Ask Uncle Bill

Don't Throw Anything Away

That advice does not apply to garages or attics.

It does apply to trying new stuff.  Anyone trying to get a job or get into a new field knows the frustration.  No experience, no job.  So how do you get the experience and the job?  Keep throwing stuff up against the wall and don't quit.

Example--the guys that wrote 'Shrek' and then 'Pirates of the Caribbean' did not sell anything, nothing for five years.  FIVE years working near full time writing scripts and getting no all the time.  Hang in there.  And don't throw anything away.

Because you don't know when you will need it.  About three years ago I decided I would become the next GREAT AMERICAN HISTORY BOOK writer.  Not the textbook stuff but interesting, human interest kind of stuff.  Plus there was an opening.  Stephen Ambrose had just passed away and I rushed in to fill the void. 

And got nowhere.  Well, not really.  I did write a couple of interesting articles that got published in a little magazine.  Actually they are pretty good but American Heritage didn't knock my door down.  Also spent some time at various writing clubs which are interesting but mainly people sitting around talking about writing rather than doing the hard work which is sitting down and writing something. 

And one night we had a celebrity, a published author.  The crowd was pretty excited when he was introduced because he had written "The Night Before A Redneck Christmas."  I am not kidding.  There is such a book and it actually sold pretty well.  Sold well enough that I saw it at Barnes and Noble last Christmas. 

For those who don't follow the redneck market, the genre was invented by Jeff Foxworthy with his books, comedy routine and videos revolving around "You May Be A Redneck If..."  Pretty big, as you can imagine, in the south.  Anyway, the guy  that showed up at our writing group was a frustrated cartoonist, heard some of Foxworthy's stuff and came up with and illustrated (probably over a few beers) "The Night Before A Redneck Christmas." 

And the questions started.  And the main question is always "How did you get published?"  He put together a prototype, looked up some publishers, primarily located in the former slave states and threw the manuscript 'over the transom.'  Where it landed on the 'slush pile.'  Over the transom means it came in unsolicited and the slush pile is the mass of unsolicited manuscripts and proposals that show up in the mail every day to be culled and tossed by the junior editor.

And "The Night Before A Redneck Christmas" got picked up and printed and sold and sold again.  And a groan went up from the crowd because they know the odds of being picked up after coming in over the transom are miniscule.   

But I thought stupidly "Why not?"  After the meeting I cornered the redneck guy and asked about his publisher.  Asked for the editor's name and got it along with "Don't use my name."  That wasn't much help but went home and looked up the publishing company on the internet.  Southern specializing in cookbooks.  That's out.  Poetry.  Nope.  Travel books.  Maybe but not interesting to me.  And history.  Local stuff like the 3rd Georgia Infantry Regiment and the Battle of Stone Mountain. 

I could do that.  Well, not Georgia but Texas.  So sat down and thought for a minute.  Oil, politics, George, Lyndon, Battle of Adobe Walls, and the Alamo.  My personal favorite was the Battle for Adobe Walls which happened up in the Panhandle in the late 1800's.  Adobe Walls was a trading spot and hotel for buffalo hunters and the local Indians didn't like it because the hunters were killing off  the food supply.  One day about 3,000 of them decided enough was enough and attacked the 50 or so hunters and settlers.  The hunters somehow held off the Indians for a day or so but things were looking bleak so they called for a Hail Mary.  The Indians were lining up a mile away for their final assault.  The hunters decided on the best shot and he set up his best rifle on a stand, took aim and plugged the medicine man sitting on a horse next to the chief from a mile away.  Dead as a doornail.  Since the medicine man had assured everybody that they were immune to the bullets, his credibility was shot and so was he.  The battle was over.

So put that down as a subject and a few others but kept coming back to the Alamo.  And like the world needs another book about the Alamo.  Or another movie.  But there was a sideshow to the Alamo which was the massacre at Goliad and is little written about because, well, it was a massacre.  So put that down as a topic as well, typed up a letter and threw it over the transom.

And nothing.  For three months.  Forgot about it.  Then an e-mail that went roughly like this--"We are possibly interested in a manuscript on Goliad and the Texas Revolution.  Please send a proposal."  Back to the internet to determine what constituted a proposal--author background, competition, scope, three sample chapters.  Piece of cake.  Down to the libary.  Checked out all the books on the Texas Revolution and wrote the proposal.

