The Inside Scoop on Staffing Companies
By Kristan Rowland
Morningstar, 08-25-06
The aging United States workforce boasts broad implications for the country. The 78 million strong baby boomer population (those born between 1946 and 1964) not only controls much of the nation's net worth and makes up about half of U.S. discretionary spending, but it also accounts for a significant portion of the U.S. labor force. According to the Bureau of Labor Statistics, the 55 and older age group is projected to gain share of the U.S. labor force, from about 16% currently to 21.2% by 2014. Let's take a look at how an older workforce might create some investing opportunities in the staffing industry.
According to IDC, a global provider of industry information, about 19% of the entire U.S. workforce holding executive, administrative, and managerial positions will retire in the next five years, which we think bodes well for firms like Heidrick & Struggles HSII . It is the leading executive search firm that fills the most-senior-level positions and enjoys a 50-year history. This firm's strong brand and network will be the keys to its success. We think that the firm will continue to attract talent given its huge share of topnotch employment opportunities. Furthermore, with this looming talent shortage, companies are likely to rely more heavily on Heidrick & Struggles given its long history and extensive unparalleled network of relationships. Also, companies may be forced to pay more for talent, given supply constraints. Heidrick & Struggles should benefit from this trend, as its per-placement revenues are based on the size of executives' first-year pay packages.
Current baby boomer spending habits, a lack of savings, increased longevity, and lifestyle choices may mean that many boomers continue to work part-time. A working paper from the Bureau of Labor Statistics using data from the University of Michigan's Health and Retirement Study found that half to two thirds of respondents with full-time careers take on "bridge" jobs before exiting the labor force and that more individuals are choosing to work part-time after leaving full-time career employment.
Several temporary staffing firms may stand to benefit from these workforce trends. Robert Half International RHI is one of our favorite professional staffing firms. It is the leader in specialty staffing, and benefits from topnotch management. Its gross margins are among the highest in the staffing industry, a reflection of its focus on highly skilled temporary workers. It boasts average returns on invested capital of 18% over the last 13 years. Other temporary staffing firms that may also benefit include Manpower MAN and Adecco ADO . Adecco is the worldwide leader in temporary staffing, with Manpower not too far behind. These two firms have a strong network and the ability to attract workers with their solid brand names. They may also benefit from similar demographic trends in Europe and other countries as individuals may supplement benefits with part-time temporary work.
Now is not the time to be buying these stocks. All of the companies listed have Morningstar ratings of 3 stars, but because these companies are cyclical, the ratings can change dramatically. Typically these stocks decline during recessions, when the employment picture is poor. Following the end of the 2001 recession, the unemployment rate peaked 19 months later. Likewise, most of the above stocks hit bottom in 2003, as unemployment peaked, and have all at least doubled in value since then. We think these rough periods provide good buying opportunities and would seek to pick up any of these names when they return to 5-star territory.
Friday, August 25, 2006
Why Economists Blog?
Why Economists Blog?
The Economist, Aug 3, 2006
Clearly there is here a problem of the division of knowledge, which is quite analogous to, and at least as important as, the problem of the division of labour,” Friedrich Hayek told the London Economic Club in 1936. What Mr Hayek could not have known about knowledge was that 70 years later weblogs, or blogs, would be pooling it into a vast, virtual conversation. That economists are typing as prolifically as anyone speaks both to the value of the medium and to the worth they put on their time.
Like millions of others, economists from circles of academia and public policy spend hours each day writing for nothing. The concept seems at odds with the notion of economists as intellectual instruments trained in the maximisation of utility or profit. Yet the demand is there: some of their blogs get thousands of visitors daily, often from people at influential institutions like the IMF and the Federal Reserve. One of the most active “econobloggers” is Brad DeLong, of the University of California, Berkeley, whose site, delong.typepad.com, features a morning-coffee videocast and an afternoon-tea audiocast in which he holds forth on a spread of topics from the Treasury to Trotsky.
So why do it? “It's a place in the intellectual influence game,” Mr DeLong replies (by e-mail, naturally). For prominent economists, that place can come with a price. Time spent on the internet could otherwise be spent on traditional publishing or collecting consulting fees. Mr DeLong caps his blogging at 90 minutes a day. His only blog revenue comes from selling advertising links to help cover the cost of his servers, which handle more than 20,000 visitors daily.
Gary Becker, a Nobel-prize winning economist, and Richard Posner, a federal circuit judge and law professor, began a joint blog in 2004. The pair, colleagues at the University of Chicago, believed that their site, becker-posner-blog.com, would permit “instantaneous pooling (and hence correction, refinement, and amplification) of the ideas and opinions, facts and images, reportage and scholarship, generated by bloggers.”
The practice began as an educational tool for Greg Mankiw, a professor of economics at Harvard and a former chairman of George Bush's Council of Economic Advisers. His site, gregmankiw.blogspot.com, started as a group e-mail sent to students, with commentary on articles and new ideas. But the market for his musings grew beyond the classroom, and a blog was the solution. “It's a natural extension of my day job—to engage in intellectual discourse about economics,” Mr Mankiw says.
With professors spending so much time blogging for no payment, universities might wonder whether this detracts from their value. Although there is no evidence of a direct link between blogging and publishing productivity, a new study* by E. Han Kim and Adair Morse, of the University of Michigan, and Luigi Zingales, of the University of Chicago, shows that the internet's ability to spread knowledge beyond university classrooms has diminished the competitive edge that elite schools once held.
Top universities once benefited from having clusters of star professors. The study showed that during the 1970s, an economics professor from a random university, outside the top 25 programmes, would double his research productivity by moving to Harvard. The strong relationship between individual output and that of one's colleagues weakened in the 1980s, and vanished by the end of the 1990s.
The faster flow of information and the waning importance of location—which blogs exemplify—have made it easier for economists from any university to have access to the best brains in their field. That anyone with an internet connection can sit in on a virtual lecture from Mr DeLong means that his ideas move freely beyond the boundaries of Berkeley, creating a welfare gain for professors and the public.
