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I wonder how Microsoft calculates the expeccted return on their search expenditures. My guess is that it believes that trying to grow search is an attempt to keep its real options alive and worth something - perhaps it will allow for some breakthrough later on. I don't know, but I do know that they are losing the battle. I wonder if Ballmer knows when to say when just like he did with the Yahoo merger which showed great discipline. We'll see. BERK
It certainly isn't original to say that Google has changed the world and promises to keep on rolling by growing extremely profitably. GOOG's 3 year average cash flow return above its cost of capital, what AFGView.com calls "economic margin", is +12.5%, which is in the top 10% of the Russell 1000 companies.
And as you can see from the chart below the value created in US dollars as measured by EVA (Economic Value Added) has been $1.2 billion, including the premiums paid for its many acquisitions. As remarkable as that record is, EVA is projected to grow another $700 million between 2009 - 2010.
That tells us about the performance of GOOG, but not whether the stock is a buy or not. Tonight's $405 per share close implies only +8% sales growth for the next five years. The median five year historical growth has been +72%. While we do not expect that type of hyper growth to continue, we suspect that +8% implied growth is too little, plus this type of analysis does not take into consideration any "real" option value for the many applications brewing in their labs and engineers' minds. The data is there and their growing analytical abilities are scarce and valuable. Analysts think that over the next 5 years GOOG's sales will grow about +18% per year. If we plug that number into the AFG value expectations framework we get a stock worth about $580 some +40% higher from tonight's close. Again, no real option value is being considered here at all.
It's been said that Microsoft (MSFT) is desperately seeking GOOG, and that seems true. GOOG and CEO Eric Schmidt have a considerable advantage over MSFT in my opinion. What is that part of GOOG's business model that makes it's advantages so defensible? GOOG gives away many of its most valuable tools. Remember MSFT used to do that too. They would charge lots of money for the operating system and then add on other's functionality, for which they would get paid, to the operating system for nothing - like the media player or an internet browser thereby killing other businesses. Of course, MSFT could do this because of the monopoly cash gusher coming from the sales of the operating system.
GOOG gives things away that keep people on the network - programs and applications that keep people searching and clicking. And eventually it is beginning to give away for free on the network what MSFT has been charging for all along. How does it do this? Because GOOG has its own monopoly - Search and AdWare - the cash from that business keeps GOOG cranking stuff out that seems free but just keep people clicking and the data flowing to the GOOG engineers so they can optimize the advertiser's return on investment. It is nothing short of revolutionary. And it's not just the ads - its what made the ads possible - billions of micro auctions for search terms. That's the advantage and who knows where that competence, head start and data mining will lead.
In Secret of Googlenomics: Data-Fueled Recipe Brews Profitability by Steven Levy in WIRED, the essence of this money machine is captured in the possibilities of auctions of all kinds.
Can the rest of the world be far behind? Although Eric Schmidt doesn't think it will happen as quickly as some believe, he does think that Google-style auctions are applicable to all sorts of transactions. The solution to the glut in auto inventory? Put the entire supply of unsold cars up for bid. That'll clear out the lot. Housing, too: "People use auctions now in cases of distress, like auctioning a house when there are no buyers," Schmidt says. "But you can imagine a situation in which it was a normal and routine way of doing things."
Varian believes that a new era is dawning for what you might call the datarati—and it's all about harnessing supply and demand. "What's ubiquitous and cheap?" Varian asks. "Data." And what is scarce? The analytic ability to utilize that data. As a result, he believes that the kind of technical person who once would have wound up working for a hedge fund on Wall Street will now work at a firm whose business hinges on making smart, daring choices—decisions based on surprising results gleaned from algorithmic spelunking and executed with the confidence that comes from really doing the math.
I remember talking to companies all the time about what their Return on investment (ROI) was from ad and marketing spending. Most had no clue and some tried to give a fake answer. Ad spending was not a science or even a business, it was an art form for gurus and "special" creative people. Now with the GOOG continuous micro auctions and other tools, expected returns from ad spending on-line is getting more accurate and higher all the time.
No wonder the Newspapers are dying - who knows what the ROI is for a full page ad in the NY Times - no one with any degree of accuracy. Data mining and analytics are where its at and the amount of EVA created so far is nothing compared to what GOOG will earn in the future.
BERK
Disclosure: Berk Advisory and Rapidan Capital, LLC clients are long GOOG and MSFT.
May 21 (Bloomberg) -- The Conference Board’s leading gauge increased 1 percent in April, the biggest gain since November 2005, the New York-based group said today. The index points to the direction of the economy over the next three to six months.
Then today this:
WLI Growth at 35-Week High
Reuters
May 22, 2009(Reuters) - A measure of U.S. future economic growth inched higher in the latest week, while its yearly growth rate continued to climb toward positive territory, a research group said on Friday.
