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| For many years now, it has been clear that China would soon be pulling the strings in the U.S. financial system. In July 2015, the American people owed the Chinese government nearly $1.25 trillion. I know big numbers don't mean much to most people, but keep in mind… this tab is now hundreds of billions of dollars more than what the U.S. government collects in ALL income taxes (both corporate and individual) each year. It's basically a sum we can never, ever hope to repay – at least, not by normal means. Of course, the Chinese aren't stupid. They realize we are both trapped. We are stuck with an enormous debt we can never realistically repay… And the Chinese are trapped with an outstanding loan they can neither get rid of nor hope to collect. So the Chinese government is now taking a secret and somewhat radical approach. China has recently put into place a covert plan to get back as much of its money as possible – by extracting colossal sums from both the United States government and ordinary citizens, like you and me. The Chinese State Administration of Foreign Exchange (SAFE) is now engaged in a full-fledged currency war with the United States. The ultimate goals – as the Chinese have publicly stated – are to create a new dominant world currency, dislodge the U.S. dollar from its current reserve role, and recover as much of the $1.25 trillion the U.S. government has borrowed as possible. Lucky for us, we know what's going to happen. And we even have a pretty good idea of how it will all unfold. How do we know so much? Well, this isn't the first time the U.S. has tried to stiff its foreign creditors. Most Americans probably don't remember this, but our last big currency war took place in the 1960s. Back then, French President Charles de Gaulle denounced the U.S. government's policy of printing overvalued U.S. dollars to pay its trade deficits… which allowed U.S. companies to buy European assets with dollars that were artificially held up in value by a gold peg that was nothing more than an accounting fiction. So de Gaulle took action… In 1965, he took $150 million of his country's dollar reserves and redeemed the paper currency for U.S. gold from Ft. Knox. De Gaulle even offered to send the French Navy to escort the gold back to France. Today, this gold is worth about $5 billion. Keep in mind… this occurred during a time when foreign governments could legally redeem their paper dollars for gold, but U.S. citizens could not. And France was not the only nation to do this… Spain soon redeemed $60 million of U.S. dollar reserves for gold, and many other nations followed suit. By March 1968, gold was flowing out of the United States at an alarming rate. By 1950, U.S. depositories held more gold than had ever been assembled in one place in world history (roughly 702 million ounces). But to manipulate our currency, the U.S. government was willing to give away more than half of the country's gold. It's estimated that between the 1950s and early 1970s, we essentially gave away about two-thirds of our nation's gold reserves… around 400 million ounces… all because the U.S. government was trying to defend the U.S. dollar at a fixed rate of $35 per ounce of gold. In short, we gave away 400 million ounces of gold and got $14 billion in exchange. Today, that same gold would be worth $450 billion… a 3,100% difference. Incredibly stupid, wouldn't you agree? This blunder cost the U.S. much of its gold hoard. When the history books are finally written, this chapter will go down as one of our nation's most incompetent political blunders. Of course, as is typical with politicians, they managed to make a bad situation even worse… The root cause of the weakness in the U.S. dollar was easy to understand. Americans were consuming far more than they were producing. You could see this by looking at our government's annual deficits, which were larger than ever and growing… thanks to the gigantic new welfare programs and the Vietnam "police action." You could also see this by looking at our trade deficit, which continued to get bigger and bigger, forecasting a dramatic drop (eventually) in the value of the U.S. dollar. Of course, economic realities are never foremost on the minds of politicians – especially not Richard Nixon's. On August 15, 1971, he went on live television before the most popular show in America (Bonanza) and announced a new plan… The U.S. gold window would close effective immediately – and no nation or individual anywhere in the world would be allowed to exchange U.S. dollars for gold. The president announced a 10% surtax on ALL imports! Such tariffs never accomplish much in terms of actually altering the balance of trade, as our trading partners simply put matching charges on our exports. So what happens is just less trade overall, which slows the whole global economy, making the impact of inflation worse. Of course, Nixon pitched these moves as patriotic, saying: "I am determined that the American dollar must never again be a hostage in the hands of international speculators." The "sheeple" cheered, as they always do whenever something is done to "stop the speculators." But the joke was on them. Within two years, America was in its worst recession since WWII… with an oil crisis, skyrocketing unemployment, a 30% drop in the stock market, and soaring inflation. Instead of becoming richer, millions of Americans got a lot poorer, practically overnight. And that brings us to today… Roughly 40 years later, the United States is in the middle of another currency war. But this time, our main adversary is not Europe. It's China. And this time, the situation is far more serious. Our nation and our economy are already in an extremely fragile state. In the 1960s, the American economy was growing rapidly, with decades of expansion still to come. That's not the case today. This new currency war with China will wreak absolute havoc on the lives of millions of ordinary Americans, much sooner than most people think. It's critical over the next few years for you to understand exactly what the Chinese are doing, why they are doing it, and the near-certain outcome. Regards, Porter Stansberry Source: International Man Follow us on Twitter: @blacklioncm |