Universities can also benefit in this part of the equation. Although communications technology may have made a dent in the productivity edge of elite schools, productivity is hardly the only measure of success for a university. Prominent professors with popular blogs are good publicity, and distance in academia is not dead: the best students will still seek proximity to the best minds. When a top university hires academics, it enhances the reputations of the professors, too. That is likely to make their blogs more popular.
Self-interest lives on, as well. Not all economics bloggers toil entirely for nothing. Mr Mankiw frequently plugs his textbook. Brad Setser, of Roubini Global Economics, an economic-analysis website, is paid to spend two to three hours or so each day blogging as a part of his job. His blog, rgemonitor.com/blog/setser, often concentrates on macroeconomic topics, notably China. Each week, 3,000 people read it—more than bought his last book. “I certainly have not found a comparable way to get my ideas out. It allows me to have a voice I would not otherwise get,” Mr Setser says. Blogs have enabled economists to turn their microphones into megaphones. In this model, the value of influence is priceless
The Economist, Aug 3, 2006
Clearly there is here a problem of the division of knowledge, which is quite analogous to, and at least as important as, the problem of the division of labour,” Friedrich Hayek told the London Economic Club in 1936. What Mr Hayek could not have known about knowledge was that 70 years later weblogs, or blogs, would be pooling it into a vast, virtual conversation. That economists are typing as prolifically as anyone speaks both to the value of the medium and to the worth they put on their time.
Like millions of others, economists from circles of academia and public policy spend hours each day writing for nothing. The concept seems at odds with the notion of economists as intellectual instruments trained in the maximisation of utility or profit. Yet the demand is there: some of their blogs get thousands of visitors daily, often from people at influential institutions like the IMF and the Federal Reserve. One of the most active “econobloggers” is Brad DeLong, of the University of California, Berkeley, whose site, delong.typepad.com, features a morning-coffee videocast and an afternoon-tea audiocast in which he holds forth on a spread of topics from the Treasury to Trotsky.
So why do it? “It's a place in the intellectual influence game,” Mr DeLong replies (by e-mail, naturally). For prominent economists, that place can come with a price. Time spent on the internet could otherwise be spent on traditional publishing or collecting consulting fees. Mr DeLong caps his blogging at 90 minutes a day. His only blog revenue comes from selling advertising links to help cover the cost of his servers, which handle more than 20,000 visitors daily.
Gary Becker, a Nobel-prize winning economist, and Richard Posner, a federal circuit judge and law professor, began a joint blog in 2004. The pair, colleagues at the University of Chicago, believed that their site, becker-posner-blog.com, would permit “instantaneous pooling (and hence correction, refinement, and amplification) of the ideas and opinions, facts and images, reportage and scholarship, generated by bloggers.”
The practice began as an educational tool for Greg Mankiw, a professor of economics at Harvard and a former chairman of George Bush's Council of Economic Advisers. His site, gregmankiw.blogspot.com, started as a group e-mail sent to students, with commentary on articles and new ideas. But the market for his musings grew beyond the classroom, and a blog was the solution. “It's a natural extension of my day job—to engage in intellectual discourse about economics,” Mr Mankiw says.
With professors spending so much time blogging for no payment, universities might wonder whether this detracts from their value. Although there is no evidence of a direct link between blogging and publishing productivity, a new study* by E. Han Kim and Adair Morse, of the University of Michigan, and Luigi Zingales, of the University of Chicago, shows that the internet's ability to spread knowledge beyond university classrooms has diminished the competitive edge that elite schools once held.
Top universities once benefited from having clusters of star professors. The study showed that during the 1970s, an economics professor from a random university, outside the top 25 programmes, would double his research productivity by moving to Harvard. The strong relationship between individual output and that of one's colleagues weakened in the 1980s, and vanished by the end of the 1990s.
The faster flow of information and the waning importance of location—which blogs exemplify—have made it easier for economists from any university to have access to the best brains in their field. That anyone with an internet connection can sit in on a virtual lecture from Mr DeLong means that his ideas move freely beyond the boundaries of Berkeley, creating a welfare gain for professors and the public.
Universities can also benefit in this part of the equation. Although communications technology may have made a dent in the productivity edge of elite schools, productivity is hardly the only measure of success for a university. Prominent professors with popular blogs are good publicity, and distance in academia is not dead: the best students will still seek proximity to the best minds. When a top university hires academics, it enhances the reputations of the professors, too. That is likely to make their blogs more popular.
Self-interest lives on, as well. Not all economics bloggers toil entirely for nothing. Mr Mankiw frequently plugs his textbook. Brad Setser, of Roubini Global Economics, an economic-analysis website, is paid to spend two to three hours or so each day blogging as a part of his job. His blog, rgemonitor.com/blog/setser, often concentrates on macroeconomic topics, notably China. Each week, 3,000 people read it—more than bought his last book. “I certainly have not found a comparable way to get my ideas out. It allows me to have a voice I would not otherwise get,” Mr Setser says. Blogs have enabled economists to turn their microphones into megaphones. In this model, the value of influence is priceless
Small Caps for the Picking
Small Caps for the Picking
by Pat Dorsey, CFA
Morningstart, 08-11-06
As regular Morningstar readers know, we've been pounding the table for high-quality large caps for quite some time now. Lo and behold, it seems that the tide may finally be turning: Morningstar's Large-Cap Index is now ahead of our small-cap index both year-to-date and for the trailing year. Over the past three months, in fact, small caps have lost almost 12%, while large caps have held up pretty well, with a 3% loss.
This is a really great development for a couple of reasons. For one, it means that almost two years after initially advancing the notion that lower-risk, high-quality large caps were cheap relative to generally riskier small fry, I might finally be right. (Long stretches of looking dumb are an occupational hazard in the stock analysis profession.) But even better, the poor recent performance of small caps means that, in typical fashion, Wall Street has been throwing the baby out with the bathwater, and there are now some very interesting smaller companies that are cheap enough to buy.
So, I trolled our coverage universe of more than 1,800 stocks--which includes about 600 small caps--for some of the most promising smaller companies that we cover. Here's what I came up with.