Put it in the mail a year ago and nothing.  Three months later, dusted it off and sent it to some more regional publishers.  Nothing.  Reject. Reject. Reject.  A friend mentioned university presses.  Figured non-profits had plenty of money and sent it off to ten or so.  Snubbed.  No PhD, no publication.  Elitists.  That one really made me mad.

So forgot about it.  Davy and the boys receded into history again.  Until last night.  An e-mail basically saying "Sorry about the delay but we had two hurricanes and just getting back to business and we want to publish your book.  Will send contract.  Let us know length and timing.  We pay x on sales.  Best regards.  Bye."

And I went racing back to the computer to make sure I had not deleted anything.  So don't throw anything away because you don't know when and if you may need it.  And don't give up.  That last push may be the one that opens the door. 

   

A Crack In The Wall

I love Marie.  She's a cutie and a great friend of Margots.  But old guys going on about 21 years olds is not a good thing so enough.  And Marie has one major fault.  She's a Liberal Arts major.  Gasp.  Even worse, majoring in Psychology.  The shame of it all.

I know.  I've been there.  I'm a recovering Liberal Arts major.  In history.  I know the embarrassment when people turn up their noses and ask "What are you going to do with that?  Teach?"  When I met a girl's father the disappointment was written all over his face--great, a history major.  He was really thinking--bum.  I would mumble something about law school which I never would attend and thank God for that.  My father did want a lawyer in the family and he got one when my sister went to Stanford.  Good for her.  Go Cardinal.   

So when I delivered Margot's refurbished car down to College Station last month I studiously avoided any mention of majors and future plans with Margot, Megan and Marie.  (About twenty years ago there must have been a run on M names.)  In fact, I was pretty much shut out as I had the temerity to show up late and avoid, for once, my primary responsibility--paying for lunch. 

Also, I wasn't paying much attention until Marie announced she was studying to take an entrance exam to be a PA announcer.  I didn't know you had to take an exam to be a PA announcer and you don't but you do have to take an exam to become a PA.

A PA is a Physicians Assistant.  Margot jumped the gun on me and asked "Like, isn't that a nurse?" as I was thinking the same thing.  Marie said, "No, stupid, it's not."  If I had asked the question, Marie wouldn't have called me stupid but she would have thought it.  Marie went on.  It went something like this. 

"Physician assistants are health care professionals licensed to practice medicine with physician supervision. PAs employed by the federal government are credentialed to practice. As part of their comprehensive responsibilities, PAs conduct physical exams, diagnose and treat illnesses, order and interpret tests, counsel on preventive health care, assist in surgery, and in virtually all states can write prescriptions. Within the physician-PA relationship, physician assistants exercise autonomy in medical decision making and provide a broad range of diagnostic and therapeutic services. A PA's practice may also include education, research, and administrative services.

PAs are trained in intensive education programs accredited by the Accreditation Review Commission on Education for the Physician Assistant (ARC-PA) .

Because of the close working relationship the PAs have with physicians, PAs are educated in the medical model designed to complement physician training. Upon graduation, physician assistants take a national certification examination developed by the National Commission on Certification of PAs in conjunction with the National Board of Medical Examiners. To maintain their national certification, PAs must log 100 hours of continuing medical education every two years and sit for a recertification every six years. Graduation from an accredited physician assistant program and passage of the national certifying exam are required for state licensure.

Curriculum usually lasts for about 26 months, there are 130 accredited programs.  http://www.aapa.org/pgmlist.php3 

Education consists of classroom and laboratory instruction in the basic medical and behavioral sciences (such as anatomy, pharmacology, pathophysiology, clinical medicine, and physical diagnosis), followed by clinical rotations in internal medicine, family medicine, surgery, pediatrics, obstetrics and gynecology, emergency medicine, and geriatric medicine."

I was rapidly losing interest until I heard the Bottom Line.  "And they make about $100,000."

Pretty good for a psych major.  And then I heard the crack in the wall.

This is the future for medical costs.  The invisible hand is finally making itself known.  Costs are coming down, or at least, moderating.  The PA thing, Health Savings Accounts, and corporations limiting or eliminating health insurance are forcing the industy to become, gasp again, efficient.   

I have long had a plan for lowering health costs.  It is two fold. 1) Lower the entrance requirements for medical school and 2) set a cap on the amount you can sue for under medical malpractice. 

Lowering entrance requirements for medical school ain't gonna happen.  It's a monopoly. 

