Mat’s Investing Blog

One of the things I’ve been saying a lot recently to my close friends is that I’m blessed to have been born at such a time as to have one of the largest stock market movements in history take place in my early adult life. This, coupled with a few of my major traits and my free cashflow, should allow me to profit handsomely in the years to come as I can snap up fantastic companies at bargain prices. It was therefore with keen interest that I noticed a new book being released titled “Outliers: The story of success” which proposes that genius often is superseded by hard work and the timing of your birth. For those eager to know more an extract is available which is quite enlightening in and of itself. With that in mind it’s back to work for me!

Midway through last month I wrote about the levels of the Dow and S&P 500 and how they had basically gone nowhere for the last 9 years. 5 weeks later however and how things have changed:

11,433 - Dow Jones, 11th Sept, 2008

8,852 - Dow Jones, 17th Oct, 2008

Marketwatch headline: “Stocks to search for stability”.

“I have discovered that all human evil comes from this, man’s being unable to sit still in a room” - Blaise Pascal

Throughout the history of business, great companies have been run into the ground by management that has tried to move away from their domain of expertise. Whether it was due to their want to climb the ranks of the Fortune 500 by increasing revenue, a misguided sense that diversification makes a company better, or even to relieve boredom, they have committed this sin time and time again. Not only does it make management look like fools but it is to the detriment of the shareholders; the only people management should ever care about.

Coca-Cola in the 70s was a prime example. The company had blanketed the globe with its ubiquitous brand of cola but sales had stagnated due to the failed marketing of international bottlers. J. Paul Austin, the chief executive officer, decided to spend some of the companies surplus cash on some totally left-field ideas: wine, plastics, whey-based drinks, water purification and even shrimp farming. The result? A 1% average annual return throughout that decade. When Roberto Goizueta took over in 1981 he decided to continue diversifying by acquiring Columbia Pictures and the annual report took on the form of a magazine advertisement for the latest movies coming out of the studio!

Fortunately for the company they didn’t let the cola business completely stagnate and rolled out the highly successful Diet Coke which shifted Goizueta’s attention back to the core of the company. With his competitive spirit awakened he took the fight to Pepsi and made another stupendous error: he unveiled “New Coke”. When the American public discovered what happened they totally boycott the new cola and proceeded to demand the old formula back adversely affecting sales and the share price. However, no matter what management did they couldn’t permanently tarnish the name of Coca-Cola and the company continued making a profit until management finally awoke from their slumber, albeit 15 years later, divested of the diversified distractions and focused on the marketing of the brand. Today the success is quite apparent as they blanket the globe with colas, juices and other liquid refreshments to the great fortune of their shareholders.

Any company that passes the first 5 years of existence and continues to grow profits without undue leverage already has a good thing going. The key for management is to continue to milk the gold mine while only branching into areas that they are experts in and continuing to provide high levels of return. Software companies should remain software companies, Cola companies should remain cola companies and energy companies should remain energy companies. It is a very good thing indeed when management sit quietly in a room.

11,405 - Dow Jones, 24th Dec, 1999

11,433 - Dow Jones, 11th Sept, 2008

1,279 - S&P 500, 24th Jan, 1999

1,249 - S&P 500, 11th Sept, 2008

Warren Buffett, in a speech he gave back in 1999, discussed the ebbs and flows of the market during the previous 34 years. The most interesting part of the speech was his analysis of the two distinct phases that he was witness too; where from 1964 to 1981 the Dow Jones didn’t move 1 point and from 1982 to 1999 it increased tenfold. This 17 year pattern was only unique in one regard: it’s length. The pendulum of investor opinion has swung back and forth many times since the turn of the 20th century and the only guarantee for the 21st century is that it will continue doing so.

Fast forward to today as we near the end of 2008 and the figures at the beginning of this post tell a familiar story. Here we are 9 years later and nothing has moved even though the US economy has grown throughout that time period. How long will this negative pendulum swing last? Who knows. The one thing I can say with certainty though is that when it does go positive again the ride up will be much smaller and shorter than the epic bull market that ended in 1999.

Fairfax is currently recommending a company with no revenue or profits and a net worth that would require it to earn $350 million this year. If anyone is interested in that stock I also have a bridge you might like.

The product that I made my nest-egg off has been re-released by Happy Hour Code under the guidance of John Devor. I think he has done a fantastic job on the application and the new icon is simply stunning. Grab yourself a copy if you value your Mac and iPod.

When it comes to trading securities one of the most amusing aspects is how little pieces of information will quickly cause outrageous movements in prices. Take today for instance; last night’s news was that metal prices had fallen causing the resource sector to move into the red. Fortunately for the companies involved nearly all the contracts they sign are in the 6-12 month range so the daily fluctuations in metal prices wont make any difference to the companies profits today, tomorrow or even this month. However, the change in share price has wiped out tens of millions of dollars of shareholders money.

Due to the ever changing mood of the stock market the only way to reliably earn money from securities for the average investor is to invest over an extended period of time; generally the longer the better. The Australian government has an incentive to cause people to hold onto their securities longer whereby the capital gains tax moves from the standard 30% to 15% after 12 months. While this rewards long term investment I don’t necessarily think it does enough to stop people making short term trades. After all, if you’re an individual paying capital gains tax still feels psychologically less than paying income tax of 40% even though you’re more than likely going to end up paying capital gains more times due to your incessant buying and selling.

To further force people to invest for longer periods I propose to replace the current capital gains tax with one that scales a bit further on either end of the spectrum. Here’s my suggestion:

• 0-12 months: 50%
• 1-2 years: 30%
• 2-5 years: 15%
• Anytime after 0%

As you can see holding your securities for 5 years or longer gives you a major tax break allowing the citizens to be that much better off. This extra money allows the government to do its job of increasing the welfare of their populace without having to resort to extra education or holding their hands through retirement via the old age pension; a win-win situation for everyone.

Mistakes of commission:

• Acquired BHP (ASX:BHP) at $34.64 as it was undervalued and sold it at $39.96 due to my realisation that I never really understood the stock. Current value: $48.57. Unrealised loss of 25%.
• Acquired AED (ASX:AED) at $1.75 as there was unrealised value. Sold at $1.91 for no obvious reason. Current value: $2.70. Unrealised loss of 41%.
• Acquired BEN (ASX:BEN) at $9.92 as it was severely undervalued. Sold at $9.48 for no obvious reason. Current price $14.05. Unrealised loss of 40%.