that with many managed funds that take 1% to 2%).

Watch out though – there are a few new generation listed investment companies that charge very large fees- just like managed funds.

For legal reasons I have to be careful giving out names of listed investment companies – it sounds like investment advice – but if you want to know who they are, prowl through some broking advice or (as a last resort) send me an email.

Some of these listed investment companies have been returning an average total return of 11% to 13%, on average, for the last 20 years. Some have returned slightly better.

Not bad for a complete set-and-forget, low-cost, no-thought, do nothing investment!

Obligatory legal disclaimer stuff The author does not have a financial services license and is not legally qualified to give financial advice. Readers should treat everything here as opinion. Readers should get qualified, independant financial advice (and treat it with suspicion).

Want to make a lazy $14,000? for only 5 minutes per day?

Sounds good heh?

$14,000 for only 5 minutes per day. Must be a scam!

Nup – easy. Here is how:

Make your own lunch.

When you go to work, what do you pay for lunch? I can’t buy lunch for less than $5.

If I make my own, I pay around $1 for bread, sandwich fillers and some fruit.

So, with about $4 of savings per day, and 48 working weeks per year that means we can save around $960 per year by spending 5 minutes per day.

But… how do you get $14,000?

Simple – compound interest.

Lets assume a few things:

1. No inflation – my lunch has been about $5 to buy for the last 10 years or so – food goes up a bit but not hugely. Let’s ignore inflation to simplify the maths.

2. We cannot get our $960 per year – it’s just too hard. So assume we can only save $800 per year.

3. We can invest our $800 at 10% return. We should be able to better than that, but let’s aim low.

Then, saving $800 per year for 10 years, compounding at 10%, and only tipping in the savings once per year we get:

10 year saving = $800 * (1.1^10 + 1.1^9 + 1.1^8 + … + 1.1^2 + 1.1)

or… $800 * 17.53 = $14024

Imagine – money for nothing!

Now… are you married or partnered, or have children? Want to make more money?

Simple…

If there are two of you and you both do it you save $28,000 over the 10 years. With children, just keep on multiplying that $14K number…

Why 10 years? Why not 20? Most people have a working life of 30 to 40 years… Well, if thats what turns you on, go and calculate it – you’ll be stunned at the results. I’ve used 10 years because it is a nice round number, and a realistic timeframe.

By the way – that 5 minutes per day adds up to 12,000 minutes over the 10 years, which is 200 hours. So the effective rate of pay for your 5 minutes per day is 14,000 / 200 = $70 per hour. You have to be a VERY high flyer to earn that.

So why don’t more people take their own lunch to work????

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