Jim Rogers FT interview

I have to say I've learned more over the years from Rogers' take on the markets than from anyone else.

So here's a four-part interview with the original gnome of Zurich investor.

"Lynch Rebates"

Most people today who write about value investing emphasize discounted cash flow valuations and various other techniques that rely on projections of future earnings or cash flow in determining the intrinsic value of a stock.

That's fine. But if you read the beginning of Graham and Dodd's 1940 edition of Security Analysis you find that Graham's entire argument for asset-based investing is that projection of current earnings trends into the future is inherently an unreliable exercise. Anticipating today's behavioral economists, Graham understood far better than most (with the help of being bankrupted by the Great Depression) that we as investors are not nearly as accurate in predicting the future as we think we are.

To fight this bias, Graham argued for investment in stocks that had share prices trading at less than two-thirds of their net current asset value. Buying cheaply in this sense, or at any other deep discount to readily ascertainable corporate value, meant that an investor didn't have to predict anything to make money.

Many extremely literal readers of Graham and Dodd (we could call these "value fundamentalists") took this advice to mean that investors must only buy Graham's "net-nets." So they sat around through the second half of the twentieth century with their hands in their pockets as the population of always-rare net-nets thinned out further and further.

Peter Lynch introduced a brilliant solution to this problem in One Up on Wall Street, a book that is far too often caricatured as a simplistic "buy what you know" manifesto. Lynch's technique is to take the net cash of a company--that is, cash on the books net of long-term debt, and apply that figure to the share price as a "rebate" of sorts.

Here's an example of how this works . . .

Take 4Kids Entertainment (NYSE:KDE), which licenses the rights to use Pokemon and several other children's entertainment franchises that may or may not have value.

The stock closed today at $16.85. According to the most recent balance sheet, the company has 105.64 million of cash and liquid short-term investments, along with no long-term debt. For the sake of simplicity, this is assuming that there are no substantial lease obligations or other obligations that are not readily ascertainable from the balance sheet. That gives us a figure of about $9 a share in cash or assets readily convertible to cash.

So you subtract that $9 from the share price of $16.85, leaving you an effective share price of $7.85, since you're getting paid 9 bucks to hold each share. So you're buying the business at about a 53% discount.

You then compare that $7.85 to the value of each share of the business to see whether the business is worth that discounted price. I don't know if the business at 4Kids is attractive at that price, but it's clear that it's considerably more attractive than it would appear without getting this sort of discount.

In my experience, this technique is a terrific way to find businesses at extremely attractive values.

Disclosure: I do not own shares of KDE.

China Goes Parabolic . . .

See for yourself.


I believe China is headed for a 1929-style wipeout, which will be bad news in the short term for them, but good news in the long term as they implement a range of market and economic controls that mirror those imposed in the US depression era.

China now has the financial clout of a world power, but the market infrastructure of an emerging country. This is great for them on the upside (the above chart) as it accelerates the boom, but is going to make the bust equally ugly.

And unlike Japan in the 1980s, I don't believe China has a stable, coordinated-enough banking system to prop its equities up indefinitely.

We're likely to see some great opportunities in China over the next 5-7 years--I mean the exact same companies now, but at PEs of 3-5.

Keep your powder dry.

Reading Berkshire's Chart

I've found that Berkshire Hathaway (BRK-A), run by a man with no use for technical analysis, is more technically driven than just about any stock I deal with.

That may not be the definition of irony, but it's not far off.

I guess this is because 1) there are not many traders who want to swing 115K chunks of stock around and 2) the stock attracts people who are thinking in the long term anyway.

Look at how BRK has struggled to clear each major round number, then usually dutifully held above it.

I'm holding the B-shares, which basically mirror the performance of the A-shares. Are we about to see a break above 120K?

Quiet Booms

Those of us who live in commodity-producing areas have noticed something recently that many others haven't: the commodity boom is beginning to make its way into the broader economies of these areas throughout the US and Canada.

Cash generated by high prices for tangibles is trickling out into banks, real estate, luxury purchases, and capital investment of every part of North America that has an economy reliant on production or distribution of "stuff."

Minyanville's Ryan Krueger, for example, sees a petrodollar-driven boom unfolding in the oil-refining region of Port Arthur, Texas.