But the PA is the next best thing.    "PAs conduct physical exams, diagnose and treat illnesses, order and interpret tests, counsel on preventive health care, assist in surgery, and in virtually all states can write prescriptions."  What else is there?  May not be a doctor but if it walks like a duck, quacks like a duck...  And it costs less.  $100,000 is a lot of money but less than doctors make so medical costs go down.

The second step in my groundbreaking medical plan is limiting damages for malpractice.  That's a tough one but we are getting there.  Primarily anecdotal evidence but a friend of mine, a lawyer, had a partner specializing in medical malpratice.  He went out of business.  And there are precedents for limiting damages.  Like in just about every country outside the United States.

Go to Germany and some quack cuts off the wrong leg.  Tough luck.  The judge looks up legs in his book, sees 1,000 Euros and you get 1,000 Euros.  Just an example, of course, but that's pretty much the way it goes.  It's the future for us.

So good for Marie.  Go for that PA and bring down health costs.  Marie is the future.  And she is a cutie.   

How You Gonna Keep'Em Down On The Farm After They've Seen Paree?

I'm not a big fan of France.  It's the only place I've had a gun shoved in my stomach and I had to leave my daughter there when she, for some reason, decided to go to school in Rennes.  Her in the rearview mirror just about broke my heart.  It worked out though.  She doesn't like France either.

But I really don't dislike France.  I dislike the business envrironment.  Put more correctly, I dislike the lack of a business environment.  In my 25 plus year career I worked for four multi-nationals that had operations in France.  And how many made money?  Zero.  Nobody.

So why were we there?  Beats me but we were and we poured money into the stupid country because France has some pretty tough laws on bankruptcy and capital requirements which I used to understand but not anymore.  All I know is I wrote, and got rejected, a lot of capital requests in my time and most of them had to do with France.  (A note to future capital request writers--a country manager thinks he/she has a god given right to the parent companies capital.  The parent company CEO thinks otherwise.  Tell the country manager that they will get the capital if and when 1) the country manager admits, in writing, that the company is on the verge of bankruptcy, 2) there is no alternative to capital and 3) the whole thing is so screwed up that there is no short term or medium term hope for a turnaround.  The country manager will think long and hard before signing that.  Unless they are French.) 

But what is it about France?  Well, let's look at the last two riots.  The first one was disaffected Muslim youth doing what they can for the auto industry by burning cars.  They are dissatisfied because they have no jobs.  And they are right.  Go in any of the French companies I worked with and they are lily white and male.  Except for the secretaries, excuse me, administrative assistants.  If your name is Mommar, forget it.

The second riot is, according to the papers, youth rebelling against a law, not passed yet, that would allow companies to fire anyone under the age of 26 with less than two years tenure.  Makes your second review a bit of a nail biter. 

First, let's look at the 'youth' that are protesting the new law, or new proposed law.  Most are university students and they are never going to work anyway.  At least not in a 'for profit' institution.  In France you go to university to be a lawyer, doctor, diplomat, or engineer but you don't go to work in business.  Oh, there are business schools but those students aren't rioting.  And most university students look old enough (because they are) to be your father or way older brother.  If you doubt this take a stroll through the Sorbonne on your next trip and look around.

The other rioting group is unions.  If not actually rioting they are supporting the demonstrations because THEY have jobs.  And they don't want any laws that would endanger those current jobs.  The key phrase here is 'current jobs', not future jobs or job creation. 

French unemployment is 9.6% versus 4.6% in the US.  And French youth unemployment is north of 20% which means a lot of kids out there ready and willing to burn cars.

So what's the point?  The point is that capital and jobs are not attracted to a country where 1) you have a law saying you can't fire someone, 2) capital and jobs are not attracted to a country where the universities turn out anti-capital graduates, 3) capital and jobs are not attracted to a country where the unions only care about themselves and not their children, and 4) capital and jobs are not attracted to a country where you can not get a positive return on that capital. 

A demonstration against a law that allows a company to fire somebody certainly does make that demonstrator feel righteous.  But what is really cruel is a country where 1 out of 10 workers is unemployed and 1 out of 5 youth workers is out of a job because companies can't fire someone. 

The Sage of Omaha and the Wayback Machine

Forbes magazine is the best even though they once savaged the wife of a friend of mine for her work as the CFO at Polaroid.  I still don't think it was her fault. 

