December Reading

I've said before that recently, changes in supply/demand for money and risk are the biggest risks to my investments. I've intentionally not focused on these areas in the past; there are plenty of smarter, better connected, well capitalized people out there who can and will beat me at currencies. So I actually never took economics in college (met requirements with AP Economics), and economics was less than 10% of the CFA tests.

Also, the stuff I did learn just didn't seem right. Purchasing power parity seemed to show little of the real world, if I recall correctly the carry trade should have been impossible in theory, and GDP and CPI are considered far more - accurate, or precise - than makes sense... I got the impression it was over influenced by Keynes and started reading Mises' Human Action. I didn't think that was going to help me invest much, so I quit a hundred or two pages in.

This winter break I want to figure things out. My reading/skimming list:

-A Monetary History of the United States (Friedman)
-The General Theory of Employment Interest and Money (Keynes)
-Speeches from fed governers
-chapter 3 of Alchemy of Finance (Soros)
-The Theory of Money and Credit (Mises)
-then move on to this reading list (but no access to academic articles)

Wish I had more from practitioners...

T2 Partners on NFLX

Via Neo-Alpha, T2 Partners have given brief reasons for being long NFLX. They compare the balance sheet but only mention the contract obligations as necessary for growth. They cite 166million net cash and 201million fcf as strong positions, but this is up against these streaming content obligations:

Less than one year		$	740.8
Due after one year and through 3 years			2,136.9
Due after 3 years and through 5 years			535.7
Due after 5 years			45.5
Total streaming content obligations		$	3,458.9

These are up massively compared to prior periods.

Hey, maybe they'll pull it off. I hope they do, I had a great experience as a customer. I agree it looks good from a takeover perspective. But I wouldn't call that a strong balance sheet. (ok so technically it's off balance sheet...)

NFLX - Two Mistakes

I don't like NFLX even at the current price. The reason is the massive operating leverage they've taken on to maintain and expand their digital offerings. I suspect it has positive expected value, but definitely risky, so inappropriate for my situation.

1) First mistake was buying a small position after the huge drop, while starting researching it. I was thinking that there was significant overreaction - and likely many stop outs from the momentum players - and it would soon bounce back up. I had a wee bit of confidence because I'd looked over NFLX last December. Not enough to hold it over night, but I still shouldn't have done it - the situation had materially changed with their increased obligations.

Of course go figure with investing and speculating, I made money despite making a mistake. I would have made more if I hadn't fixed the mistake right away (now up over 10%).

2) I looked at NFLX in December from the short side. I should have kept up with it; if I'd read all their filings, I would have noticed the increased operating leverage, and been willing to short after the stock started dropping with the rebranding fiasco.

Miscellaneous

-Interesting to see Jim Chanos present on Gamestop. I've thought about it before. I didn't end up doing research because honestly, I don't know why their sales haven't dropped a lot more already. Nobody I know likes or uses the place. Bad customer service, average-bad prices... If I don't understand the motivations of their customers, it's going to be pretty damn hard to predict changes in customer behavior.

-Currently reading Security Analysis. This seems *far* better to me than The Intelligent Investor; next time I'm back in the US I'll have to look over my copy of the latter and see if I can figure out why my reaction is so different. Very useful in understanding the current situation.

-I've essentially finished my energy market research, need to write up my thoughts, but first -

-Currently studying NFLX (after yesterday's 35% drop, it has now gone from way overpriced to interesting in less than one year)

-Via Mish, bank runs in Greece; what the heck? What did they wait till now for? But then again maybe this is just the man in the street - those with more assets have been leaving for a while.

Pet Peeve

Bit off topic here, but the just a comment on the financial community in general...
The level of elitism is a huge turnoff. That just doesn't exist in my current work environment and circles. It's disappointing to see it show up so strongly on a blog I really like, kid dynamite's. Hopefully it doesn't continue down that road, like equityprivate...

August '11

Whew! I feel like Ritholz - the last two big market moves I've been traveling. The first one, during the Sendai Tsunami and Fukushima nuclear disasters, I bought a netbook and attempted to put on some trades from my hotel. This time I followed along and put in trades from a smartphone.

Performance wise I've been okay. I went in net short US equities, but with most of my assets in US cash - so on a yen basis or 50/50 USD/YEN basis I'm slightly down for the last few months. I actually cut two short positions during the prior two weeks, and bought some HII on the Friday before the big drop. Beautiful timing eh? On fundamentals I think it's quite strong though. At these prices it's at a tasty multiple. It wasn't hit as bad as some other stocks but had declined quite a bit. The Navy is the only significant customer, which won't be affected by an economic downturn. And a wind down in Iraq/Afghanistan military spending shouldn't affect them much (although they trade at roughly the same multiple as army/air force companies).

