It's Expensive to be Poor

I read a pretty compelling story online today called "The High Cost of Poverty: Why the Poor Pay More", written by DeNeen Brown for the Washington Post. It raised some issues that you might never think of, sort of "hidden taxes" on being poor.

Having grown up in pretty modest means myself, I am pretty familiar with the amount of time you waste when you don't have much money or your own house. Poor people have to spend time at the laundromat waiting for clothes to wash and dry every week (I have done this) and time waiting for multiple public transportation connections to get to work every day (I have done this too). But the article points out that it is sometimes impossible for poor people to go to the big grocery stores where the middle class shop for discounted food. They have to buy their milk and butter from the local corner store, costing them significantly more.

The article also points to high rates charged by check cashing places as a cost of being poor, but I'm not as convinced that they are a necessity. For example, a man quoted in the story pays a fee to have the check cashing place pay a bill for him... it seems to me that fee (at least) is avoidable).

In any event, this article is an eye-opener (and includes a pretty memorable exchange between a man and the checkout person at a grocery store) that I think is worth a few minutes of your time. If you are in this situation- you're not alone. If you're not- be thankful for what you have.

Richard Bernstein's Investment Guidelines

A blurb in the Wall Street Journal's "Heard on the Street" section caught my eye as I was on my way in to work last week:

"Overheard - Most people gush thanks (or occasionally spit bile) in their farewell address. Richard Bernstein, whose 20 years at Merrill Lynch drew to a close on Wednesday, went 10 steps further. In a final note, having thanked colleagues and clients, the bank's chief investment strategist signed off with 10 guidelines. All are worth remembering, but perhaps the last resonates strongest: 'Leverage gives the illusion of wealth. Saving is wealth.'"

This caught my eye and I made a mental note to see if I could find the complete list of 10. Lo and behold, through the magic of the Internet, I found the guidelines on seeking alpha.

They are the following: 

1. Income is as important as capital gains. Because most investors ignore income opportunities, income may be more important than capital gains.

2. Most stock market indicators have never actually been tested. Most don’t work.

3. Most investors’ time horizons are much too short. Statistics indicate that day trading is largely based on luck.

4. Bull markets are made of risk aversion and undervalued assets. They are not made of cheering and a rush to buy.

5. Diversification doesn’t depend on the number of asset classes in a portfolio. Rather, it depends on the correlations between the asset classes in a portfolio.

6. Balance sheets are generally more important than income or cash-flow statements.

7. Investors should focus strongly on GAAP accounting and should pay little attention to “pro forma” or “unaudited” financial statements.

8. Investors should be providers of scarce capital. Return on capital is typically highest where capital is scarce.

9. Investors should research financial history as much as possible.

10. Leverage gives the illusion of wealth. Saving is wealth.

I thought these were some pretty good observations. Number 1 definitely hit close to home for me. As I've grown my savings more over time and seen the impact a huge market downturn can have on the value of certain stocks, I've begun to pay a little more attention to income. Although I still believe capital gains are where the big payoff comes from in stocks, income is something tangible and shouldn't be overlooked. Number 5 is pretty important as well... over the past 2 years, people have seen every single asset class in their "diversified" portfolios sink almost in unison. Many were operating under an illusion of diversification and when the tide went out, we saw who wasn't wearing a bathing suit. 

I cocked my head sideways when I read number 4 because I think nothing fuels a bull market more than cheering and a rush to buy. I kind of see his point though. He is saying bull markets are more the result of assets being unfairly punished and undervalued prior to the bull market than the actual enthusiasm during the bull market. In my opinion, you can't have one without the other so this is kind of a circular argument.

This list reminded me of another post I made a while back on nine market lessons from John Dorfman, a Bloomberg columnist who retired a while back. For the sake of completeness and comparison, I list Dorfman's lessons here:

1) Out-of-favor stocks are the best road to capital gains.

2) Don't be swayed by what Wall Street analysts say.

3) High portfolio turnover is not necessary for good results.

4) The investment value of a stock is independent of whether it has been moving up or down.

5) Predicting the market with consistency is extremely difficult.

6) Predicting the economy is probably even harder.

7) High valuations alone aren't a good reason to sell a stock short.

8) High profits alone are no reason to invest in a stock.

9) Dialog with readers was one of the best parts of my experience as a columnist

Maybe one day I'll come up with my own list, but I have no plans to retire anytime soon :)

A Year off Work, With Pay

I came across an interesting article in the New York Times (which I rarely read, since I prefer the WSJ) about a lawyer who is getting paid $80,000 to take a year off from work. Apparently the big NYC lawfirm Skadden is offering some of its workers a year off at 1/3 of their salary as a way to reduce costs and retain employees during the current economic downturn. Since this particular woman made $240,000 a year, her drastic paycut still leaves her with a pretty hefty salary so she decided to take the year off and tour around the world.

I don't blame her. I would take this deal if I could (though I am sure I wouldn't be able to travel and would only just be able to scrape by on 1/3 of my salary). I've worked with people at big lawfirms like this in the past and I know the kind of grueling schedules they put in. I put in these kinds of hours myself for certains stretches throughout the year and over time it tends to get to you. A break like this would be a most welcome relief.