The Economic Cycle Research Institute, a New York-based independent forecasting group, said its Weekly Leading Index edged up to a 29-week high of 111.1 for the week ending May 15 from 111.0 the prior week.
The index's annualized growth rate reached a 35-week high of minus 11.5 percent from last week's rate of minus 13.6 percent.
It was the highest yearly growth reading since the week ended September 12, when it stood at minus 11.4 percent.
"With WLI growth rising steadily to a 35-week high, it is increasingly obvious that the 'green shoots' will blossom this summer," said Lakshman Achuthan, managing director at ECRI.
The group's index rose because of lower interest rates and higher commodity prices,and was partly offset by weaker housing activity, Achuthan said.
BERK: Leading indicators are designed to "predict" movements in the economy 6-9 months out. the Economic Cycle Research Institute founded by famed economist Sir Geoffrey Moore out of my Alma Mater Columbia U, has done a great job in pinpointing changes in the business cycle. Their most recent call coincided with the almost 40% move in the market off the March low. It continues to rise as does the less timely and less reliable (but still pretty good) Conference Board's Leading Index. It's up to 1.0 in April - the highest since Jan 2005 - which means recovery could happen a bit quicker than expected. We are betting that this is going to happen but the level and persistence of growth will disappoint.
May 22 (Bloomberg) -- Treasury Secretary Timothy Geithner called for major changes in compensation practices at financial companies and said the Obama administration’s plan to help realign pay with performance will be rolled out by mid-June.
“I don’t think we can go back to the way it was,” Geithner said in an interview on Bloomberg Television’s “Political Capital with Al Hunt,” to be aired tonight and over the weekend. “We’re going to need to see very, very substantial change.”
There are a lot of reasons the U.S. dollar goes down and up. One of the main reasons is capital flows - Americans, multi-nationals, foreigners and other governments either liquidating (selling) US dollar investments or buying US dollar investments. Sure enough speculators and traders will try to guess which way the flows go and buy or sell dollars accordingly. And so will the Chinese, Russians, Saudi's, etc. bet which way the value of their dollar investments are going and either get in or get out.
Therefore, while our Treasury Secretary is dickering over compensation at banks, he seems not to notice that his blind loyalty to the gang from chicago in the White House is bringing down the whole ball of wax.
Because then there is this:
May 22 (Bloomberg) -- Treasury Secretary Timothy Geithner committed to cutting the budget deficit as concern about deteriorating U.S. creditworthiness deepened, and ascribed a sell-off in Treasuries to prospects for an economic recovery. “It’s very important that this Congress and this president put in place policies that will bring those deficits down to a sustainable level over the medium term,” Geithner said in an interview with Bloomberg Television yesterday. He added that the target is reducing the gap to about 3 percent of gross domestic product, from a projected 12.9 percent this year. The President and Congress have made it very very clear that the United States is going down the road ofCalifornia. Huge spending on entitlements - limited "investment" spending and higher taxes down the road. Control by interest groups with perceived grievances - read public sector unions. It can't be both -spending on non-investments and no tax increases - if you are going stop the debt from climbing as a percentage of GDP. You can spend like this for awhile but it needs to be temporary and you need to show you understand how to put in place "growth" policies so the denominator of the debt/GDP equation starts rising much faster than the numerator. No credible economist believes that is where we are headed. More important is that no knowledgeable citizen or businessperson believes Congress and the President are spending on investments (assets) that have future pay-offs - recall all the criticism about the lack of real infrastructure spending in the stimulus bill - or have will institute pro-growth policies. The U.K. was put on Credit Watch for possible downgrade by S&P yesterday because their Debt to GDP ratio is too high. The market is speaking in advance in reference to this government's policies. Oh yeh, and there is another reason the dollar goes down - people flee for lack of security. And after Obama's democratic response and excuses to Cheney yesterday, the world is re-thinking US security. We need to support our values but the Jews stuck to their values in Europe last century and were slaughtered. Everywhere you look, sticking to your values was necessary but never sufficient to provide security. There is a leadership crisis and the world is voting by selling the buck. BERK
Any time you make a bet with the best of it, where the odds are in your favor, you have earned something on that bet, whether you actually win or lose the bet. By the same token, when you make a bet with the worst of it, where the odds are not in your favor, you have lost something, whether you actually win or lose the bet.
-David Sklansky, The Theory of Poker
Listen up! This is an important post for my wonderful friends and colleagues that are worried about their savings, their futures and what to do now. The simple answer is get an advisor and/or money manager like us that understands the difference between process and outcomes, and that knows that our added value comes from our experience and our ability to incorporate factors that distort human judgment.