Although Blue Nile NILE would be near the top of the list alphabetically, it would still be at the top even if the online diamond merchant were named Zambezi. The firm has a beautiful business model with negative working capital--the firm holds no inventory, so Blue Nile doesn't need to pay suppliers until after the consumer has paid for the diamond--that generates enormous returns on capital. Moreover, the firm has a management team that seems to understand the importance of capital allocation, rather than growth for growth's sake, as evidenced by management's decision to pull back on paid search advertising late last year when keywords became too expensive. Although the shares popped recently on the heels of a solid earnings report, we think they still have substantial upside.
Another high-quality smaller name that looks attractive is for-profit education company DeVry DV , which saw enrollment in its technology-related programs get whacked during the bursting of the tech bubble. However, as improved enrollment levels work their way through the firm's multiyear programs, margins should improve nicely, and the firm has not suffered from any of the investigations that have dogged some of its peers. At 15 times cash flow, the shares look pretty attractive to us.
Sticking with the growth theme, logistics firm Forward Air FWRD has seen its shares plunge recently on fears of a slowing economy to a point at which we think they offer a compelling value. This asset-light firm occupies an interesting niche of the transportation industry, moving freight via truck between airports with such efficiency that customers use it as an alternative to pricier air-cargo services. The firm has a great track record of creating shareholder value, and we think that it has many years of excess returns ahead of it.
These are three very high-quality firms trading at fair prices. Moving down the quality--and valuation--scale somewhat, I'd highlight three more companies that are all solid and trade at very attractive prices. It's an eclectic group: a beaten-up specialty retailer, a slumping casual-dining chain, and the owner of two great education brands.
Tuesday Morning TUES is the beaten-up retailer, and it has suffered from the same slump in houseware spending that's taken Pier One PIR from $20 to $6 over the past couple of years. The difference is that Tuesday Morning has no debt, is still generating meaningful free cash flow, and occupies a defensible niche--selling branded closeout goods. This is a very solid little company that's gotten very, very cheap. Even better, the private equity firm that took it private about 10 years ago still has a sizable stake, which means it may very well just take the company private again if the share price stays as cheap as it is now.
The casual-dining chain is Applebee's APPB , which caters to a less-well-off clientele that's been pinched badly by higher gas prices. This is not great, but neither is it a terminal problem, and we think Applebee's has more sticking power than most restaurant chains given its scale, advertising muscle, and unique attributes, like an exclusive alliance with Weight Watchers WTW . A reasonable top-line growth estimate coupled with steady margins yields a fair value estimate almost twice the current price.
The smallest of the firms in this group is Educate EEEE , which operates Sylvan Learning tutoring centers and owns the well-known Hooked on Phonics brand. The firm's management has made a hash of things over the past year by getting too aggressive in an ongoing plan of buying back franchised Sylvan centers; this seriously damaged operational performance. As a result, the shares have been absolutely hammered. However, the brands are still strong, the demand for tutoring services is still solid, and the operational problems are fixable. We think the shares are cheap enough to be worth a look, and we also think that Educate's majority owner--private equity firm Apollo Management--could very well make a bid for the whole company.
Finally, we have three small caps that all have serious warts, but which are all so dirt cheap that adventuresome types should give them a look. Homebuilder Levitt LEV trades for just 60% of book value, and while the shares may very well take time to turn around, the current stock price assumes a doomsday scenario that we think is unlikely to occur. Radware RDWR is an Israel-based maker of networking equipment that's got solid products, decent growth potential, and a dirt-cheap stock--net of the firm's almost $9 per share in cash, the shares trade at just 1 times our 2006 sales estimate. (Radware could also make a tasty treat for one of the major networking companies.)
Then there's video-game company Take Two Interactive TTWO , which has some of the worst corporate governance we've seen, but also owns the amazingly successful Grand Theft Auto gaming franchise. We estimate this one game alone is worth about 40% more than the current share price, and that the whole company (which does have some other successful games) could be worth as much as twice the current share price. This one's not for the timid, but a large enough margin of safety can compensate for a lot of risks.
by Pat Dorsey, CFA
Morningstart, 08-11-06
As regular Morningstar readers know, we've been pounding the table for high-quality large caps for quite some time now. Lo and behold, it seems that the tide may finally be turning: Morningstar's Large-Cap Index is now ahead of our small-cap index both year-to-date and for the trailing year. Over the past three months, in fact, small caps have lost almost 12%, while large caps have held up pretty well, with a 3% loss.
This is a really great development for a couple of reasons. For one, it means that almost two years after initially advancing the notion that lower-risk, high-quality large caps were cheap relative to generally riskier small fry, I might finally be right. (Long stretches of looking dumb are an occupational hazard in the stock analysis profession.) But even better, the poor recent performance of small caps means that, in typical fashion, Wall Street has been throwing the baby out with the bathwater, and there are now some very interesting smaller companies that are cheap enough to buy.
So, I trolled our coverage universe of more than 1,800 stocks--which includes about 600 small caps--for some of the most promising smaller companies that we cover. Here's what I came up with.
Although Blue Nile NILE would be near the top of the list alphabetically, it would still be at the top even if the online diamond merchant were named Zambezi. The firm has a beautiful business model with negative working capital--the firm holds no inventory, so Blue Nile doesn't need to pay suppliers until after the consumer has paid for the diamond--that generates enormous returns on capital. Moreover, the firm has a management team that seems to understand the importance of capital allocation, rather than growth for growth's sake, as evidenced by management's decision to pull back on paid search advertising late last year when keywords became too expensive. Although the shares popped recently on the heels of a solid earnings report, we think they still have substantial upside.
Another high-quality smaller name that looks attractive is for-profit education company DeVry DV , which saw enrollment in its technology-related programs get whacked during the bursting of the tech bubble. However, as improved enrollment levels work their way through the firm's multiyear programs, margins should improve nicely, and the firm has not suffered from any of the investigations that have dogged some of its peers. At 15 times cash flow, the shares look pretty attractive to us.
