Book Review - The Little Book That Builds Wealth

The Little Book That Builds Wealth: The Knockout Formula for Finding Great Investments.

I generally love short investment books. Too often, it seems to me, an author takes a couple of basic ideas - and rather than give concise, germane, explanations and examples - instead stretches the book out to be one or two hundred pages longer than necessary.

Thankfully, that isn't the case here with this great little book.

The author is Pat Dorsey who is the Director of Equity Research for investment research provider Morningstar. Mr. Dorsey takes Warren Buffett's popularized "economic moat" term and show you how you can analyze businesses to see whether they possess such an advantage.

After screening for an above average return (both return on assets [ROA] and return on equity [ROE]), you can begin to consider whether your potential investment target has a long-term business advantage - an economic moat. Mr. Dorsey explains the four most common sources of moats: intangible assets, cost advantages, customer-switching costs, and network economics.

In clear and concise language, he explains these moats and gives examples. Later chapters give you some valuation basics to ensure that you aren't acquiring your target at too high a price - something that is always deadly to superior investment returns. Finally, he also suggests when to sell an investment.

I believe that this book deserves a place on any long-term investor's bookshelf, and highly recommend it. I would like to thank Mr. Peter Knox of Wiley for providing me with a review copy.

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JW

The Confused Capitalist

Playing an acknowledged theme - is outperformance possible?

"It's tough to make predictions, especially about the future." - Yogi Berra

Just like a trying to see a lighthouse on a foggy day, trying to clearly envision the future can be tough. However, making out the likely shape and dimensions of those things you are trying to avoid, or aim towards, will likely speed you safely on your journey.

It's like that in investing too. Picking out the broad trends to aim for, or avoid, can help elevate your portfolio returns.

Agricultural commodities are one big, broad, theme going forward. The popular press has recently jumped all over this, pointing to food unrest around the world. While the 'contra the herd" crowd would suggest that any trend reaching the front cover of your favorite pop magazine or newspaper is, most likely, nearly played out, they would probably be not so certain that this trend has.

Examination of the underlying factors suggest that this trend is likely to continue for awhile. Here are the factors, as I see them:

• Continued global population growth - check, this is still ongoing and unlikely to stop for several decades.
• Continued use of food stocks for bio-fuels - check, this is still ongoing. In the US, about 30% of the corn crop is going towards bio-fuel, compared to around 10% in the early 1990's. Given the presidential candidates positions to date, and the strength of the lobbying industry in the US, this appears unlikely to diminish any time soon.
• Diet - a meat-centric diet is a huge consumer of grains for animal feed (it takes anywhere from 5lbs to 18lbs of grain to produce one lbs of meat [depends primarily on meat type]). With a rising middle class in China and India turning away from a formerly mostly vegetarian diet, this will continue to pressure grains. Check, this factor remains in play.
• Arable land is decreasing - decades of industrialization, and of water course management, have reduced the amount of quality arable land available. Growing desertification is also a factor too. Check, this factor remains in play.
• Climate change - long known by scientists to be likely to reduce yield in several ways. Humanity continues to pump out voluminous greenhouse gases, suggesting this factor will only intensify in the future. Check, this remains a factor.

Of course, against those trends, you have to consider the possibility of opposing trends occurring. I see those potentially as:

• Potential reduction in bio-fuel use - a possibility, but with the opposition of vested interests, unlikely within a 10 year window.
• Change in diet - again a possibility, the increasing cost of a meat-centric diet may reduce the volume of meat consumed in some areas,. Yet with this burgeoning middle class in so much of the world, it feels unlikely to occur without some support from government, and people's own conscience. Overall, it feels unlikely to occur much within a five year window.
• Finally, the potential for increased production of foods, due to farmer's using more fertilizers and bringing all available land into production. This, I consider very likely. However, this may very well be offset by the declining yields associated with climate change.

On balance, I'd say that the current trend isn't anywhere near played out, and that agriculture remains a major investment theme going forward. If you agree, then you may very well want to stuff your portfolio with agricultural-related investment products, something I believe will fuel investment returns for a very long period of time.

Full disclosure: Long JJG, MOO, & COW (TSX exchange).

JW

The Confused Capitalist

Agricultural, it's all about the diet ...

Agricultural-related investments remains one of the big, visible, themes going forward over the next ten years. While there's been some mainstream acknowledgement of these major food issues going forward, for the most part, the media has been relatively quiet about the food inflation.

Maybe that's because many countries focus on "core" inflation, which ignores volatile changes in energy and food. These, especially food pricing, are likely to continue to ramp upwards over the next five to ten years.

Feeding the world continues to develop into one of the biggest stories of this century. The supply and demand curves for food, especially due to changing diets in the Far East to have more dairy and meat, continues to favour higher prices for these commodities. Other drivers of agricultural prices are:

- Strong population growth, expected to reach 7 billion by 2013;

- Rising income in developed markets and increased demand for soft commodities in developing markets;

- Climate changes challenging agricultural production processes and product quality;

- Arable land per person is decreasing;

- Demand for agricultural products from Bio-energy (sustainable energy resources) market adds an important and competitive new demand source. Agricultural commodities are getting
more and more important for energy generation.