Showing posts with label Honesty. Show all posts
Showing posts with label Honesty. Show all posts
Wednesday, December 9, 2015
How the Chinese Will Establish a New Financial Order
Monday, December 7, 2015
Four Easy Steps to Banish Fear and Change Your Life, Today
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| I used to dread the thought of public speaking. And when I was forced to make a speech, I did a terrible job – which only made me dread the next speech even more. It was a vicious cycle. When I became the editorial director of a newsletter business in South Florida in 1982, I found myself in an uncomfortable position… I had to conduct meetings and give presentations at industry functions on a fairly regular basis – something I was ill-prepared to do. So, I decided to enroll in a Dale Carnegie program for public speaking. Somehow, I registered for the wrong course. Instead of focusing on speech-making, it had a broader goal. And that program changed my life. It taught me the importance of setting goals and taking action. But it also taught me to be more comfortable as a speaker. My speech-making skills improved almost accidentally. Every week, we had to read a chapter of Carnegie's classic book, How to Win Friends and Influence People, and then make a two-minute in-class presentation about how we were going to put the principle of that chapter to work in our lives. On Thursday evenings after work, I would drive a half-hour to the meeting place. During that drive, I thought about what I was going to say. It was difficult in the beginning, but it got a little easier each week. By the end of the 14-week course, I was performing at a near-professional level. I had won several awards in competitions and was routinely rated at the top of the class. The final session was a sort of commencement ceremony. Relatives and friends were allowed to attend, which tripled the size of the audience we had to speak to. I gave the last speech. I was still a little nervous when I got up to the podium, but I'd learned a lot by then. So, I took a deep breath and did my thing. I got a strong round of applause. Several people I didn't even know came up to congratulate me… and one suggested I should become a comedian. I wasn't foolish enough to take his advice to heart, but it did make me happy to think I had made so much progress in so little time, starting from practically zero. How did I conquer my fear of public speaking? The same way you would conquer the fear of anything else. Humiliation and Humility A big part of what we are afraid of is embarrassment – being shamed in front of other people. When embarrassment is extreme, we call it humiliation. If you pass gas at a fancy dinner party, you feel embarrassed. If your big project at work fails miserably – and you've been bragging it would be a "sure thing" – you feel humiliated. Humiliation is what happens to embarrassment when it's mixed with pride. The prouder you are, the more failure hurts. Which brings us to our cure for the fear of failure: humility. I'm guilty of priding myself. I'm proud of my writing, for example, and the success I've had in business. So, I have to keep reminding myself to be humble about those things. But I'm not proud of everything I do. I take no pride in my ability to dance, sing, or speak foreign languages because I do those things so badly. And because my ego isn't involved, I'm not embarrassed to ask stupid questions, to show myself as a beginner, and, ultimately, to fail again and again as I attempt to master those skills. The truth is, when I started out in business, I wasn't very good at that, either. Again, that made it possible for me to ask lots of questions, look stupid, and make mistakes… which accelerated my learning curve. That last observation brings us to an important principle of success. I call it "the secret of accelerated failure." It's a principle I developed in the early 1990s. The principle of accelerated failure is this: To develop any complex skill, you must be willing to make mistakes and endure failures. The faster you can make those mistakes and suffer those failures, the quicker you will master the skill. At the Palm Beach Research Group, we teach this secret to our managers. We encourage them to allow their employees to fail. Not to fail stupidly. Not to make the same mistakes over and over again. But to feel free to fail at something – so long as it was done in the pursuit of knowledge. If you play golf or practice Brazilian jiu-jitsu, you know this to be true: If you tense up and focus on avoiding mistakes, you will learn very slowly. If you relax, let the mistakes happen, and learn from them, you will advance quickly. It starts with being humble. Humble enough to accept the fact that when you begin anything new, you're likely to do it poorly. Humility Is Nature's First Gift Pride prevents us from admitting we are incompetent. But we're all incompetent when we're learning. Think of how a baby learns to walk. He begins by crawling, then advances to "forward falling" (as my brother calls it), then to walking like a little drunkard, and then, finally, to walking masterfully. Babies don't feel shame, because they're not proud. There's a reason pride doesn't invade the human psyche until 6 or 7 years of age: There's simply too much to learn before then. If toddlers had pride, it would take them years – or even decades – to walk and talk properly. Humility is a much-underrated virtue. It provides us with at least three significant advantages:
If Humility Is the Solution, How Does a Proud Person Become Humble? Now we are coming to the most important part of this discussion – a practical plan for defeating the fear of failure. Here's how you can do it:
Defeat your fear of failure by being happy – and even eager – to try and fail until you succeed. That's how Edison invented the lightbulb. That's how Michael Jordan, a very mediocre basketball player in high school, became the greatest hoops player of all time. They weren't afraid of failure. You shouldn't be, either. Regards, Mark Ford Source: Daily Wealth Follow us on Twitter: @blacklioncm |
Friday, December 4, 2015
Don't Let 'The Glidepath Illusion' Ruin Your Retirement
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| The traditional notion of retirement says you should take bigger risks in the stock market when you're young. You have more time to make up for losses than when you're older. As you age, you should take less and less risk, so you won't lose your retirement money. This strategy is called "Glidepath investing." And it could ruin your retirement. Let me explain… The emotional appeal of Glidepath investing is obvious. Young people feel like they're going to live forever, so it feels better to them to take more risks. Buying more risky stocks and fewer safe bonds feels right. Older people feel they have more to lose and might not be able to support themselves one day, so they tend to be more risk averse. For them, buying fewer stocks and more bonds feels safer. There's an army of financial planners and other "helpers" out there selling products designed to get you to retirement with a big, safe nest egg, based on this feel-good notion. However, research suggests that what feels good isn't necessarily what you should do… Investor and researcher Rob Arnott of Research Affiliates published a report in September 2012 called, "The Glidepath Illusion." Arnott says Glidepath investing will make you less money because it will lead you to put less money in higher-return investments (stocks). Arnott studied 141 years of stock and bond returns from 1871 to 2011. From these data, he hypothesized a range of possible outcomes. In general, Arnott found evidence that the range of outcomes from doing the opposite of Glidepath investing was superior to the range of Glidepath-based outcomes. It's well documented that stocks outperform bonds over the long term.Glidepath investors wind up putting a bigger percentage of their assets in stocks when they're younger and have less to invest. They put a higher percentage into bonds when they're older and have more to invest. That's the basic error. Investors put fewer dollars into higher-return investments, then interrupt the compounding process to put more dollars into lower-return investments. So they make lower returns than if they had done the opposite of Glidepath investing. Glidepath investing is a good recipe for feeling good, but a poor one for making as much money as possible in stocks and bonds. Arnott's conclusion is worth quoting and keeping close at hand as a reminder… Investors who are prepared to save aggressively, spend cautiously, and work a few years longer (because we're living longer), will be fine. Those who do not follow this course are likely to suffer grievous disappointment… No strategy can make up for inadequate savings or premature retirement. Save aggressively. Spend cautiously. Let your investments compound as long as possible before drawing them down. That's sound advice. Sadly, it makes perfect sense that the financial services industry is once again doing exactly the wrong thing for clients. Don't trust financial planners and brokers. They're commissioned salespeople. They're incentivized to sell investments, NOT to make you money in stocks and bonds. For as long as my health holds out, I'll stay productive and hopefully get well compensated for my efforts, saving aggressively and spending cautiously. I recommend you do the same. Good investing, Dan Ferris Source: Daily Wealth Follow us on Twitter: @blacklioncm |
Tuesday, December 1, 2015
The Fed Is Bluffing... Interest Rates Won't Rise in 2015
The Fed Is Bluffing... Interest Rates Won't Rise in 2015
BALTIMORE, Maryland – What did we tell you…
The Janet Yellen Fed will not raise interest rates in any meaningful way anytime soon. Instead, she will announce new QE programs.
Yesterday, red was showing up just about everywhere – U.S. stocks, European stocks, Asian stocks, emerging markets stocks, crude oil…
But it could have been worse…
U.S. stocks recovered some of their losses for the day, after the minutes of the most recent Fed meeting showed Yellen and team still won’t pull the trigger on a rate hike until certain unspecified conditions are met.
According to the Fed, the conditions for a rate increase are “approaching” but haven’t been met yet.
Well, guess what… Conditions will never be met.
It doesn’t work that way. This economy will never recover – not as long as it is under the current Keynesian management. It is like a patient attended by quack doctors – doomed to get sicker from their quack “cures.”
Market Morphine
Today’s economy depends on large doses of cheap credit…
And like morphine, you have to up the dosage just to stay in the same place. Take away the drugs, and the pain rises.
The pain caused by falling stock prices, for example.
Take away the cheap credit… and the buybacks on Wall Street dry up. That means earnings per share – the ultimate driver of stock prices – fall, too.
With falling corporate earnings and stagnant household incomes, the inevitable direction for stock prices is also down.
As we discussed in last Friday’s Diary, we’ve already seen that today’s stock prices are not the result of sober reflection on the part of investors.