Sticking with the growth theme, logistics firm Forward Air FWRD has seen its shares plunge recently on fears of a slowing economy to a point at which we think they offer a compelling value. This asset-light firm occupies an interesting niche of the transportation industry, moving freight via truck between airports with such efficiency that customers use it as an alternative to pricier air-cargo services. The firm has a great track record of creating shareholder value, and we think that it has many years of excess returns ahead of it.
These are three very high-quality firms trading at fair prices. Moving down the quality--and valuation--scale somewhat, I'd highlight three more companies that are all solid and trade at very attractive prices. It's an eclectic group: a beaten-up specialty retailer, a slumping casual-dining chain, and the owner of two great education brands.
Tuesday Morning TUES is the beaten-up retailer, and it has suffered from the same slump in houseware spending that's taken Pier One PIR from $20 to $6 over the past couple of years. The difference is that Tuesday Morning has no debt, is still generating meaningful free cash flow, and occupies a defensible niche--selling branded closeout goods. This is a very solid little company that's gotten very, very cheap. Even better, the private equity firm that took it private about 10 years ago still has a sizable stake, which means it may very well just take the company private again if the share price stays as cheap as it is now.
The casual-dining chain is Applebee's APPB , which caters to a less-well-off clientele that's been pinched badly by higher gas prices. This is not great, but neither is it a terminal problem, and we think Applebee's has more sticking power than most restaurant chains given its scale, advertising muscle, and unique attributes, like an exclusive alliance with Weight Watchers WTW . A reasonable top-line growth estimate coupled with steady margins yields a fair value estimate almost twice the current price.
The smallest of the firms in this group is Educate EEEE , which operates Sylvan Learning tutoring centers and owns the well-known Hooked on Phonics brand. The firm's management has made a hash of things over the past year by getting too aggressive in an ongoing plan of buying back franchised Sylvan centers; this seriously damaged operational performance. As a result, the shares have been absolutely hammered. However, the brands are still strong, the demand for tutoring services is still solid, and the operational problems are fixable. We think the shares are cheap enough to be worth a look, and we also think that Educate's majority owner--private equity firm Apollo Management--could very well make a bid for the whole company.
Finally, we have three small caps that all have serious warts, but which are all so dirt cheap that adventuresome types should give them a look. Homebuilder Levitt LEV trades for just 60% of book value, and while the shares may very well take time to turn around, the current stock price assumes a doomsday scenario that we think is unlikely to occur. Radware RDWR is an Israel-based maker of networking equipment that's got solid products, decent growth potential, and a dirt-cheap stock--net of the firm's almost $9 per share in cash, the shares trade at just 1 times our 2006 sales estimate. (Radware could also make a tasty treat for one of the major networking companies.)
Then there's video-game company Take Two Interactive TTWO , which has some of the worst corporate governance we've seen, but also owns the amazingly successful Grand Theft Auto gaming franchise. We estimate this one game alone is worth about 40% more than the current share price, and that the whole company (which does have some other successful games) could be worth as much as twice the current share price. This one's not for the timid, but a large enough margin of safety can compensate for a lot of risks.
Quality Will Withstand
Quality Will Withstand
By Paul A. Larson
Morningstart, 08-09-06
One of my favorite Warren Buffett quotes is, "It's only when the tide goes out that you learn who's been swimming naked." In the early part of 2006, it seemed that many were swimming in their birthday suits in the strong economy's high tide, plowing into everything from risky commodity companies to emerging markets with abandon. Now that the markets have taken a breather since May and the tide has started to roll out, the benefits of investing in wide-moat firms have made themselves more evident.
A booming economy like we've experienced in the past couple of years covers up a lot of sins made by marginal companies. Meanwhile, the types of companies we own in the Tortoise and Hare portfolios in StockInvestor--ones that have wide economic moats--are not economic sinners. They are like the tallest trees, withstanding the wildfires that occasionally wipe out the weaker or poorly positioned competitors.
The companies we own at StockInvestor may not partake in the party created by a strong market rally, but I strongly suspect they will hold up much better when an economic downturn hits. And a downturn will indeed hit … eventually. As the saying goes, "If something cannot go on forever, it will eventually stop."
I don't mean to sound like an alarmist, but the worldwide economy will slow down from its recent record pace at some point. I am not certain what the catalyst will be--perhaps China will consolidate its white-hot growth of the past couple of years, maybe high energy prices will hit the economic brakes, or the two-headed monster of inflation and higher interest rates might mop up all the worldwide excess liquidity. I don't have any reasonable projection when the clouds will come, but come they will.
I am not worried. The companies we own in our Tortoise and Hare portfolios are well-positioned for nearly any economic condition short of a world war. And for those portfolio holdings that do have some meaningful economic sensitivity, we have given ourselves a sufficient margin of safety by modeling a significant decrease in sales and earnings into our discounted cash-flows.
Just think of investing as taking a long, cross-country road trip with other investors. Those who forgo the tire chains, spare tire, emergency supplies, and pre-trip mechanical checkup may be able to leave sooner and, with less weight, possibly drive faster--when the weather is good. (Or as Buffett might say, there is no need for swimsuits at high tide.) But when some bumps in the road appear and it starts to snow, those who planned ahead for the longer term will get the last laugh. We expect the companies we have bought to hold up much better than average over the long haul.
Last spring, my colleague Pat Dorsey (Morningstar's director of equity research) published a very interesting article titled "Buy Quality, Buy It Now." In his studies published in late April, Pat found a direct correlation between a stock’s riskiness (as measured by Morningstar’s business risk rating) and its three-year trailing return. The riskier the company, the better the trailing return. He found a similar phenomenon with the economic moat rating. Those companies without a moat had far outperformed those we have rated "wide."
I am here to preach patience, since I think it is only a matter of time before this trend reverses, particularly on the moat side. Almost by definition, companies with wide economic moats earn large returns on their invested capital, while those with no moat tend to earn low returns. Over very long periods of time, a company's returns on capital will drive its stock price.
Companies with no economic moat can occasionally earn oversized returns when the economy is good (like today), but the profits are usually fleeting. Meanwhile, I'm highly confident that nearly all of the companies we own in the Tortoise and Hare portfolios will continue to earn high returns on capital 10 years from now and will have significantly larger earnings streams at that time. This is what is truly important in investing--the long-term cash-flow-generating power of a company, and its ability to defend those cash flows. Focus on this, and I think your returns will be much better.