But back to Forbes.  One column I always read is the Flashbacks section where they revisit articles from 25, 15, and 10 years ago.  The one that caught my eye this month is the 25 year old column.  Now get in the Wayback Machine and revisit the good old days where 1) Reagan had just been elected president after Jimmy Carter threw in the towel saying there was a 'malaise on the people' (note to all future presidents out there-you don't get elected by telling somebody it's their fault.  If you are in a bind tell the electorate how WE are going to fix it.), unemployment was 10% or more, inflation was surging and interest rates were zooming thru the teens.  Also, Japan was going to take over the world and New York, Cleveland, Pittsburgh, and Chicago were all lumped together as the Rust Belt and would soon blow away.  The good old days and one less than enthusiastic investor was the Sage of Omaha, Warren Buffett. 

Here is the article.

Putting Stock In Buffett-October 26, 1981

Are stocks a great buy again?  Alas.  If you expected a happy answer from Warren Buffett, you won't get it.  "There won't be any great buying juncture for stocks until there's one for bonds," he says.  How can stocks compete with bonds at current yields, he asks.  Buffett is not yet convinced the Administration has inflation licked, and until it eases, bonds will be under pressure.  But don't sell all your stocks.  Buffett says he's fully invested in them.  Why?  "You lose less to inflation than with most other investments," he says.  But he doesn't expect a bull market soon.  He doesn't feel the old sap rising.

That's it.  The sum total of the article and the sum total of Buffett's investing philosophy and all you need to know to get rich.  Let's break it down.

"There won't be any great buying juncture for stocks until there's one for bonds." 

Huh?  He was saying that the time was not ripe for investing in FINANCIAL assets.  Inflation was raging and neither stocks nor bonds were a buy, yet.  But interest rates were above 10%.  What a buy.  Not really if the inflation rate, or the expected inflation rate, was 15%.  You made 10% but lost 15%.  And stocks were dead in the water because they couldn't even compete with the return on bonds.  No, the 'smart' investors were piling into 'hard' assets--gold, silver, Swiss francs, Persian rugs.

"Buffett is not yet convinced the Administration has inflation licked, and until it eases, bonds will remain under pressure."    

So what happened?  Reagan understood that inflation was the enemy and he brought out the only tool that works.  He created a recession.  When somebody loses their job, they quit buying and inflationary pressure goes away.  Harsh but it works.  How do you create a recession?  Crank up interest rates way above inflation.  And he did.  Short term rates went into the twenties.  25% minus inflation of 15% equals a real return of 10%.  Money flowed into bonds.  Wish I had done that.  I knew a lady that did.  She made a fortune.  I think she is the CFO at Qwest now. 

"But don't sell all your stocks.  Buffett says he's fully invested in them."

WHAT?  Interest rates below inflation.  Stocks dead in the water.  Doesn't trust the Administration.  And this IDIOT is fully invested?  Yep.

And what happened?  As noted, real interest rates came on creating Buffett's 'buying juncture' for both stocks and bonds.  Inflation disappeared, unemployment went down, albeit slowly.  Gold and silver sank like the rocks they are.  AND STOCKS WENT ON A 20 YEAR RIDE UP, WAY UP.

So what was Warren thinking back then?  What did he know that everybody, and I mean everybody, missed?  Warren knew, and knows,  that stocks historically return 11% a year vs. 7% for bonds vs. 3% for cash.  He is also an optimist that knows cooler heads will prevail and while the world is far from perfect, it's not all that screwed up either.

And that is all you need to know.

What Goes Up Must Go...

Note--Pick up on some pretty good finance tips at Carnival of Personal Finance at http://financialbabysteps.blogspot.com/2006/03/carnival-of-personal-finance-41_26.html

Also, check out the Carnival of Investing at http://www.fatpitchfinancials.com/260/carnival-of-investing-15/

Writing about markets going down is not much fun.  I would much rather write about going to my son's B-52 navigator graduation and may this week but last week I said I would write about things that cause the market to go down, so I will. 

What can cause the market to go down?  Anything.  In the short run just about anything can cause the market to go down.  Or up.  Short term ups and downs are hard (impossible?) to forecast but that is what the world is fixated on.  More than once I listened to the news and some bit of financial information came on--inflation up, the dollar weak, trade deficit a record--and thought, Ok the market will tank on that and, of course, the market went up.  Short term market movements are almost impossible to predict which explains the disappearance of that 1990's phenom, the day trader.   

So short term is out--ignore all the pundits, ignore the financial writers who are under a deadline, ignore the guy in the next cubicle who is thinking about getting back into day trading and concentrate on the long run.  Regular contributions over time into the equity markets. 