There has been some scattered coverage in the national media about this. Both New York Times and the Los Angeles Times have noted Houston's boom-town characteristics over the past year.

By the time it's all said and done, Houston will prove to have been just the first (and probably the biggest) of many of these kinds of booms.

Dallas, Denver, Kansas City, Oklahoma City (where I live) and other centers of commodity production and distribution will experience similar effects on capital investment, luxury spending, and high-end real estate as oil, grains, livestock, and metals prices remain high.

Maybe it's some facet of this boom-time mentality that has rich OKC oil execs barely able to disguise their lust for other cities' sports teams.

The point I would take from this whole phenomenon of quiet booms, as illustrated by Mr. Krueger's observation, is to avoid letting a blanket conviction obscure the potentially profitable subtleties of a situation.

You don't want to let the idea, for example, that "all real estate is going down" lead you astray any more than the thought that "all real estate is going up" led many investors astray several years ago.

Gross national figures can be illusory: there's no reason an economy or an asset market has to correspond to a national boundary.

They say "all real estate is local." Well, all economics is local, too . . . and it's worth it for an investor to pay very close attention to what's really driving the economy of a particular area before those numbers get folded into GDP.

An Emerging Consensus

Recently, more and more investors and journalists have begun to argue that the center of world financial gravity is shifting decisively away from the US.

There's an emerging consensus that emerging markets are the place to be for the near future, and potentially for longer.

This author points to the fact that increased accumulation of foreign reserves has put many emerging market countries in the position of being net creditors, describing emerging markets as being in a "golden age."

The Washington Post has a piece that is even more eyebrow-raising, showing how hot money is pushing further and further out along the risk curve by investing in "frontiers" around the world. For a potential target, the piece even points to the hyperinflationary disaster that is Zimbabwe, once one of Africa's most promising states before the tyrannical Robert Mugabe (pictured) single-handedly ran it into the ground.

Past performance, of course, doesn't necessarily have any bearing on what's going to happen in the future. It's worth looking at the explosive growth these markets have already experienced over the last five years, though.


All the "golden age" talk has me skeptical. Emerging markets' expansion has run in lockstep with the unprecedented credit expansion in the developed world beginning in 2001-2002, and as we know, a rising tide lifts all boats.

We have yet to see how these countries will respond to slowing growth in their primary export markets, or if they truly are as immune to the need to access credit markets as the bulls contend.

My opinion is that the emerging market talk is evidence that the longtime market advance is probably picking up speed as we enter a euphoric phase. Viable investment opportunities are saturated with capital, so creative investors are moving to places that aren't really viable, as they assume that the bull market will continue forever.

Speculators should see this as an opportunity to ride a sector that is beginning to go parabolic, and may have already begun to do so.

Long-term investors, however, should tread lightly. All of this stuff should be available in the future much more cheaply, after these countries have proven that they can thrive when credit is not so plentiful.

A Bubble in Retrospect

Barry Ritholtz's excellent summary of the housing market's woes got me thinking as he discussed David Lereah, the former chief economist for the National Association of Realtors. Lereah wrote a number of ill-advised and ill-timed investment books, ranging from tech stocks to real estate.

In 2005, Lereah published Why the Real Estate Boom Will Not Bust, which looks fated to become an inadvertent classic of bubble-market psychology, taking its place alongside James Glassman's Dow 36,000 and the South Sea Bubble-era launch of "an undertaking of great advantage, but no one to know what it is."

I was curious about what people said about the book when it was published, so I looked back at the oldest reader comments from Amazon, circa 2005.

What I found was interesting. The first thing that jumped out was that a few people recognized that following the book's bullish advice would be dangerous.

But at the same time, the emotional momentum remained with the bulls. As you move from older to newer comments, you can see the bulls disappear and the bears gain confidence as the comments shift from optimistic to dismissive.

I think this little exercise shows that--contrary to the views of Alan Greenspan and others--it's entirely possible to identify financial bubbles as they are going on.

The trick is having the stomach to resist the crowd. I have to say that it does gets easier, though, as you experience and read about more historical bubbles.

Here are a couple of books that will help out by giving you indigestion at stories of monks who day trade:

• Edward Chancellor, Devil Take the Hindmost: A History of Financial Speculation
  
• John Kenneth Galbraith, A Short History of Financial Euphoria
• Charles Kindleberger, Manias, Panics, and Crashes