Keith Hays of Hays Advisory(a great strategy service, an invaluable part of our risk management processes and coffee enjoyment) has a wonderful note this morning about ways to buy stocks. The most important job of a financial advisor is to help clients to maintain their investment course no matter how volatile or uncertain the short-term investment climate might become. Of course, the financial advisor or broker or overlay manager or chief investment officer of the family office must always remind the client of the fundamental reasons why they hired a manager in the first place. And it all starts with process.
Keith reminds us that the real value of a financial advisor is to help keep clients’ emotions in check, stay the course with their long-term plan and to evaluate whether or not a particular manager’s process is controlled, likely to succeed over time and has incorporated the awareness of the factors that distort human judgment.
We have shown many times before, as has Keith, the following results of a study by Jack Bogle. It shows the returns that investors actually receive are much less than the market’s returns, and even less than the time weighted returns of the funds’ in which they are invested.
Why? Investors chase performance and do not understand or have confidence in the investment manager’s process – even when short-term outcomes are not favorable. So investors and many brokers/advisors chase the recent best performers after that manager just had some short-term success (and therefore miss the good times), and sell the recent worst performers after a bad run (subsequently missing the good times again). This happens over and over again as the investor pays taxes, fees to the manager and fees to the advisor for allowing him to behave some way.
All this reminds us of the great Process versus Outcomes debate in investing – and in life. When we evaluate companies, for example, we are most concerned with their internal management processes – how they measure and reward success and how they allocate capital. We do that because we know that most on Wall Street will focus on short-term outcomes – this or that quarter’s sales or EPS growth. But we identify good process and we understand that other investors do not, then when they sell a stock down well below expected value we can snap it up with conviction that the odds that performance over time will improve and our returns are much more likely to be greater than the risk of loss. Good process assures us that we are betting with the odds in our favor, just like the house at a casino.
Michael Mauboussin, Chief Investment Strategist at Legg Mason often writes about this topic, and it occupies Chapter 1 of his best selling business book: More Than You Know – Finding Financial Wisdom in Unconventional Places.
Chapter One: Be the House: Process and Outcome in Investing.
Paul DePodesta, a former baseball executive and one of the protagonists in Michael Lewis’s Moneyball, tells about playing blackjack in Las Vegas when a guy to his right, sitting on a seventeen, asks for a hit. Everyone at the table stops, and even the dealer asks if he is sure. The player nods yes, and the dealer, of course, produces a four. What did the dealer say? “Nice hit.” Yeah, great hit. That’s just the way you want people to bet -- if you work for a casino.
But investors often make the critical mistake of assuming that good outcomes are the result of a good process and that bad outcomes imply a bad process. In contrast, the best long-term performers in any probabilistic field -- such as investing, sports-team management, and pari-mutuel betting -- all emphasize process over outcome.
Berk Advisory understands that the signatures of a quality long-term investment process include a focus on economic (versus accounting) value, low turnover for your winners and relative portfolio concentration because there are just not that many companies that are undervalued whose processes are well-aligned with the creation of shareowner value over time.
Cheers! I love that way of saying good-bye.
BERK
Many investor advisors and investors believe that timing the market is not possible, and in fact is a fool's game because long-term returns suffer as a result of trying. The critics talk about too much trading leading to transaction costs and taxes that can only be avoided with a BUY and HOLD strategy. Also, the critics point towards the fact that much of the performance in a BUY and Hold strategy comes from very few small periods where investors often get out before the run but don't get back in until much of the performance has past. The great Value Expectations blog has this to say about the subject:
Market timing is the practice of many investors to try to predict the best time to buy and sell stocks based on expected market direction. For example, a mutual fund manager might switch a portion of his fund's holdings from stocks into cash when he believes that the market has peaked. If he times the market correctly, he could make a huge profit. Then, when he thinks the stock market is significantly undervalued, he could shift back into stocks in an effort to make another hefty gain. If such an investor was able to successfully time the market since 1950 till today and avoided the 20 worst performing months for the period, he would outperform an invested at all times strategy by 458 basis points annually.
Missing the worst months, yields more incremental performance than missing the best months since 1950. This is why we consider this a "risk" management process, not just something called a market timing process.
We have developed a business model and an investment process which takes care of two of the main objections of the BUY and Hold crowd. First, the cost of transactions is relatively small in our institutional world. In fact, we use a new technology so that our separately managed accounts at Rapidan Capital's service called Berk Advisory can trade frequently with NO COMMISSIONS. That's right it cost NOTHING per transaction for most stocks when we trade, re-balance or otherwise "time" our purchases and sales. There is simply one flat fee of about $300 per year!.
Second, in our private hedge funds we have always maximized AFTER-TAX returns so we deliver as little realized gains as possible through the best tax deferral scheme known to US investors - and that is BUY stocks of Great Companies and let them ride through time. Sometimes, however, we have to sell those stocks when the market's greed pushes prices to excessive levels. Remember we want to maximize after-tax return - the goal is not to pay any taxes, but we know that that can't be done at the same time we are trying to maximiz after-tax return. We do not want the tax tail wagging the life-time return dog.