Boring.  Plus, as Lord Maynard Keynes said, in the long run we are all dead.  Ok, so let's look at what could cause the market to go down significantly and for a period of time, like in excess of three years.  I mean, nobody wants to be in a train wreck if it can be avoided.   

So here is what can cause stocks to go down:

rising interest rates,

inflation,

protectionism,

poor corporate performance,

politics,

irrational exuberance.

I'm sure there are more but I think I've covered the bases with these guys.  And they are all interrelated but let's take a look.  Rising interest rates are used by the Fed to wring out inflation.  So the real culprit is inflation, not rising interest rates.  But, you say, we have rising interest rates now.  Well, not really, we are only returning to normal.  The Fed beat down interest rates in 2001-2005 to get over the 2000 economic meltdown and 9/11.  Draw a line linking interest rates from then to now and the interest rates now are still probably below rates then.  But they are rising so bear watching, especially foreign rates.

Already touched on that but inflation is, I think, the primary cause of stock market weakness.  Panic inflation is an abandonment of society.  It's every man for himself and screw the other guy.  It is also a vote of no confidence in government and institutions.  For examples, check out Argentina, Mexico, and Brazil in the 70's and 80's and the Weimar Republic in the 1930's.  Or the US in the late 70's and early 80's.  None of which you remember so ask your parents.  It was ugly.  The good old days were a bummer.  And the stock market was dead in the water.  Actually, it sunk and sat on the bottom until 1982. 

Protectionism.  We are a global society but a lot of people, primarily politicians, refuse to accept the fact.  But blaming outsourcing and the exporting of jobs has a nice ring to it and makes out of work steelworkers feel good.  But those steelworkers have been out of work for a long time because we are not competitive in that field and probably never will be again.  The same goes for autoworkers.  It also goes for roofers--when was the last time you saw a guy up on a roof named Jones?

But we don't have protectionism, you say.  Oh yes we do.  Just ask those guys in Dubai and a bunch of other finance ministers changing their investment decisions as we speak because they don't trust us.  And they shouldn't.  The Dubai thing was stupid.  But it did introduce some bi-partisanship into the Congress.  Stupid but if you wanted bi-partisanship, you got it.  Watch out for protectionism--it starts slow and then really gets rolling and hard to stop.

Poor corporate performance is usually blamed on outside variables like inflation, high interest rates, regulation and foreign competition.  Corporate America is pretty good now.  It wasn't in the late 70's when they blamed everybody from Jimmy Carter to the Japanese for their performance.  If you hear companies singing the blues about external variables, head for the exits.

Politics can impact.  Republicans are mostly pro business and Democrats anti business.  I know that comes as a shock but usually works out that way.  My brother-in-law is very successful and voted for Clinton.  He was outraged when Clinton raised taxes.  I was kind of like, 'Dude.'  But, you say,  Clinton was president in a time of great market success.  Correct but not because of Clinton.  Except for the tax increase Clinton did nothing except get in trouble with women.  He left the market alone which rose on technology and the Baby Boomers generating a lot of wealth as they experienced their most productive years.  But watch out for politics and the impact on the tax code if certain groups get elected.

The biggest reason for markets going down is greed.  When things get going really good, they get out of control.  The roaring 20's led to the depression of the 30's but the steady growth of the 50's made for a pretty solid market in the 60's.  The 70's were a washout as the country regrouped leading to a great stock market from 1982 till 1987 when it got overdone and the market had the biggest one day drop in history. 

Then the market kind of sat around until the 90's and then really, really took off until hitting the wall in 2000 when the fundamentals got out of whack.  Well, everybody should have seen that, right?  No, they didn't because all the financial writers and analysts said, "It's different this time."  When you hear that, sell everything you got.

I'm not hearing it now.

    

Wild Blue Yonder

No real Ask Uncle Bill this morning.  I have to leave right now for Barksdale Air Force Base.  My son, Marc, is graduating from B-52 navigator training this afternoon and going operational tomorrow.  Going operational means doing the real thing and not classroom anymore.

Was going to leave later but he just called and thinks we can get a tour of a B-52.  This I got to see.

We have been talking a lot about why the market is, and should be, up.  Next post--what makes a market go down and what is on the horizon in the way of bad news.

Market Psychology or The Wall Of Worry

The bull market is not over.  It is not over because most people don't even think we are in one. 