They do not sit down with a yellow pad and a No. 2 pencil and calculate streams of income over the next 10 years. Instead, they count on the cronies to rig the market for their benefit.
As regular readers know, corporate execs have been borrowing at ultra-low rates and using the money to buy and cancel shares in their own companies. This clever piece of financial engineering reduces the count of outstanding shares and pushes up their value.
The insiders get bonuses… by looting the company’s capital and replacing it with debt. And shareholders get a nice bump in their portfolios.
Since 2009, the market cap of the S&P 500 has risen by almost $11.7 trillion.
And according to a new report from Aranca Investment Research, S&P 500 companies have spent almost $2.3 trillion on buybacks over the same period.
So about one-fifth of the increase in market cap is due to buybacks.
Cheap credit is essential to the looting process. Take it away and the flimflam falls apart. So do stock prices.
The “Recovery” Illusion
But the Fed can’t allow a real crash in the stock market. The “recovery” illusion is based on rising prices for equities.
Supposedly, this leads to a “wealth effect.” According to Fed doctrine, as investors see the values of their investment portfolios rise, they start to spend like drunken capitalists.
The economy is then supposed to explode with growth as “animal spirits” return to shoppers… leaving shiny coins all over the street for the poor to pick up.
Of course, it doesn’t happen…
Instead, the real spoils of cheap credit go to the C-suite cronies, who manipulate the stock market by pumping borrowed funds into buybacks. Stocks go up. But the real economy goes nowhere.
At the Sprott-Stansberry Natural Resource Symposium in Vancouver last month, our friend and Stansberry Research analyst Dr. Steve Sjuggerud debunked the idea that a rising interest rate cycle always coincides with falling stock prices. He pointed out that stocks have tended to rise in value during periods of rising rates.
Don’t worry about the Fed tightening, he told the audience. It doesn’t have to mean lower stock prices.
We don’t doubt that Steve is right. Typically, when the economy heats up due to organic growth, interest rates rise… and so do stocks.
But this is no typical bull market… and no typical economy.
The stock market is being driven higher by ultra-low rates, QE, and clever financial engineering. And the economy is not in the kind of healthy expansion mode that pushes up stock prices and interest rates at the same time.
Instead, much of today’s economy is as cold and lifeless as a corpse.
Commodities are plumbing record lows – most notably oil and “Dr. Copper,” widely seen to signal a deteriorating economy worldwide.
Shipping and freight prices reveal a slowdown in trade. (See today’s Market Insight below for more on that…)
A strong dollar, slowing exports, and falling commodities prices are hammering many of the emerging markets.
And China is struggling to avoid its own Great Depression.
That’s why Ms. Yellen is reluctant to raise rates. She knows it will be painful when she does.
Instead, she’ll administer another dose of morphine…
Bill Bonner
Source: Daily Reckoning
Follow us on Twitter: @blacklioncm
Wednesday, November 25, 2015
Caution! Corporate Cronies At Work...
Caution! Corporate Cronies At Work...
TIVOLI, New York – U.S. stocks flat. A bump in Tokyo. A bump up in Shanghai. Gold registered a $7 loss in New York trading.
Noise, in other words. Nothing to worry about. So let us remind readers, and ourselves, of what is really going on.
This is a Great Zombie War. The fight is between zombies and their crony allies and the rest of the world.
That is the real struggle in Greece, for example.
The insiders – taking advantage of the Greek government’s ability to borrow at low interest rates – enjoy benefits that would otherwise be unavailable.
Now, Athens is deeply in debt… and the insiders are desperate to keep the credit flowing (to them!).
Jackass Codes
You’ll recall that zombies are people who live at others’ expense. They are not bad people, but the system either allows them… or condemns them… to take advantage of others.
Some of the ways the zombies do this are obvious. They get subsidies, guarantees, and direct payments from the feds (who claim to be providing an essential service).
Other ways are less visible. Extensive regulations, for example, keep out competitors, raise profit margins, and provide zombie jobs for inspectors, regulators, and assorted hacks.
Charles Hugh Smith, the chief writer at the Of Two Minds blog, gives a good illustration, relaying the experience of one of his correspondents:
For many years, many of my friends and family who have come to my home and experienced my cooking, have told me that I should ‘open a restaurant’…
About five years ago, there was a restaurant for sale, not too far from my home and business. I thought about buying the restaurant, but at that time, the economy was not doing well, and I wanted to take a wait-and-see attitude before I committed to anything.
Eventually, the restaurant closed down and a different type of business opened up in the space that had been a restaurant. That business went under in the middle of 2014, and I decided it might be time to open a retail food establishment in the space that used to be a restaurant. How hard could it be?
How hard?
