Starting Today, November 30, $1 Trillion Starts Moving to China

Starting Today, November 30, $1 Trillion Starts Moving to China By Dr. Steve Sjuggerud Monday, November 30, 2015

Nobody is talking about it… but two incredibly important things are happening TODAY that have to do with China's financial markets… These two things are just the beginning… The two things happening today represent the beginning of up to $1 trillion moving into Chinese financial assets. (That $1 trillion is not my number. It is from two giants of finance – Standard Chartered and AXA Insurance.) I'll share both of these big changes with you today and tomorrow. First, let's look at what's happening in China's currency… China will finally join the global superpower club.  Today, China's currency, the yuan, will likely be allowed to join the big four currencies – the U.S. dollar, the euro, the Japanese yen, and the British pound – as the fifth member of the International Monetary Fund's currency (the Special Drawing Rights, or "SDR").  Specifically, earlier this month, the head of the International Monetary Fund ("IMF"), Christine Lagarde, said:  "The IMF staff assesses that [China's currency] meets the requirements to be… [included] in the SDR basket as a fifth currency, along with the British pound, euro, Japanese yen, and the U.S. dollar."  Here's the timeline for all of this…  The IMF will OFFICIALLY announce if the yuan gets to join its SDR reverse currency basket today. If the yuan gets approved, China will "join the club" on October 1, 2016.  The thing is, it's already a foregone conclusion…  There's no need to wait to hear the answer. You see, any country protesting the inclusion of the yuan would look like an idiot at this point. So what does this mean? In short, it's a vote of confidence in China's drastic reforms by the world's major powers.  This move is largely symbolic (as none of us actually use the IMF's currency). What it means is far more important in the long run… It means that China's currency "passes the test." China's currency is finally considered to be as legit as the other four, in the eyes of the world's superpowers.  Most folks are blowing off the significance of this. I think that's a mistake…  After today, hundreds of billions of dollars will likely flow into China's currency in the coming years, and from a variety of sources… As a reserve currency for central banks… as a way for investors to diversify outside of the U.S. dollar… as a speculation… as a medium of exchange in global trade… etc., etc.  The era of China's yuan as a legitimate currency starts today. (You can check www.IMF.org to be sure it happened.)  My humble suggestion is, get your money there first…  Tomorrow, I'll show you what's going on in China's stock market… And why it gives us an incredible investment opportunity right now.  Good investing,  Steve Source: Daily Wealth Follow us on Twitter: @blacklioncm

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

The Most Important Lesson When Buying Stocks

One of the Most Important Lessons When Buying Stocks By Mike Barrett, analyst, Extreme Value Friday, July 10, 2015

You're not going to succeed in the stock market by just buying the world's best businesses… For the past several years, my colleague Dan Ferris and I have urged Extreme Value readers to buy great businesses… Businesses that gush free cash flow, reward shareholders, have great balance sheets, earn consistent profit margins, and have high returns on equity. But if you pay too much, even a fantastic company can turn into a mediocre and possibly terrible investment… That's why we also tell readers to never buy a great business until it's trading at a cheap price. This is a discipline I impose upon myself and encourage you to embrace. To see just how a great business can turn into a mediocre – and even terrible – investment if you pay too much, let's look at American candy icon Tootsie Roll Industries (TR)…We've never recommended Tootsie Roll, but Dan and I have followed the high-quality business for years. Tootsie Roll's results don't change much from year to year or decade to decade. Since 2005, revenue and free cash flow (FCF) have compounded at low levels of about 1.5% per year. Since revenue doesn't change much year-to-year, neither do dividends or shareholder equity.  Return on equity, or "ROE" (using free cash flow instead of the usual net income because the business is capital-intensive), is routinely a strong 15%-20%. Occasionally, when manufacturing equipment is updated and capital expenditures exceed 2% of revenue, the ROE drops to 5%-10%.  Since things don't change much operationally, it's crucial you buy shares at a cheap price. Otherwise, you lock yourself in for years of meager returns, despite the regular cash and stock dividends.  Let me illustrate…  Right now, shares trade around 24.5 times trailing 12-month free cash flow. That's expensive for outside passive minority investors like us.  If you'd bought Tootsie Roll in 2005, you'd have paid a similarly expensive multiple. Shares ended that year at $28.93, valued near 23 times FCF.  Since then, approximately $10 in cash dividends and stock splits would have reduced your cost basis from $28.93 to $18.66. (Capital returned to you lowers your cost basis dollar for dollar.)  At the end of 2014, shares closed at $30.65. That produced a compound return of just 6% per year over the full nine-year holding period. At Extreme Value, we want our investment capital to earn double-digit compound returns of 10% or better.  It was the same story if you bought in 2010. Shares were trading near $29 and at an expensive 23 times 12-month FCF. By the end of 2014, your cost basis would have been reduced to $24 by cash dividends and stock splits. Again, that's a compound return of only around 6% per year over the four-year holding period.  If you had bought when shares were cheap, though, it would have been a different story entirely…  Shares temporarily dropped to $20 in 2009 and the valuation multiple was a much-lower 15 times FCF. Since then, cash dividends and stock splits would have reduced the cost basis to about $13.68… and the compounded return on investment would've been closer to 18%, not 6%, per year.  This is one of most important lessons I can teach you about buying stocks: A great business is a great long-term investment only if you buy it when it's unusually cheap. Pay too much and you're doomed to underperform, or possibly even lose money.  This is why you should be choosy about making new trades. Stock prices have soared the past six years so most individual stocks are still too expensive to buy today.  In short, if a great business you want to buy is expensive right now, be patient. Prices tend to fluctuate. Eventually, you'll get a chance to buy it at a price that will also make it a great investment.  Good investing, Mike Barrett Source: Daily Wealth Follow us on Twitter: @blacklioncm

Four Steps for Finding Great Investments

By Porter Stansberry 

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...

 

Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, 10, and 20 years from now.

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