The crushing market reversal of 2000-2001 is a huge anchor holding down the market.  Investors with a historical bent point out, correctly, that the Dow and S&P are just about where they were six years ago.  And the NASDAQ is still below water. 

On top of that fact, pessimistic investors throw in such show stoppers as

-high oil prices

-Iran and Iraq

-A recession (haven't had one of those for awhile so guess we are due)

-the weak dollar

-inverted yield curve

-inflation and/or deflation

-a new Fed chief

-over inflated real estate prices

-GM and pensions and medical costs

So the market should go down because there are a lot of things to worry about.  Guess what, there are always a lot of things to worry about and, in the past, a lot more worrisome things than those things listed above. 

But let's look at a few just for fun.  The stock market being just where it was six years ago.  The market may be right where it was but the economy is not.  Six years ago, PE's were through the roof and IPO's were making investment bankers rich and investors poor, or soon to be poor.  Today, PE's are down, companies have strong balance sheets, and tons of cash laying around burning a hole in the pockets of management.  The stock market was overvalued in 2000 and probably undervalued today. 

Iran and Iraq and high oil prices--so what else is new?  What's going to happen?  I don't know but the world is already aware of these events and it is fairly safe to assume that any concerns are already priced into the market.  This meaning that any downside events (bad news) probably won't impact the market much as the market assumes any news coming out of these places will be bad and has adjusted accordingly.  Any good news would help the market.

A recession?  Maybe, maybe not.  But probably not this year so a non-starter to the market.

The perennial weak dollar.  Here's the news.  The dollar is up, not down. 

Inverted yield curve which means short term rates are higher than long term rates.  They're not.  But not by much so perhaps something to be concerned about but since I don't really understand this arguement, I will make it a neutral to the market. 

Inflation and/or deflation--when you get one, people worry.  When you get the other, people worry.    When inflation goes up, that is bad.  When prices go down, like in Japan, that is bad because it slows the economy.  In regard to inflation, the Fed is doing something about it by hiking interest rates which is the traditional weapon for contolling inflation.  And believe me, we are not Japan.  Japan has no population growth and they save so their economy tanked.  Everybody, even terrorists, want to live here so our population is growing due to immigration.  And we spend.  We spend a lot.  So I don't see a Japan scenario for this country.

A new Fed chief?  The new boss looks pretty much like the old boss.

GM and pension costs?  In the 1950's a GM CEO testified in a Congressional hearing that "What is good for GM is good for America."  And, boy, did he catch it for that.  And he was right.  Now he would be wrong.  America does not revolve around GM.  GM is a dinosaur waiting to expire.  The impact will be significant (especially if you are a UAW member) but not earth shaking.

But the main reason the bull market will not end is because, again, people don't think we are in one.  Bubbles need enthusiasm and wacky prices.  I don't see that now.  But if somebody starts saying "This time it's different." head toward the exits.  That's what people were saying to justify the market in 2000.  Like I said, I don't hear it now.

How Do You Do An Acquisition Anyway?

As noted yesterday, increased M&A activity is good, initially, for the stock market as it 1) reduces the supply of existing stocks and 2) one deal leads to another so the process feeds on itself.  But how does a company decide 1) which other company to buy and 2) for how much?

The first one is easy--look real hard at who might buy you.  If you are in the food business your potential targets are Campbell Soup, General Mills, Kelloggs, ConAgra and any other company with a presence in the grocery store.  Same goes for tires--Bridgestone, Goodyear, Cooper and some of these might already belong to one of the above.  I know a guy that manages a discount tire store and I trotted down to get some Goodyears and he sold me Kellys because Goodyear owns Kelly and they are basically the same tire but for about 60% of the price of Goodyears.  Same goes for cars with Ford buying Volvo and Jaguar and GM owning part of Mazda, or is that Ford again?  And Mercedes buying Chrysler and so on and so forth. 

Who does the work?  If you work for a large company just look in the company directory for a group called Business Development as these are the guys doing the analysis.  They are usually pretty close mouthed but you can get to know them, just don't be tempted to do any insider trading as you will lose your job and may end up in jail.  It just ain't worth it. 

And what do they do?  They do analysis.  Not business analysis like product analysis or demographics or new products but financial analysis.  How much do we have to pay to get this target company? 

And here is how they do it.  As mentioned yesterday, if you have ever taken any finance course you were introduced to discounted cash flow analysis which translates into something like projecting a companys cash flows and then discounting them back using the corporations cost of capital to determine the value.  Huh?   