Too hard…
The story is too long for us to repeat here. One permit led to the need for another. Then he needed an inspection. The inspection led to further requirements – enlarge this, replace that, put in this system, take out that… one after another… month after month… paper after paper.
Pettifogging standards… jackass codes… pointless rules… every one of them expensive and time-consuming. Finally, even a seasoned entrepreneur was forced to give up:
Essentially, I spent seven months trying to not only figure out what I needed to do, while I was paying rent and utilities, but I also spent many hours trying to figure out the complexities of what the state required.
The law in Nevada is called the Nevada Revised Statutes, or NRS. The statutes for retail food are about 500 pages thick. That’s just the codes that cover food. This does not cover the building, electrical, plumbing, and service codes (such as ADA compliance, handicap parking, etc.).
So, I quit. They beat me.
It always amazes me when politicians use the sound bite of how they will ‘create jobs.’ Well, I am an entrepreneur and have created thousands of jobs over the past 25 years…
But here are at least six jobs that I won’t be creating.
Profits Without Prosperity
Meanwhile, the Harvard Business Review reports a shocking figure: Between 2003 and 2012, companies listed on the S&P 500 spent 54% of their profits buying back their shares (reducing the number – and raising the price – of outstanding shares).
These companies devoted another 37% of their earnings to dividends. That means 91% of profits of America’s top corporations went to shareholders. Just 9% went into capital investment, research and development, expansions, and wage increases.
When we first saw that number we thought it must be a mistake. In our business, we have reinvested about 90% of our profits over the past 20 years – the opposite of the 449 S&P 500 companies in question.
What kind of business would be so shortsighted as to give up so much of its capital?
What kind of corporation would spend so little on R&D… business development… and capital investment?
Ah… then we realized: It’s the cronies at work!
Cronies in the C-Suite
First, as to why a company would do such a foolish thing, the Harvard Business Review gives us the answer:
In 2012, the 500 highest-paid executives named in proxy statements of U.S. public companies received, on average, $30.3 million each; 42% of their compensation came from stock options and 41% from stock awards.
By increasing the demand for a company’s shares, open-market buybacks automatically lift its stock price, even if only temporarily, and can enable the company to hit quarterly earnings-per-share targets.
The cronies are paid to do it.
You’re probably wondering how this fits into the Great Zombie War. Isn’t this just capitalism at work? Isn’t this their own money… and they can do with it what they choose?
We answer these questions with questions of our own: How is it possible for them to do this? In the normal course of business you’d think they would need to hold on to more of their money. They are capitalists, aren’t they? They must need capital, don’t they?
Well, you are underestimating the subtlety of the zombies’ war plan.
It is fueled almost entirely with credit… provided at ultra-low cost by their cronies at the Fed. The cheap credit permits corporate America to borrow heavily at little cost and distribute this cash to shareholders… and, more importantly, to corporate insiders.
C-suite cronies are looting America’s top corporations of their capital and replacing it with debt. The public will shoulder the cost of so much cheap credit in the form of future inflation. Meantime, corporate insiders enjoy the spoils in the form of blowout bonuses.
That is why the zombies are fighting so hard to keep the credit bubble inflated – not, as commonly advertised, because it stimulates a recovery.
Cheap credit gives them a way to take what isn’t theirs.
And the war goes on…
Regards,
Bill Bonner
Source: Daily Reckoning
Follow us on Twitter: @blacklioncm
Monday, November 23, 2015
Four Steps for Finding Great Investments
Four Steps for Finding Great Investments
By
Wednesday, June 24, 2015
We're going to do something that's hard for most people in today's essay...
It involves some math. It involves thinking hard about rather abstract ideas. For most of you, it will involve learning new jargon, which is probably the hardest part. No, it's not as hard as walking across a giant desert for 40 days. But it's something most people will go to great lengths to avoid. So let me tell you why you should first calculate these four things every time you buy another stock.
What you'll find below is a nearly foolproof way to evaluate the quality and the value of any business. This four-part test will allow you to quantify, with surprising precision, exactly what makes a given business great, average, or poor. This knowledge will allow you to make vastly better and more-informed decisions about what any business is worth and what you should be willing to pay for it on a per-share basis. But that's not the best reason to learn this four-part test...
The real secret is, once you develop the discipline to always do this work before you buy any stock, you'll never make a quick decision to buy a stock ever again. Once you add something that's hard to do, that requires a little bit of time, a little rigor, and a little discipline to your investment process, you're going to greatly reduce the number of stocks you buy.
You're also going to radically improve the quality of the stocks you're willing to invest in because you'll have the skills to do so. And that will eliminate more than 90% of your investment mistakes. Remember... you don't need to find a great investment every month, or even every year. You just need to find them every now and then... and have capital ready to put to work.