The good news is that the recent down draft in the stock market has caused a large number of high-quality companies to trade at very compelling prices. Whether it is Johnson & Johnson JNJ , Microsoft MSFT or Berkshire Hathaway BRK.B , I think our investments in the Tortoise and Hare will hold up well no matter what happens to the economy.
By Paul A. Larson
Morningstart, 08-09-06
One of my favorite Warren Buffett quotes is, "It's only when the tide goes out that you learn who's been swimming naked." In the early part of 2006, it seemed that many were swimming in their birthday suits in the strong economy's high tide, plowing into everything from risky commodity companies to emerging markets with abandon. Now that the markets have taken a breather since May and the tide has started to roll out, the benefits of investing in wide-moat firms have made themselves more evident.
A booming economy like we've experienced in the past couple of years covers up a lot of sins made by marginal companies. Meanwhile, the types of companies we own in the Tortoise and Hare portfolios in StockInvestor--ones that have wide economic moats--are not economic sinners. They are like the tallest trees, withstanding the wildfires that occasionally wipe out the weaker or poorly positioned competitors.
The companies we own at StockInvestor may not partake in the party created by a strong market rally, but I strongly suspect they will hold up much better when an economic downturn hits. And a downturn will indeed hit … eventually. As the saying goes, "If something cannot go on forever, it will eventually stop."
I don't mean to sound like an alarmist, but the worldwide economy will slow down from its recent record pace at some point. I am not certain what the catalyst will be--perhaps China will consolidate its white-hot growth of the past couple of years, maybe high energy prices will hit the economic brakes, or the two-headed monster of inflation and higher interest rates might mop up all the worldwide excess liquidity. I don't have any reasonable projection when the clouds will come, but come they will.
I am not worried. The companies we own in our Tortoise and Hare portfolios are well-positioned for nearly any economic condition short of a world war. And for those portfolio holdings that do have some meaningful economic sensitivity, we have given ourselves a sufficient margin of safety by modeling a significant decrease in sales and earnings into our discounted cash-flows.
Just think of investing as taking a long, cross-country road trip with other investors. Those who forgo the tire chains, spare tire, emergency supplies, and pre-trip mechanical checkup may be able to leave sooner and, with less weight, possibly drive faster--when the weather is good. (Or as Buffett might say, there is no need for swimsuits at high tide.) But when some bumps in the road appear and it starts to snow, those who planned ahead for the longer term will get the last laugh. We expect the companies we have bought to hold up much better than average over the long haul.
Last spring, my colleague Pat Dorsey (Morningstar's director of equity research) published a very interesting article titled "Buy Quality, Buy It Now." In his studies published in late April, Pat found a direct correlation between a stock’s riskiness (as measured by Morningstar’s business risk rating) and its three-year trailing return. The riskier the company, the better the trailing return. He found a similar phenomenon with the economic moat rating. Those companies without a moat had far outperformed those we have rated "wide."
I am here to preach patience, since I think it is only a matter of time before this trend reverses, particularly on the moat side. Almost by definition, companies with wide economic moats earn large returns on their invested capital, while those with no moat tend to earn low returns. Over very long periods of time, a company's returns on capital will drive its stock price.
Companies with no economic moat can occasionally earn oversized returns when the economy is good (like today), but the profits are usually fleeting. Meanwhile, I'm highly confident that nearly all of the companies we own in the Tortoise and Hare portfolios will continue to earn high returns on capital 10 years from now and will have significantly larger earnings streams at that time. This is what is truly important in investing--the long-term cash-flow-generating power of a company, and its ability to defend those cash flows. Focus on this, and I think your returns will be much better.
The good news is that the recent down draft in the stock market has caused a large number of high-quality companies to trade at very compelling prices. Whether it is Johnson & Johnson JNJ , Microsoft MSFT or Berkshire Hathaway BRK.B , I think our investments in the Tortoise and Hare will hold up well no matter what happens to the economy.
An Afternoon with Charlie Munger
An Afternoon with Charlie Munger
by Toan Tran
Morningstart, 07-26-06
I had the pleasure of attending Wesco Financial's WSC annual meeting in early May. The main attraction, of course, was Wesco chairman and Berkshire Hathaway BRK.B vice chairman Charlie Munger. Although Munger is sometimes obscured by the long shadow of his more famous partner, Warren Buffett, his contributions to the philosophy of value investing cannot be overstated. Buffett never hesitates to say that without Munger's influence, Berkshire may have never purchased great growth businesses like See's Candy or Coca-Cola KO .
We also owe much of what we do at Morningstar GrowthInvestor, the monthly newsletter that I edit, to Munger's thinking, so the annual meeting was a superb opportunity to learn at the foot of the master. Here are some of his nuggets of wisdom.
Opportunity Cost
"There is this company in an emerging market that was presented to Warren. His response was, 'I don't feel more comfortable buying that than I do of adding to Wells Fargo.' He was using that as his opportunity cost. No one can tell me why I shouldn't buy more Wells Fargo. Warren is scanning the world trying to get his opportunity cost as high as he can so that his individual decisions are better."
When you are evaluating any investment, you must compare it to every other available investment, including ones you may already own. Instead, many investors collect stocks like baseball cards and the resulting portfolio bloat will likely not increase returns or reduce risk. So when you hear about the new hot stock in the next can't-miss sector, ask yourself two questions: (1) Do I understand the investment as well or better than one I already own? (2) Is the risk and reward profile of the investment superior to all other alternatives? If the answer is "no" to either questions, it is probably best to stay away.
Rationality
"Rationality is not just something you do so that you can make more money, it is a binding principle. Rationality is a really good idea. You must avoid the nonsense that is conventional in one's own time. It requires developing systems of thought that improve your batting average over time."