It is actually pretty simple.  Company A will generate cash flow of $100 in year one, $120 in year two, $135 in year three and so on for ten years.  Then you calculate the company's cost of capital.  Actually, you don't.  Somebody in treasury or planning does and gives you the number.  The cost of capital is the weighted average of the after tax cost of debt ( the easy part) and the cost of equity (the hard part.)  We won't go into all that because the number usually comes out to be around 10% because the cost of equity (the return needed to have somebody buy your stock as opposed to buying some other stock) is pretty high. 

So you discount the cash flows using the cost of capital and you get a number, say, like $500.  That's the highest price you can bid for the target company.  I said this was simple.

Actually, the analysis is simple but humans make it complex because there are a bunch of smart MBA's in the target company doing the same analysis and they want a lot more money or they just might turn the tables and buy you.

So what is a poor analyst to do?  You want to keep your job but the CEO is hot and wants to do the deal and the target company and their shareholders want more than your measly $500.  What to do, what to do? 

There are three things you can do.  First, juice the numbers.  Your analysis is based on what the operations guys tell you they can do with the company.  They will ballpark low because they want to look good when they take over and do better than plan.  So you juice the numbers, spread the margins, increase sales by 20% a year  and get the present value up to, say, $650.  Still not good enough.

Step two.  Extend the life of the analysis.  Good companies last more than ten years so why only project cash flows out ten years?  Let's go 20 or 30.  Now you are up to a present value of $900.  Still not good enough.

Step three, the neutron bomb of financial analsyis known as the RESIDUAL VALUE.  Residual value used to have another name, salvage value, or what you could sell a broken down asset or broken down company for in a fire sale.  Then somebody got smart and said you are not going to sell a perfectly well running company for salvage value and they juiced residual value.  If you think your company will have a value greater than the GNP of South Korea in 20 years, plug it in at the end of the analysis and see your value soar.  And nobody will catch it. 

So trot into the CEO's office and give him/her the answer they want.  And you won't be around in ten, twenty years so don't sweat it.

This sounds pretty cynical.  It is not because in a well run company cooler heads will prevail.  Plus, financial analysis is not a crystal ball, it is only an estimate based on known facts.  A successful acquisition is usually the result of some unknown or unseen variable popping up and taking everybody by surprise.  Gatorade is a great example--nobody saw a market going south (colas) and a market going north (water) with that product sandwiched right in between ready to take off. 

Merger Mania

Well, not really.  Not yet anyway.  But M&A activity is up this year and that is good for stocks because, again, mergers and acquisitions reduce the pool of stocks.  And when the supply of something is reduced, the price goes up for the remaining supply.  Usually.  Not always but usually.  So the general rule is that increased M&A activity is good for stock prices.

It is also good for stock prices because one deal leads to another and so analysts and investment managers are looking for the next deal and trying to get in on that before the stock gets bid up.  If there is no M&A activity there is no searching for the next deal and the market just kind of sits there. 

CFO's and corporate treasurers make the same analysis that we did last week--if you can borrow at 4-5% and invest (buy a company) that produces 6-7% or more it is, to quote George Tenet, a slam dunk.  The CFO and treasurer trot into the CEO's office and he/she loves the idea because he/she wants a bigger company to brag about at the club and get his/her name in the paper.  And there are other reasons to buy--often the CEO hates the guy at the other company and wants to put him out of business. 

That can also be counter productive.  Dresser Industries and Halliburton  talked for years about merging but the two chairmen hated each other so much that there wasn't a deal until they retired and Dick Cheney came along.  The deal was actually hatched in a duck blind when our chairman went hunting with Cheney.  I would have been better off if Cheney had just shot our guy.  (Heard a joke about Cheney and his hunting accident going something like "I can't understand why everybody is mad at Cheney.  He did what we only dream about--he shot a lawyer.)  Ok, not great but not bad.

Other acquisitions are 'strategic.'  Filling a hole in the product line.  A perfect example of this was Pepsico buying Quaker Oats.  Pepsico wanted Aunt Jemima, Captain Crunch and oatmeal like a hole in the head but they did want something and that something was Gatorade.  They wanted Gatorade because traditional soft drinks are going down in sales as water and alternative drinks (Gatorade) are going up.  If you don't think so look at Coke's stock price over the last five years compared to Pepsico.  No contest.   For a more indepth look at Pepsico and Coke take a look at Category 12-Investments.