As I explained yesterday, I believe the No. 1 thing you need to know to be successful as an investor in common stocks is what type of business makes for a great investment.
Investment legend Warren Buffett says the same thing. He puts it this way...
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So... what makes a great business? How can you be certain its earnings will materially grow over reasonable periods of time? To figure it out, let's take one of Buffett's most famous investments – Coca-Cola (KO).
Coke sells addictive (caffeine-laced) sugar water for more than the price of gasoline all around the world. It has integrated its brand into people's lives through decades of advertising spending – an investment that has paid off tremendously. Coke has one of the world's most universally recognized and admired brands.
But how do these advantages translate into hard numbers? The most obvious characteristic of a great business is high profit margins. High profit margins are proof of a great brand, a superior product, or some form of regulatory capture that permits greater-than-normal profitability. On every dollar of revenue last year, Coke earned nearly $0.25 in cash. And it brought in $46 billion in revenue.
To figure out exactly how much money Coke earns in cash, we simply look at the company's cash flow statement, under the line: "total cash flow from operating activities." We see that in 2014, this was $10.6 billion. (You can get this by looking at the company's annual report, Yahoo Finance, or any number of other online databases, like Bloomberg. Here's a link to Coke's cash flow statement on Yahoo Finance.)
Next, we divide those cash profits by the company's total revenue ($45.9 billion), which you can find on the income statement. Doing the math gives you a fraction that is commonly expressed in percentage form: 23%. Coke's cash operating profit margin is 23%. It's earning $0.23 in profit on every dollar it generates in sales. In our experience, businesses with cash operating profit margins in excess of 20% are world-class. If you were putting together a checklist, you could start there. A great business must have cash operating profit margins greater than 20%.
The next "mile marker" you're looking for is something we call capital efficiency. This is another concept that, like profitability, is easy for most people to grasp. All you're trying to understand with this test is how much capital the company requires to maintain its facilities and grow its revenues. For example, oil and gas companies are notorious for spending every penny they make on drilling more holes and building more facilities. Their capital-spending programs leave little of their profits to be distributed to shareholders (often less than zero).
We've developed a sophisticated way to measure, in precise terms, the capital efficiency of any business using several factors in our monthly Capital Efficiency Monitor – a part of our supplemental Stansberry Data service.
But you can use a much simpler equation as part of our four-part test of a great business. All you need to do is figure out whether the company in question distributes more capital back to shareholders... or spends more money "on itself" via capital-spending programs.
A great business is able to distribute more profits to its shareholders than it consumes via capital investments. Coke, for example, spent $2.4 billion on capital investments in its own business in 2014. It spent $5.35 billion on dividends and $2.63 billion on share buybacks in the same period. You can see that Coke is spending far more on its shareholders than it spends on itself. (By the way, all of these numbers are labeled clearly on the cash flow statement I linked to earlier.)
What's powerful for investors about businesses like these is that you don't have to depend on a "greater fool" to come along and pay you more money for your shares than they're really worth. You don't need lower interest rates or a raging bull market to be successful. As these businesses grow, they're going to increase their payout amounts, year after year. It's the compounding effect of this growth that will make you wealthy – not the misguided actions of foolish investors. That's why Buffett says you should never buy a stock you wouldn't be happy to hold for a decade, even if the stock market was closed.
The third part of our four-part litmus test for great businesses is return on invested capital. (Here comes the jargon.) Yes, it's a mouthful. But I promise, with just a little practice, you'll be able to easily calculate this figure in your head. We use this metric because there's no purer way of determining the value and the power of a company's "moat" – the degree to which the company is sheltered from profit-eliminating competition.
The business school formula for determining the precise amount of invested capital is complex and requires several different numbers (and judgments about each of them). It's a pain. And there's a much easier way to get a ballpark figure – just add the total amount of a company's long-term debt and the total value of the company's equity capital. You'll find both numbers as simple line items on the balance sheet.
Coke has $30 billion worth of equity capital and $42 billion worth of debt (adding the current position of long-term debt to long-term debt). So in our book, the company has invested capital of $72 billion. On this capital last year, the company reported $7 billion worth of net income, or "earnings." You'll find Coke's net income on the key statistics page, or you can look at the income statement directly. Once you have the numbers, you just do the basic math (seven divided by 72) to derive another percentage: 10%. As you'll see, this is where Coke falls a bit flat. The beverage market is ultra-competitive and Coke's brand only provides a small measure of protection against competitive pricing.
The last part of our great business test is also a bit "wonky" and will make you sound like a finance geek. It's called return on net tangible assets. This number gives you the best overall measure of the quality of any business. It's similar to the more commonly used return on equity (ROE) with two important differences.