Munger is an evangelist for the virtues of rationality and his outstanding investment record is testimony to a lifetime of disciplined thought. To succeed as an investor, one has to make good decisions that are anchored in reality and free from emotional and cognitive distractions. At GrowthInvestor, we are searching for companies with significant market potential, rising demand, an economic moat, and growth-oriented management for purchase in the portfolio. This is not merely a checklist, but a research process focused on helping us make the most-rational decisions. If we make enough rational decisions, we will eventually have the returns to show for it.
Envy
"Harvard and Yale concentrated with venture capitalists that got the best calls and brainpower. Very few firms made most of the money, and they made it in just a few periods. Everyone else returned between mediocre and lousy. When returns happened, envy rippled through institutional money management. The amount invested in venture capital went up 10 times post-1999. That later money was lost very quickly. It will happen again. I don't know anyone who successfully resists this stuff. It becomes a new orthodoxy."
Munger and Buffett often say that envy is worst of the seven deadly sins because it is the only one that isn't fun to commit. When a group of people make money, others are compelled by an irresistible force to get a piece of the action, even though prices have risen so far above fair value as to guarantee disappointing returns and there are much better alternatives available. I am completely puzzled by this behavior, but I am also glad it exists.
Learning
"We all are learning, modifying, or destroying ideas all the time. Rapid destruction of your ideas when the time is right is one of the most valuable qualities you can acquire. You must force yourself to consider arguments on the other side. If you can't state arguments against what you believe better than your detractors, you don't know enough."
Carl Jacobi, a noted 19th-century mathematician, counseled his students to "invert, always invert" when they encountered a particularly vexing problem. I think this is a great way to approach investing. After you compile all the reasons you should buy a stock, invert the question and state the reasons why you should not buy the stock. By doing this, you ensure that your research process is more complete.
Mistakes
"Chris Davis [of the Davis funds] has a temple of shame. He celebrates the things they did that lost them a lot of money. What is also needed is a temple of shame squared for things you didn't do that would have made you rich. Forgetting your mistakes is a terrible error if you are trying to improve your cognition. Reality doesn't remind you. Why not celebrate stupidities in both categories?"
I have kept track of my investing mistakes for some time now, and it is a painful, but illuminating, experience. Without doubt, I am a better investor for it. I will be keeping track of our mistakes at GrowthInvestor, and I suggest you do the same with your portfolio. With a post-mortem catalog of your mistakes, you will be able to identify patterns in your decision-making process that produce unforced errors.
Risk
"I know a man named John Arriaga. After he graduated from Stanford, he started to develop properties around Stanford. There was no better time to do it then when he did. Rents have gone up and up. Normal developers would borrow and borrow. What John did was gradually pay off his debt, so when the crash came and 3 million of his 15 million square feet of buildings went vacant, he didn't bat an eyebrow. The man deliberately took risk out of his life, and he was glad not to have leverage. There is a lot to be said that when the world is going crazy, to put yourself in a position where you take risk off the table. We might all consider imitating John."
Palatial casinos are built in the desert because people find risk to be fun and exciting. I am not much of a gambler, so whenever I visit Las Vegas, I spend most of my time watching friends try their luck. One intriguing thing I have noticed is that when things are going well and money has been won, it is nearly impossible for many people to walk away from table. Instead, they take on more risk by betting larger amounts, even though the odds are clearly stacked in favor of the house. Taking on risk only makes sense when it is sufficiently outweighed by the potential reward, which is why we only buy stocks when there is a margin of safety. Otherwise, consider Munger's advice and imitate John Arriaga.
by Toan Tran
Morningstart, 07-26-06
I had the pleasure of attending Wesco Financial's WSC annual meeting in early May. The main attraction, of course, was Wesco chairman and Berkshire Hathaway BRK.B vice chairman Charlie Munger. Although Munger is sometimes obscured by the long shadow of his more famous partner, Warren Buffett, his contributions to the philosophy of value investing cannot be overstated. Buffett never hesitates to say that without Munger's influence, Berkshire may have never purchased great growth businesses like See's Candy or Coca-Cola KO .
We also owe much of what we do at Morningstar GrowthInvestor, the monthly newsletter that I edit, to Munger's thinking, so the annual meeting was a superb opportunity to learn at the foot of the master. Here are some of his nuggets of wisdom.
Opportunity Cost
"There is this company in an emerging market that was presented to Warren. His response was, 'I don't feel more comfortable buying that than I do of adding to Wells Fargo.' He was using that as his opportunity cost. No one can tell me why I shouldn't buy more Wells Fargo. Warren is scanning the world trying to get his opportunity cost as high as he can so that his individual decisions are better."
When you are evaluating any investment, you must compare it to every other available investment, including ones you may already own. Instead, many investors collect stocks like baseball cards and the resulting portfolio bloat will likely not increase returns or reduce risk. So when you hear about the new hot stock in the next can't-miss sector, ask yourself two questions: (1) Do I understand the investment as well or better than one I already own? (2) Is the risk and reward profile of the investment superior to all other alternatives? If the answer is "no" to either questions, it is probably best to stay away.
Rationality
"Rationality is not just something you do so that you can make more money, it is a binding principle. Rationality is a really good idea. You must avoid the nonsense that is conventional in one's own time. It requires developing systems of thought that improve your batting average over time."
Munger is an evangelist for the virtues of rationality and his outstanding investment record is testimony to a lifetime of disciplined thought. To succeed as an investor, one has to make good decisions that are anchored in reality and free from emotional and cognitive distractions. At GrowthInvestor, we are searching for companies with significant market potential, rising demand, an economic moat, and growth-oriented management for purchase in the portfolio. This is not merely a checklist, but a research process focused on helping us make the most-rational decisions. If we make enough rational decisions, we will eventually have the returns to show for it.
Envy
"Harvard and Yale concentrated with venture capitalists that got the best calls and brainpower. Very few firms made most of the money, and they made it in just a few periods. Everyone else returned between mediocre and lousy. When returns happened, envy rippled through institutional money management. The amount invested in venture capital went up 10 times post-1999. That later money was lost very quickly. It will happen again. I don't know anyone who successfully resists this stuff. It becomes a new orthodoxy."