But of course I am not getting this deal. And neither are you. But we can dream.

What would you do if you got this offer?

Buffett Invests in Chinese Electric Car Company

Fortune published a recent article describing Berkshire Hathaway's purchase of a 10% stake in BYD, a Chinese electric car manufacturer last fall. I didn't really notice this announcement when it came out, but it was a decent-sized investment at $230 million for the 10% stake.

Looking at the net income graph in the article, it looks like BYD earned about $180 million in 2008. Dividing that by 10 gets about 18 million of earnings, or a P/E of about 12.7x. (This is just to give you a general sense of valuation, see this site for the current P/E of the S&P 500. Not sure if this site gets the calculation right or not, but I found it after a brief google search).

The reason this acquisition caught my attention is because (as others have noted), Buffett broke some of his own rules to make it. I don't see how an auto company could ever meet his criteria for an excellent business (for more on his criteria, see my review of Buffettology, particularly the 9 questions). I don't think he understands the industry either. It seems like this investment was more likely the brainchild of David Sokol, chariman of MidAmerican Energy and Charlie Munger than it was of Buffett.

I don't have much of an opinion either way but I do note that it continues the trend of Berkshire making acquisitions outside of the United States.

How to Become As Rich As Bill Gates

I came across this pretty instructional post written by Philip Greenspun that offers some simple steps showing how you can become as rich as Bill Gates. It's funny I had this vision in my head that Gates was more of a self-made man but as it turns out, he came from pretty fortunate circumstances. Interesting stuff.

I haven't been posting all that much lately, but there has been much to absorb in the markets. There has been no shortage of negative headlines. We can't go a day without a new company being bailed out or a headline about a financial catastrophe of epic proportions.

I think people are starting to get numb to it all.

I hope Twitter is a Fad

I hope Twitter is the POG of this decade and that after a few years it sinks into oblivion, never to be heard from again. I really don't get it. You couldn't pay me to go on to Twitter and write that im tying my shoe or read about someone else tying theirs. But a lot of people are talking about it.

The reason I hope it fades away is that it would really ruin my faith in humanity to find out that we've stooped as low as making this kind of thing an integral part of our daily lives. Reading about some guy who is buying eggs, or some gal who is getting a new key made. Really?

I hope it's a fad.

Update 1/1/2016: So twitter was not a fad (at least in the medium term). Turns out it ended up being decent for things like real time news etc. However (like basically all good things on the internet that get popular) it became polluted by advertising, publicists, vapid celebrities etc. and I'm not a fan.

Buffett Invests in Harley Davidson

As many of you know, I'm an avid Warren Buffett follower, so I was interested to read that Buffett agreed to buy $300 million of debt issued by Harley Davidson (NYSE: HOG) yesterday.

(Note: many people use Buffett and Berkshire interchangably, as if he makes every decision at the company he runs. While I am sure this is not true, I often use the two interchangably as well, so whenever you see me mentioning Buffett and Berkshire in the same entry, assume I'm referring to Berkshire Hathaway in all cases unless I specify otherwise. I promise to try to be more precise in the future.)

Harley announced that it was selling $600 million of senior unsecured debt to two investors: Berkshire Hathaway (Buffett's company), and Davis Advisors, LP, which is Harley's biggest shareholder. According to an article I read, Buffett hasn't invested any other money in Harley besides this purchase. The notes are a pretty sweet deal. Though unsecured, they are senior in the capital structure which means they get paid pretty quickly if the company goes bankrupt. I am not sure what Harley's capital structure looks like, but being that Berkshire bought the notes, I'm willing to bet that Buffett or someone at BRK took a good look at it and feels there is a good chance the notes will be repaid when they mature in 2014. The best part of the deal? They pay FIFTEEN PERCENT INTEREST. So for lending Harley $300 million now, Buffett will collect a check for $45 million each year for the next five years. That's a total of $225 million in interest, plus the return of his original principal.

Harley plans to use the money for its consumer lending unit, ie to lend money to people so that they can afford to buy its motorcycles. I don't follow the company too closely, but apparently it is in the midst of a turnaround plan.

The stock jumped something like 15% yesterday on the news that Buffett was "investing" in the company. I noticed it fell about 7% today. I think it's pretty crazy when people view Berkshire buying preferred stock (as he did recently with Goldman Sachs) or loaning money via a debt purchase as some kind of an endorsement from Buffett that the company's equity is undervalued. If he thought Harley was undervalued, he could have bought the entire company, which has a market cap of only about $3 billion compared with Berkshire's $30 billion pile of cash. But he didn't. Instead he chose to lend them money for a relatively short period of time at a high interest rate. Being one of the few people with $30B cash in hand during a financial crisis helps Buffett to get some very favorable investment opportunities. 

I noticed that Moody's poured icewater on the announcement by immediately downgrading Harley Davidson Funding Corp., which is the fundraising arm of Harley's consumer finance unit. This will make it more expensive for the unit to raise money, which is not a good thing. Though Moody's does not directly come out and say it, it appears that the new $600M of debt was the catalyst for the downgrade.

In any event, I assume Buffett did his homework on this one and in the end he will get his 15% per year.