First, measuring returns against net tangible assets takes goodwill out of the calculation. So companies with large amounts of goodwill (like companies with great brands) will typically show a much higher return. Second, this measure of quality rewards companies that can borrow most of the capital they need because their results aren't cyclical.
Calculating this number is also really easy. Yahoo Finance lists “net tangible assets” among its balance sheet statistics. All you have to do is compare this number with the company's net income for the last year. In Coke's case, net tangible assets total only $3.9 billion. Coke earned a profit equal to 179% of its net tangible assets – a truly outstanding figure.
(Note: In some cases, a company will actually have more liabilities than it has tangible assets. In those cases, the math you see above no longer works because you can’t divide using a negative net tangible assets figure. When that happens, we’ll subtract out only the long-term portion of total liabilities. This provides a more meaningful number, while still measuring the company's ability to safely replace equity with debt in its capital structure.)
Putting all of these factors together, our test of business greatness starts with profits. How much money, in cash, does a business earn from its operations, expressed as a percentage of its sales? The higher the margins, the better. This tells us that the company owns high-quality brands and products, and market position. We expect great businesses to produce cash operating margins of at least 20%.
Our second test is capital efficiency. Does the business produce substantial amounts of excess capital, and does management treat shareholders well? We test this by seeing whether shareholders receive at least as much capital each year as the business reinvests in itself.
The third test is return on invested capital, which is the best measure of a company's moat. Here again, we would expect to see returns on invested capital of at least 20% to qualify as a great business.
Finally, our last measure of great companies – return on net tangible assets – is the single best overall measure of the quality of a business. It combines brand value, capital efficiency, the quality of earnings, etc. No surprise, we expect returns on net tangible assets in excess of 20% annually.
Business quality is extremely important, but the stock price is equally important for investment outcomes. Our best advice is to value high-quality businesses by the amount of cash they earn before interest, taxes, depreciation, and amortization. In finance jargon, this measure of profits is called "EBITDA." You can't use this measure with lower-quality businesses, but it works well for high-quality businesses because it allows you to quickly judge companies in different industries against each other.
Now, let me show you a trick that will show you when to buy a high-quality company. We try to avoid paying more than 10 years' worth of EBITDA per share when we buy a business. We measure the cash earnings against the enterprise value of the business (the value of all of the shares and all of the debt, minus the cash in the business). But you don't need to do all of this work yourself. You can find this multiple on Yahoo Finance on the key statistics page for any given stock. Valuing businesses is a lot more difficult than evaluating their performance. You should be willing to pay more for a high-quality business that's growing.
Below, you'll find nearly 40 different companies we consider great businesses, according to their results over the last three years. Roughly half of these companies are trading at or close to reasonable prices. Not including the valuation figure (No. 5), the numbers below were compiled using the last three years of operating metrics, so these numbers may look a little different than the ones you calculate at home, if you're only using current figures.
Company
|
Symbol
|
Share Price
|
No. 1: Profits
|
No. 2: Efficiency
|
No. 3:
Moat |
No. 4: Quality
|
No. 5:
Price |
InterDigital
|
IDCC
|
$57.80
|
45%
|
29.3
|
21%
|
48%
|
6.2
|
Shanda
|
GAME
|
$6.95
|
39%
|
15.0
|
30%