And some acquisitions are for show, the purchase of an intangible asset.  I don't know the value of AT&T but it is a shell of it's former self.  But the name has worldwide recognition while SBC does not so SBC bought AT&T and reinvented itself.  Not bad if the price was right.

Which brings us to how deals are valued.  If you have taken any finance course you know about discounted cash flow but you probably don't know the Dirty Little Secret.  That will come tomorrow but for now remember that M&A activity is good for stock prices initially because M&A activity reduces the pool of available stock to purchase.  Simple but true.  And M&A activity is up right now so another factor behind a rising stock market.

Overdone M&A activity can be bad for stocks because it gets out of control with out of control prices and this often signals a market top.  But, again, we are not there yet. 

Tomorrow we will look at how deals are done.

The Law Of Unintended Consequences or Supply Meets Demand

"Buy land.  They're not making any more."

Will Rogers

While driving long distances the mind tends to wonder and I started thinking, for lack of anything better to do, of Sarbanes Oxley and the law of supply and demand.  Not necessarily in that order but they, in combination, are another reason why stocks are attractive right now, at least as opposed to most other things.  And this is not about land but what Will said about land is now applicable to stocks.

First, I don't know the slightest thing about Sarbanes Oxley.  I don't think I even spelled it right.  But I do know that Sarbanes Oxley is not effective and is annoying and a drag on earnings.  My experience is mostly anecodotal but when I call up old friends still at the salt mine and ask "Hey, what's going on?" about half the time I hear something about Sarbanes Oxley.  And it isn't good.  Busy work.  Non-productive report filing that means hiring more 'corporate staff' which means accountants and lawyers.  And CEO's hate accountants and lawyers.  Also, Sarbanes Oxley requires the Chairman to sign a note saying that all the numbers reported are the truth, the whole truth and nothing but the truth.  Think about that--I have 30,000 employees out there worldwide doing who knows what and I have to sign something that says every number they produce is correct.  No thanks. 

But that is the basis of Sarbanes Oxley.  And people are doing something about it.  Investment bankers are slithering around whispering in CEO's and CFO's ears.  "Want to get rid of that silly signing thing?"  "Want to get rid of some lawyers?"  "Want to get rid of some accountants?"  "How about dumping the annual report and quarterly report and shareholder meetings and analyst meetings and 10k's and all the other k's out there?"  "Interested?"  You bet.  Tell me more.

What the investment bankers are saying is Go Private.  Remember the inverse of the PE ratio?  If a stock has a PE of 20 that is really a return of 5% when 1 is divided by 20.  And 5% is higher than or near the borrowing cost so basically management or somebody can borrow the money and buy the company and come out ahead.  And where is the money coming from?  From those investment bankers who will set up the deal and get the money to take you private.  No more Sarbanes Oxley and a mass execution of accountants and lawyers.

And a reduction of readily available stocks to buy.  Yeah, so what?  Well, remember supply and demand?  When the supply of something goes down, the value of that supply goes up.  Look at gasoline.  The same goes for stocks.  The fewer the stocks out there, the more valuable those remaining stocks become because they are the only game in town.

So why don't companies issue more stock and provide more supply?  Some have but not in any great number because CFO's and corporate treasurers know that debt is cheaper than issuing equity and lot less hassle.  Call up your investment banker and borrow a couple of billion.  Plunk down your low interest rate payment and deduct the interst on your tax return. 

Want to issue some stock?  Your call goes to the other end of the investment banking house and you are now filling out government required forms, prospectuses, and hiring legions of lawyers and accountants.  You are also going to dilute the value of the shares of the existing shareholders because there will be more shares out there and they don't like that.  And they might sell which drives down the stock price and you get less money for your new stock issue.  And the cost of equity is not tax deductible.  Hassles and you are not a hero to the CEO.  Stick with the debt.

Finally, there was a time when issuing equity was all the rage.  And take note of what happened.  The time was the dot.com bubble of the late '90s.  Even sock puppets were issuing equity and when that happens the SUPPLY goes up.  And when supply goes up, PRICE inevitably goes down.  And it did and billions, trillions of shareholder wealth was wiped out along with slew of sock puppets.

So times are good for stock because 1) government regulation is pushing management toward going private, 2) you can go private because debt is cheaper than equity and when that happens supply dries up and prices go up as well. 

Will it hold up?  I don't know but look at the market and see what is going on.  Also look at M&A activity which we will talk about on Monday.