I've since put on the long gold miners/short gold trade too. On a dollars term it's a net short position but in the current markets trades like a long - so I consider myself net long now. Still primarily in cash.

Currency is something I've been working to understand more but have a long ways to go. I didn't focus on it while studying for the CFA; my rationale was that I would never have a competitive advantage vs large institutions/macro traders, so it would be better to specialize in other areas and bypass currency sensitive issues. I had essentially the same reasoning for not learning about oil and energy markets. Now I don't think I can even look at many securities on a micro level without a better understanding, and perhaps even a position, on these things. My current list of areas to study:

-the oil/energy industry. I'm particularly interested in gas. Read The Prize, reading Oil 101, will read ...

-currency/inflation. Read This Time is Different, need to read - and think - a lot more.

-technical analysis. I've stayed away from this in the past because it was drilled in to me at school that technical analysis is garbage, and the little I did read looked like mysticism. I'm very aware of the human, and my own, tendency to see patterns where there are none. That said, there are times where it seems relavent and makes sense logically. I suspect learning about technical analysis will give me insight into the yen's strength...

Book Roundup

Can't call these reviews because the books were so bad I didn't finish them.

Selling Short (Joseph Walker): A shade worse than useless. The very basics of shorting are covered much better on wikipedia; the hedging strategies includes advice like writing a put against a short position and trusting the professional skills and risk management of wall street.

The Disciplined Trader (Mark Douglas): Guess I didn't drill down in the amazon reviews enough. This one is spot on; the book is simplistic and new age-y. New age is fine if that works for you, but then do yoga and meditate, don't read this.

And one good one, but a short note will suffice:

Market Wizards: Interviews with Top Traders (Jack Schwager): Very good light reading. Felt similar to reading hedge fund letters. Interesting noting where the different interviewees differed and where they were the same (who's this Martin Zweig character?). Jim Rogers' stood out as the best. Incredible how a lot of his concerns were so similar to problems today (still? again? I will definitely read his books now; if those concerns can last through the market returns of the last twenty years, that's very important to know).

Book Review - The Art of Short Selling

Summary:

Staley gives an overview of short selling and profiles of some major players. The bulk of the book (177/278 pages) is then categories of attractive shorts with in depth examples - akin to case studies. In part three, she has brief chapters on:

1. how shorts often fail (11 pages);
   
2. shorting in history (17 pages); and
   
3. a how-to chapter (20 pages).

Review:

• It is much better than that dust jacket makes it look; obviously a different author! (Perhaps the same person who chose the title "You Too Can Be a Stock Market Genius")
• I noted the number of pages in the summary because I was a bit surprised and disappointed by the focus. I thought the book would have been stronger with more history, much more on how shorts fail, and case studies where shorts failed. Specifically, I sought a book on shorting to learn to avoid buy-ins and short squeezes; her only advice on that is the obvious pay-attention-to-short-interest.
  
• One weakness is that the examples were all from the mid 80s to early 90s.
• The case studies/examples were very good; readable, reasonably thorough with clear references to primary sources, good notes on where shorts tripped up even when their thesis was correct.
  

Bottom Line:

Definitely worthwhile for anyone planning to short; a good read for other investors, but if you're limited on time choose other books which include forensic accounting. This book alone will not prepare you to short.

(While looking for a book mentioned in the footnotes, I came across this academic paper noting that while short interest is a valuable contra-indicator on individual securities, aggregate market short interest is extrapolative)

IBM

It pains me a bit to see IBM do so well recently. I took a look at them a few months back. I like their market, and I love the amount of money they are returning to investors (when I looked at it, the yield including dividends and buybacks was around 10%). But - they have a lot of acquisitions. I don't trust my ability to pick them all apart, so I can't trust the numbers.

Book Review - Margin of Safety

Summary - (paraphrased from the book's introduction)
The first section of this book examines some of the places where investors stumble.

• Chapter 1: differences between investing and speculation
  
• Chapter 2: how Wall Street maximizes its own best interests, which aren't necessarily aligned with investors.
  
• Chapter 3: the behavior and influence of institutional investors
• Chapter 4: a case study of junk bonds to illustrate many of the pitfalls highlighted in the first three chapters

The second section...explores the philosophy and substance of value investing.