|
99%
|
7.5
|
Apple *
|
AAPL
|
$128.60
|
32%
|
3.4
|
29%
|
35%
|
8.1
|
Gilead
|
GILD
|
$114.18
|
42%
|
4.0
|
29%
|
485%
|
8.9
|
TiVo
|
TIVO
|
$10.57
|
49%
|
21.2
|
16%
|
30%
|
8.9
|
Microsoft *
|
MSFT
|
$46.26
|
39%
|
3.0
|
22%
|
35%
|
9.4
|
Scripps
|
SNI
|
$67.80
|
30%
|
14.0
|
20%
|
413%
|
9.7
|
Edwards
|
EW
|
$131.77
|
30%
|
2.3
|
24%
|
38%
|
9.8
|
Coach *
|
COH
|
$35.88
|
25%
|
3.4
|
45%
|
50%
|
10.1
|
Oracle
|
ORCL
|
$43.78
|
38%
|
14.1
|
18%
|
606%
|
10.2
|
VeriSign
|
VRSN
|
$62.75
|
60%
|
13.5
|
46%
|
39%
|
11.6
|
Myriad
|
MYGN
|
$33.37
|
27%
|
10.3
|
21%
|
28%
|
12.2
|
Ubiquiti
|
UBNT
|
$31.29
|
27%
|
9.4
|
59%
|
59%
|
12.2
|
Lorillard **
|
LO
|
$71.22
|
25%
|
23.5
|
98%
|
35%
|
12.3
|
3M
|
MMM
|
$157.08
|
19%
|
3.2
|
21%
|
27%
|
12.3
|
Philip Morris **
|
PM
|
$80.04
|
30%
|
9.8
|
40%
|
34%
|
12.4
|
j2 Global
|
JCOM
|
$66.47
|
36%
|
4.9
|
15%
|
64%
|
13.0
|
AVG
|
AVG
|
$25.38
|
33%
|
0.3
|
162%
|
63%
|
13.0
|
F5 Networks
|
FFIV
|
$124.14
|
34%
|
11.6
|
21%
|
33%
|
13.2
|
CBOE
|
CBOE
|
$57.45
|
40%
|
4.5
|
69%
|
68%
|
13.6
|
Linear
|
LLTC
|
$46.67
|
44%
|
7.4
|
28%
|
42%
|
13.7
|
Check Point
|
CHKP
|
$83.87
|
58%
|
49.6
|
18%
|
23%
|
14.2
|
Moody's
|
MCO
|
$107.15
|
31%
|
15.0
|
41%
|
79%
|
14.3
|
MasterCard
|
MA
|
$92.36
|
42%
|
19.4
|
43%
|
62%
|
16.1
|
Verisk **
|
VRSK
|
$73.88
|
31%
|
2.3
|
22%
|
51%
|
16.2
|
QIWI
|
QIWI
|
$28.29
|
37%
|
5.7
|
57%
|
161%
|
16.2
|
Core Labs
|
CLB
|
$120.51
|
27%
|
8.3
|
56%
|
127%
|
16.6
|
Choice Hotels **
|
CHH
|
$56.36
|
22%
|
11.5
|
45%
|
26%
|
17.2
|
Biogen
|
BIIB
|
$387.78
|
32%
|
2.4
|
23%
|
51%
|
17.4
|
Sirius XM
|
SIRI
|
$3.90
|
28%
|
11.3
|
47%
|
71%
|
18.0
|
NetEase
|
NTES
|
$144.99
|
53%
|
3.1
|
20%
|
22%
|
18.6
|
Visa
|
V
|
$68.42
|
44%
|
8.6
|
13%
|
100%
|
18.7
|
Priceline
|
PCLN
|
$1,180.86
|
34%
|
6.4
|
28%
|
56%
|
18.7
|
FactSet
|
FDS
|
$164.58
|
30%
|
11.5
|
38%
|
85%
|
19.5
|
Celgene
|
CELG
|
$110.46
|
36%
|
12.6
|
17%
|
321%
|
25.7
|
TripAdvisor
|
TRIP
|
$75.41
|
33%
|
(0.9)
|
19%
|
89%
|
25.8
|
AbbVie
|
ABBV
|
$67.53
|
28%
|
5.9
|
24%
|
94%
|
27.9
|
Baidu
|
BIDU
|
$206.99
|
42%
|
(0.4)
|
22%
|
49%
|
28.6
|
Intuit
|
INTU
|
$105.59
|
33%
|
5.5
|
23%
|
55%
|
32.7
|
WisdomTree
|
WETF
|
$21.78
|
39%
|
0.8
|
45%
|
36%
|
35.9
|
* In the Stansberry's Investment Advisory model portfolio
| |||||||
** For Quality, using return on tangible assets because intangible assets minus long-term debt is negative
| |||||||
We believe the best overall measure of the overall quality of a business is return on net tangible assets. We derive this figure by dividing annual profits (net income) by the company's tangible assets minus total liabilities. Companies that can produce large profits on their asset base may sometimes have more debt on their balance sheets than equity, in effect replacing equity capital with long-term debt. While investors normally should seek to avoid highly indebted firms, companies like these that can produce high and consistent returns can safely use credit as a replacement for equity in their capital structure. This produces large returns on equity, making these businesses extremely attractive to outside passive investors. Please note: In certain examples, extreme amounts of negative equity made our calculations meaningless – you can't divide with a negative number. In those situations, we isolate long-term debt (as opposed total liabilities) to derive net tangible assets. If that still yields a negative number, we simply use returns on tangible assets as a substitute.
| |||||||
The Four-Step Test of Greatness:
| No. 1. Cash operating profit margin: cash from operations / revenue (should be greater than 20%). | |
| No. 2. Shareholder payout ratio: capital returned to shareholders / capital expenditures (should be greater than 1). | |
| No. 3. Return on invested capital: net income / long-term debt + shareholder equity (should be greater than 20%). | |
| No. 4. Returns on net tangible assets: net income / net tangible assets (should be greater than 20%). |
Bonus Step:
| No. 5. Share price multiple: enterprise value / EBITDA (ideally less than 10). |
Regards,
Porter Stansberry
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