Munger and Buffett often say that envy is worst of the seven deadly sins because it is the only one that isn't fun to commit. When a group of people make money, others are compelled by an irresistible force to get a piece of the action, even though prices have risen so far above fair value as to guarantee disappointing returns and there are much better alternatives available. I am completely puzzled by this behavior, but I am also glad it exists.
Learning
"We all are learning, modifying, or destroying ideas all the time. Rapid destruction of your ideas when the time is right is one of the most valuable qualities you can acquire. You must force yourself to consider arguments on the other side. If you can't state arguments against what you believe better than your detractors, you don't know enough."
Carl Jacobi, a noted 19th-century mathematician, counseled his students to "invert, always invert" when they encountered a particularly vexing problem. I think this is a great way to approach investing. After you compile all the reasons you should buy a stock, invert the question and state the reasons why you should not buy the stock. By doing this, you ensure that your research process is more complete.
Mistakes
"Chris Davis [of the Davis funds] has a temple of shame. He celebrates the things they did that lost them a lot of money. What is also needed is a temple of shame squared for things you didn't do that would have made you rich. Forgetting your mistakes is a terrible error if you are trying to improve your cognition. Reality doesn't remind you. Why not celebrate stupidities in both categories?"
I have kept track of my investing mistakes for some time now, and it is a painful, but illuminating, experience. Without doubt, I am a better investor for it. I will be keeping track of our mistakes at GrowthInvestor, and I suggest you do the same with your portfolio. With a post-mortem catalog of your mistakes, you will be able to identify patterns in your decision-making process that produce unforced errors.
Risk
"I know a man named John Arriaga. After he graduated from Stanford, he started to develop properties around Stanford. There was no better time to do it then when he did. Rents have gone up and up. Normal developers would borrow and borrow. What John did was gradually pay off his debt, so when the crash came and 3 million of his 15 million square feet of buildings went vacant, he didn't bat an eyebrow. The man deliberately took risk out of his life, and he was glad not to have leverage. There is a lot to be said that when the world is going crazy, to put yourself in a position where you take risk off the table. We might all consider imitating John."
Palatial casinos are built in the desert because people find risk to be fun and exciting. I am not much of a gambler, so whenever I visit Las Vegas, I spend most of my time watching friends try their luck. One intriguing thing I have noticed is that when things are going well and money has been won, it is nearly impossible for many people to walk away from table. Instead, they take on more risk by betting larger amounts, even though the odds are clearly stacked in favor of the house. Taking on risk only makes sense when it is sufficiently outweighed by the potential reward, which is why we only buy stocks when there is a margin of safety. Otherwise, consider Munger's advice and imitate John Arriaga.
GLW - Corning May Offer Window of Opportunity
Corning May Offer Window of Opportunity
By SARA SILVER
WSJ, August 24, 2006
Corning Inc. shares plummeted this summer as the market slowed for liquid-crystal displays used in flat-panel televisions and laptops.
The Corning, N.Y., glassmaker's stock lost $13 billion in market value since April, ceding most of the gains made earlier this year amid optimism about rising demand for ever-larger flat-panel televisions.
Now some long-term stock pickers are finding this a judicious buying opportunity, believing in the strength of Corning's core LCD business as well as new products aimed at making diesel vehicles run more cleanly and speeding the discovery of new drugs.
With concern about the inventory buildup of the LCDs easing slightly, Corning stock has recovered somewhat, but remains closer to its 52-week low of $16.61 than to its high of almost $30.
Corning shares were at $20.79, up 24 cents, in 4 p.m. New York Stock Exchange composite trading yesterday, giving the company a market value of about $32 billion.
Corning shares trade at about 35 times earnings, compared with about 20 times for the Dow Jones Wilshire U.S. Telecommunications Equipment Index, of which Corning is a component.
"At the current stock price, we think of them as call options because we are buying on the display and telecom businesses, which we think are in good shape for at least the next six to 12 months," said Christopher Baggini, manager of the $500 million Gartmore U.S. Growth Leaders Fund and the $500 million Gartmore Growth Fund. "We think the stock could hit $30 if those call options work for us."
Mr. Baggini believes the display business has gone from a hypergrowth phase, which bucks seasonal trends, to high growth.
"Seasonality becomes your friend as you move into the second half of the year, with back-to-school and Christmas purchases, which is good for TV, laptop and flat-panel purchases," he said.
Mr. Baggini says he sold one-third of his 1.5 million shares of Corning in the second quarter at $25 and bought back the same amount this summer at $19. Overall, Gartmore Global Investments, based in Conshohocken, Pa., trimmed 338,000 shares of Corning in the second quarter, giving it a total of 3.4 million shares as of the end of June, according to FactSet Research Systems Inc.
Corning has reshaped its product lines in its 155-year history. When demand for fiber-optic cable bottomed out with the technology bust, Corning teetered on the verge of bankruptcy in 2003. The company climbed back by dominating the LCD-glass market, combining sophisticated materials science with a policy of placing big bets on a few technologies. The bets pay off when Corning's technology wins over customers, its high production volume keeps them fully supplied and its low costs allow competitive pricing.
"We place big bets on long, difficult technology developments for new systems," said Wendell P. Weeks, Corning's president and chief executive. "There are inherent risks in our business. We manage this volatility by continuing to build our financial strength as well as a healthy portfolio of cash-generating businesses in different, significant markets."
Within months, the company expects to see an increase in demand for ceramic filters for diesel engines, designed to meet more stringent emissions regulations going into effect in the U.S. in 2007 and the following year in Europe.
Although it expects transport companies to load up on trucks this year ahead of the regulations, Corning predicts its $370 million investment in factories in upstate New York will start producing several hundred million dollars of sales next year.
Corning estimates the global market for diesel filters will reach $1 billion by 2008 but won't say what share of that it expects. This fall, Corning is launching a technology it believes will help speed the process by which pharmaceutical companies discover new drugs by using electronic readers to more quickly find which compounds can target a particular disease.
"We think management is overly conservative, which we applaud, and think the market will be pleasantly surprised when second-half earnings are revealed," said Tom Walker of Martin Currie Investment Management of Edinburgh, Scotland. "All the evidence of the retailers points to strong demand for ever-larger screens, where Corning is the leader in providing larger glass."