• Chapter 5: risk aversion and its investment implications
• Chapter 6: the philosophy of value investing and the meaning and importance of a margin of safety
  
• Chapter 7: three underpinnings to value investing: a bottom-up approach to investment selection, an absolute-performance orientation, and analytical emphasis on risk as well as return
  
• Chapter 8: the principal methods of securities valuation used by value investors

The third section...describes the value investment process, the implementation of a value investing process.

• Chapter 9: the research and analytical process - how ideas are found and evaluated
• Chapter 10: sample value investment opportunities
• Chapter 11: thrift conversions
• Chapter 12: financially distressed securities
• Chapter 13: portfolio management and trading
• Chapter 14: investment manager selection
  

Review -

• This is the best introduction I've read to investing. The author is clear, concise, and covers all of the important points. If this were an in-print <$10 paperback, I would pass copies out to friends/acquaintences who don't have an investing background.
• This is not a how-to, like Graham's Security Analysis. The second section is just an overview of valuation methods. As such, this books apparent value as a collectable is confusing to me.
• The recommended "hunting grounds" in the book's third section is relatively short and weak compared compared with Greenblatt's You Can Be a Stock Market Genius.
• I would particularly recommend this for pre-college students interested in finance. Klarman's criticisms of academic and Wall Street finance would have been valuable to think about while learning the former and considering employment in the latter.
  

Bottom Line - Perhaps the best introduction to investing (or value investing).

Patience

written 6/17

I've had my eye on a couple names I'm waiting for moves on. First is MCD. I've seen it mentioned over the last few months as a defensive name. Me, I like their growth prospects. Even though sociology students have decried McDonaldization for a generation, their emerging market footprint is far below Japan/US/France. I also originally looked into them because I expect the wage/exchange rate gap to narrow somewhat over the next ten years (though China's could easily expand short term). Anyway I'm waiting because of McDonald's huge exposure to the euro via France. I had no idea! I suspect but am not confident that the euro will take a major hit at that point. McD looks like uncompensated risk for that possibility. Perhaps more importantly, the popularity of defensive names will eventually pass, providing selling pressure...

The other is Google. I wrestled with considering this one for a while – I really, really don't like their corporate governance, and I'm not confident in their leadership and direction. Their acquisitions and focus on social is particularly aggrevious. Even the way they do that – the letter from the top informing everyone 25% of their bonus is dependent on success in social? Sounds like a fine way to run a manufacturing concern...

But the positives for the stock are immense. Revenue is almost all real time auction based – so they are very well protected from inflation/debasement. I expect their gravy to grow a little faster than the economy/business averages over the long term as the generations that came up on internet take over a greater share of purchasing power. Short term I think there is very good potential for growth in Local. Google maps are superb and android is solid.

But I don't like dual class shares. I wouldn't like to invest in Berkshire Hathaway for the same reason. But at least Buffet seems to put shareholders first...

Postscript (7/18) - I decided to set limits for myself on companies with weak shareholder protection; 10% in a name, 20% portfolio wide (gross? not netting out short positions). I set up a small position long GOOG short RAX. Got lucky on Google; I thought the reaction to increased expenses last quarter was way overblown but the rebound was much higher than I expected!

MCD I'm expecting to wait at least 6 months, likely well over a year.

Driverless Cars – Investment Implications

Summary: -Huge value transfer from real estate/location based advertising to internet advertising (and consumer surplus)

-Large transfer from real estate convenience value to delivery companies, car makers, energy

-Potential huge change in energy inputs

The internet has taken massive amounts of advertising money from TV and print media. Driverless cars though... that takes your attention from your surroundings – to books, TV, internet, work, chatting. How much of the business world relies on physical location for their advertising, or even business plan? This is going to cause a huge transfer of “advertising” money from real estate to the internet. Where do you go get a haircut? I used to go where I remembered seeing one. But if I'm using my computer while driving I haven't ever seen one – so I run a search, or perhaps see what my friends have recommended on Facebook or Yelp.

How much money in real estate is advertising? I have no idea how to break that out. I know when I made a business I paid $1600/mo for a tiny little place for the superb foot traffic. The exposure+convenience was worth about $600-800/mo in my mind.