That strategy creates too much risk and ignores changing competitive circumstances and prudent portfolio mamanagement using correct risk adjusted position sizes. Therefore, our professional process avoids the pitfalls of market timing - too much trading and too much in transaction costs - by using technology to avoid per transaction costs and by using tax management strategies like harvesting losses to offset against any gains, while maximizing economic returns.
The folks at Value Expectations do a good job of explaining why for most independent investors and financial advisors market timing does not usually work and they ought to just settle for the median return of 7% per year over time. Humans are subject to irrational emotional reactions that are predictable. Investors and advisors and even professional mutual fund managers are people and it has be shown that people hate losses by 2.5x more than we like gains. Thus, when we finally make the decision to get out because of losses, we certainly ease our mental pain, and it takes a lot more discomfort for us to get back in the market. Therefore, we inevitably get in too late by waiting to get back in the market . Of course, by that time the stock market has gone up and we missed some those best months. The conclusion for most do-it-yourself investors, then, is to BUY and Hold.
Behavioral issues: A huge number of investors believe they follow a certain value strategy, while in reality they are subject to irrational emotional reactions to market fluctuations, which prevent them from perfectly timing the market. Often times such investors would wait on the sidelines for too long when the market is increasing, and jump in only after they can no longer watch other investors profiting from the run. When the market is in decline, on the other hand, this irrational system prompts the investors to remain invested for too long, even as they continue to lose money, eventually selling at very depressed prices. If our investor was unable to pperfectly time the market and missed the 20 best performing months instead, that would translate into 331 basis points annual underperformance relative to an invested at all times strategy.
We do not fully agree. Notice how much more money you are left with over the period if you avoid risky markets. The graph above shows that avoiding the worst months (green line) yields $589,000 versus about $50,000 for the BUY and HOLD strategy - our process is designed to capture much of that difference.
BERK
We think we have a process that allows us to own the shares of the Best Companies who are growing long-term value (EVA) in the correct position sizes. But we also monitor the trend of the market and adjust our exposure according to the measured risk in the market...The difference is that we use an unemotional instrument panel that gives us a high probability of understanding how much money we ought to have at risk in total.
This wholly rational, data driven process allows us to avoid the pitfalls that many investors succumb to.
BERK
As many of you know my dad, William "Bill" Berkowitz, was right there along with Mr. Bent at the beginning of the money market mutual fund industry. In fact, my brothers and sister and I used to go around all the time telling people that my dad "invented" money funds when he was at Dreyfus. A little embellishment from proud children to be sure, but my dad certainly knew how to trade and manage a prudent money market portfolio.
Before he died in 2004 he would remind me that the biggest risk to the banking system and the economy was not a run on a bank or a series of banks - it was a run on money funds. Little did I know that he would be right so soon. Chairman Bernanke often has said that the holding by the Reserve Fund of Lehman paper upon Lehman's bankruptcy was the transmission mechanism that made the financial crisis a main street crisis because it blew up the commecial paper market.
Anyway, seeing his old rival for basis points being charged reminded me how smart, innovative, honest and genuinely paranoid my dad was. His prudence helped create the first shadow banking system caused by foolish government regulations - Dreyfus Liquid Assets...and, oh yeh, the Reserve Fund.
As my dad told ''Forbes'' in 1980, ''...the savings public is becoming more sophisticated. It will not stand for this 5% rate on passbooks (savings accounts).'' That's when large depositors were getting double digit short-term interest rates as Volcker tried to stamp out inflation.
He fought against the regulation of the money market industry and welcomed competition from banks by testifying in favor of lifting Regulation Q--which prevented banks from paying prevailing high interest rates on savings accounts.
RIP Dad - we'll all be alright (you were right there was way too much debt)
NEW YORK/WASHINGTON (Reuters) - The father of the money market mutual fund -- investor Bruce Bent -- was charged with fraud by U.S. regulators on Tuesday over accusations he deceived investors into believing his flagship fund was safe before it "broke the buck" last year.
The civil charges against the veteran money manager, his son and their investment company come eight months after the Reserve Primary Fund, loaded with Lehman Brothers debt, halted redemptions after the investment bank declared bankruptcy, sparking a run on money-market funds.
The fund's net asset value fell below $1 after Lehman's bankruptcy last September, meaning that investors who thought their funds were safe had lost money.
The fund is being liquidated and its collapse has spurred numerous lawsuits. Its demise has been a stunning turn for Bent, who regulators called "the public face" of the fund and "a longtime advocate of the safety and stability of money market funds."
BERK
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