Mr. Walker, product manager for the firm's global and North America portfolios, has bought Corning shares in recent weeks. The firm, which manages $21.4 billion in active equity portfolios, says it holds 763,593 Corning shares across its funds. The firm held 673,049 shares at the end of June, according to FactSet.
While two-thirds of Corning's earnings come from its LCD business, long-term investors also see new life in old business lines. In the second quarter, Corning's optical-fiber business, the company's mainstay before the telecom crash early this decade, contributed 8% of second-quarter earnings of $514 million.
Telecom companies "are upgrading their plants and trying to get fiber closer to your home -- that is very good for Corning," said Kevin Landis, chief investment officer at Firsthand Capital Management, of San Jose, Calif., which specializes in technology. "In developing countries where they are putting in fiber all over the network for the first time, that's a great driver as well," he said.
Firsthand's 1.9 million shares of Corning made up roughly 6% of its $800 million in assets under management as of June 30.
This attention to new and old product lines, while unlikely to move the stock in the near term, shows that the company is determined to insulate itself from cyclical downturns, whether in telecom equipment or consumer electronics, by diversifying its product offerings.
"The fact that they are paying attention to the market means they may have other rabbits to pull out of their hat," Mr. Landis said.
And that could only help the stock in the long term.
By SARA SILVER
WSJ, August 24, 2006
Corning Inc. shares plummeted this summer as the market slowed for liquid-crystal displays used in flat-panel televisions and laptops.
The Corning, N.Y., glassmaker's stock lost $13 billion in market value since April, ceding most of the gains made earlier this year amid optimism about rising demand for ever-larger flat-panel televisions.
Now some long-term stock pickers are finding this a judicious buying opportunity, believing in the strength of Corning's core LCD business as well as new products aimed at making diesel vehicles run more cleanly and speeding the discovery of new drugs.
With concern about the inventory buildup of the LCDs easing slightly, Corning stock has recovered somewhat, but remains closer to its 52-week low of $16.61 than to its high of almost $30.
Corning shares were at $20.79, up 24 cents, in 4 p.m. New York Stock Exchange composite trading yesterday, giving the company a market value of about $32 billion.
Corning shares trade at about 35 times earnings, compared with about 20 times for the Dow Jones Wilshire U.S. Telecommunications Equipment Index, of which Corning is a component.
"At the current stock price, we think of them as call options because we are buying on the display and telecom businesses, which we think are in good shape for at least the next six to 12 months," said Christopher Baggini, manager of the $500 million Gartmore U.S. Growth Leaders Fund and the $500 million Gartmore Growth Fund. "We think the stock could hit $30 if those call options work for us."
Mr. Baggini believes the display business has gone from a hypergrowth phase, which bucks seasonal trends, to high growth.
"Seasonality becomes your friend as you move into the second half of the year, with back-to-school and Christmas purchases, which is good for TV, laptop and flat-panel purchases," he said.
Mr. Baggini says he sold one-third of his 1.5 million shares of Corning in the second quarter at $25 and bought back the same amount this summer at $19. Overall, Gartmore Global Investments, based in Conshohocken, Pa., trimmed 338,000 shares of Corning in the second quarter, giving it a total of 3.4 million shares as of the end of June, according to FactSet Research Systems Inc.
Corning has reshaped its product lines in its 155-year history. When demand for fiber-optic cable bottomed out with the technology bust, Corning teetered on the verge of bankruptcy in 2003. The company climbed back by dominating the LCD-glass market, combining sophisticated materials science with a policy of placing big bets on a few technologies. The bets pay off when Corning's technology wins over customers, its high production volume keeps them fully supplied and its low costs allow competitive pricing.
"We place big bets on long, difficult technology developments for new systems," said Wendell P. Weeks, Corning's president and chief executive. "There are inherent risks in our business. We manage this volatility by continuing to build our financial strength as well as a healthy portfolio of cash-generating businesses in different, significant markets."
Within months, the company expects to see an increase in demand for ceramic filters for diesel engines, designed to meet more stringent emissions regulations going into effect in the U.S. in 2007 and the following year in Europe.
Although it expects transport companies to load up on trucks this year ahead of the regulations, Corning predicts its $370 million investment in factories in upstate New York will start producing several hundred million dollars of sales next year.
Corning estimates the global market for diesel filters will reach $1 billion by 2008 but won't say what share of that it expects. This fall, Corning is launching a technology it believes will help speed the process by which pharmaceutical companies discover new drugs by using electronic readers to more quickly find which compounds can target a particular disease.
"We think management is overly conservative, which we applaud, and think the market will be pleasantly surprised when second-half earnings are revealed," said Tom Walker of Martin Currie Investment Management of Edinburgh, Scotland. "All the evidence of the retailers points to strong demand for ever-larger screens, where Corning is the leader in providing larger glass."
Mr. Walker, product manager for the firm's global and North America portfolios, has bought Corning shares in recent weeks. The firm, which manages $21.4 billion in active equity portfolios, says it holds 763,593 Corning shares across its funds. The firm held 673,049 shares at the end of June, according to FactSet.
While two-thirds of Corning's earnings come from its LCD business, long-term investors also see new life in old business lines. In the second quarter, Corning's optical-fiber business, the company's mainstay before the telecom crash early this decade, contributed 8% of second-quarter earnings of $514 million.
Telecom companies "are upgrading their plants and trying to get fiber closer to your home -- that is very good for Corning," said Kevin Landis, chief investment officer at Firsthand Capital Management, of San Jose, Calif., which specializes in technology. "In developing countries where they are putting in fiber all over the network for the first time, that's a great driver as well," he said.
Firsthand's 1.9 million shares of Corning made up roughly 6% of its $800 million in assets under management as of June 30.
This attention to new and old product lines, while unlikely to move the stock in the near term, shows that the company is determined to insulate itself from cyclical downturns, whether in telecom equipment or consumer electronics, by diversifying its product offerings.
"The fact that they are paying attention to the market means they may have other rabbits to pull out of their hat," Mr. Landis said.
And that could only help the stock in the long term.
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