How about convenience? For some real estate, the value won't change – if I'm in an office building and I want to lunch or coffee on a normal day, it's not worth calling (or even getting into) a car. I'm going to take what's in the building or the next place over. But if you're going to get into a car anyway, there's not a big difference between a 5 minute and a 10-15 minute drive if you're checking your email at the time. So location becomes a lot less important for sit down restaurants and stuff. Automatic pick up or automatic delivery fleets also make 'fat tail' food choices more competitive with McDonald's in terms of convenience. More than McDonald's though, I would expect grocery stores to lose out because of this. I go to grocery stores because it's hard to get healthy food quickly. Someone like Whole Foods, on the other hand, might do very well – they have a strong brand and the kind of prepared foods I would expect to do well.

Some changes depend on how many people would switch away from car ownership completely – opting instead for a taxi service. Full time taxiing cars would probably be most cost efficient as electric or natural gas vehicles. Depending on the number of people who switch, this could pummel petrol heavy energy companies and destroy nations (and their companies) reliant on current oil prices. Travel prices would drop.

It will be interesting to watch the regulatory progress.

[originally written 6/10 - since then, Nevada seems to be pushing forward. I've heard 2018 as a potential production date]

HII Update + Another Spinoff

Huntington released an 8k with their executive comp details and it looked pretty tame. I'll take a pass.

In other spinoff news, interesting to see John Malone's name crop up in the latest - as a major (indirect) shareholder in Expedia. Of course with his interest in it, there will probably be a lot of close analysis of the transaction.

It's quite interesting that the news was released on the same day as news of justice department approval of Google's purchase of ITA (travel data). I know almost nothing about these companies but that looks like it could be neutral news for the Expedia chunk (they could commercialize their Best Fare Search data, little effect on hotwire) but very bad for Tripadvisor (as it becomes easier to order tickets after searching Google and their Hotpot/Places rating system grows). Yet market and analyst reaction seemed to focus on the value that can be unlocked for Tripadvisor.

A Small Put

I bought a few puts on Nomura ADRs (NMR). The main reason wasn't speculative; I wanted to see a trade all the way through on Interactive Brokers. I had recently been extremely gutted to find out I couldn't trade Japanese equities through them - their CSR said it was due to Japanese regulations but after poking around some message boards it looks like IB might be unique in their interpretation. I missed a couple thousand dollars on the trades I wanted.

The speculative reasoning was simple - I was looking for a large multiple payoff in the event of nuclear catastrophe. I had no special insight into the chance of that happening (I thought 1%-20%), but figured I wouldn't be trading against anyone who did - and option pricing models certainly didn't. So I didn't do any fundamental research and just looked over a few financial ADRs for some decent out of the money puts.

While the nuclear news has been mostly bad, it hasn't emptied Tokyo. I had mentally written the puts off as a 100% loss but got bailed out by the recent dip of the yen. Looks like I had lucky timing too; they were $5 strike 4/15 options I bought at $.20 and unloaded Wednesday at $.25

Currency

I'm not sure what currency or basket I should benchmark my performance in or hedge my expected expenses. Frankly, I have now idea where I'm going to be in a few years time. I might:

• Do an MBA in Singapore (Insead - EUR and SGD).
  
• Do an MBA in Australia (University of New South Wales - AUD)
• Look for a job in the US (USD)
• Continue working in Japan (JPY)

So a split perhaps? 12.5% EUR, 12.5% SGD, 25% AUD, 25% USD, 25% JPY? The thing is those don't even look like currencies any more; they look more like bets. EUR on the PIIGS, USD on Ben, JPY on the bureaucracy, AUD on resources. I'm currently about 50/50 USD and AUD (including having sold next year's expected YEN savings) but extremely uncomfortable with the situation.

HII

I recently read Joel Greenblatt's book after reading Mike Burry's recommendation in The Big Short, so I thought I'd take a look at some spinoffs (Blatt's stomping ground of choice). Huntington Ingalls Industries will be spun out of Northrop Grumman. A quick skim looked appealing - the industry PE ratios were around 10x, restructuring/writeoff charges depressed recent earnings, it's a leveraged transaction, and the transaction required and received Navy approval.

Since the only important customer is the Navy, I figured insider positions were even more important than usual for this transaction. However, I haven't been able to find insider positions! The 224 page information statement simply reported 2010 compensation info. The SEC filings for initial positions show blanks. I thought I read somewhere that the relevant data would be posted on huntingtoningalls.com but the website isn't live yet (despite the stock being tradeable for a couple days). Maybe this is normal but it seems strange to me. If I can find that information in the next few months I'll research this issue more.