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This is something I have written about here (provides some specific suggestions, which I continue to support) and here. I re-iterate those calls to make agriculture-related an important part of your portfolio. In Canada, you can now also consider a recent Claymore Investments ETF product, COW, which invests in agricultural companies.

Despite recent run-ups in prices of companies serving the agricultural sector, and the underlying commodities themselves, I consider that this investment theme is still just early in the third inning of a ballgame; a ballgame that itself may even go into lengthy overtime.


JW

The Confused Capitalist

Happy Anniversary

Just a little party for me ... to the tune of the Little River Band hit, "Happy Anniversary". This weekend is the anniversary of the start of this blog some two years ago.

Chorus:
Happy anniversary baby,
Got you on my mind,
Happy anniversary baby,
Got you on my mind.



Thanks to all my readers ... I've enjoyed the ride so far ...


JW

The Confused Capitalist

Cleaning up behind "Easy Al" (Greenspan)

If the economy was a ship, then Easy Al guided the world's largest economy within spitting distance of the shoals. Now, everybody else has to try and make sure that it doesn't crash into those shores, wrecking secondary havoc elsewhere.

The Bank of Canada is widely expected to lower its interest rate at its next meeting on January 22, in response to the slowing US economy and liquidity issues. Because Canada's largest export market is softening, having our currency float through the roof would hurt many Ontario-based manufacturers who count on this market. So we too are in the position of having to lower our interest rates, even though this is against the other relatively strong fundamentals elsewhere in the country. This, undoubtedly, will cause trouble further down the road, as in the stagflation that money manager and financial columnist Avner Mandelmann says has begun to visit its plague on the US.

While it's unfortunate that this will happen, viewed through the lens of alternative realities, which could include a depression, suffering through 10 years of stagflation seems infinitely better.

For Canada, the picture is different. Public finances are on the soundest footing in a generation, and all attempts should be made to maintain that. Accepting that American troubles are real but different, we should not follow the same asset inflation mistakes made there, by allowing our credit to become too cheap. Policy-makers and central bankers must put their heads together to make humus out of manure, so that Canada can take advantage of this situation, and not blindly follow the Americans down the manure-laden stagflation trail.

Perhaps first among these actions is lowering the cost of credit at a very slow pace, to a far lesser degree than that seen in the US. Secondly, as the cost of credit is lowered once again, perhaps accelerating our own national debt repayments would give us additional flexibility down the road.

We experimented with stagflation in the 1970s - perhaps we can try experimenting with a strong currency for a change.

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: http://confusedcapitalist.blogspot.com/) for additional articles and exclusive content!


JW

The Confused Capitalist

7.1%? Are you kidding me!!?

Picture: Kruschev (famous table pounder at the UN)

Well, 2006 seemed like the year I pounded the table for emerging markets. If you'd listened to me - heck, if I'd taken my advice more seriously - my portfolio and yours would be turning into serious dough by now.

I have a feeling that this year I'll be pounding the table about the banks.

Less than two weeks ago, I wrote about an eight stock portfolio containing three banks - stocks that Warren Buffett had recently added to his position in. Since then, two of the three stocks have fallen in price and the dividend yield has correspondingly increased. These three stocks, recent prices and yields are:

Wells Fargo (Bank) - WFC -$26 - 4.8% dividend yield

US Bancorp (Bank) - USB - $30 - 5.6% dividend yield

Bank of America (Bank) - BAC - $36 - 7.1% dividend yield

I can get a 7.1% yield on a bank stock - the largest bank in America by market capitalization -that's just announced a buyout of a troubled financial institution. 7.1%? Are you kidding me!? I say these banks offer fantastic value at these prices.

Do you really think the banking team would have even considered this buyout if they thought there was any potential they'd have to cut the dividend? Because that's what a 7.1% dividend for a major business institution implies: that a dividend cut, a la Citigroup, is in the works.

Unlike Citigroup, however, Bank of America is still buying. Does that sound like a troubled institution to you? 7.1%? You must be kidding.

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By comparison, the ETF "SPY" (S&P500) was trading at $132, and a 2.1% yield.


JW

The Confused Capitalist

Credit Crunch: Canadian Banks On Sale

Pictured: A different kind of crunch.

The global credit crunch seems to be affecting a lot of bank share prices, including many Canadian banks who have relatively little exposure to the sub-prime slime (CIBC excepted).

One analyst recently pointed out that 10 year Government of Canada bonds were yielding around 3.8%, and that the average weighted dividend yield of the six big banks was around 4.5%. The analyst pointed out that this was as large a spread as he could ever recall.

I too think that the banks offer tremendous value at current prices and yields. I look at it this way, if the credit crunch turns really bad, it's not just the banks that will suffer. There will really be no hiding out anywhere if things turn nasty. Having said that, I don't expect it, and therefore suggest that the current environment is great for buying banks stocks.

Of the Canadian ones, I like four of the six that have avoided most of the sub-prime problems and have dividend payout ratios around 40%.

These include the Royal Bank ($47, DivYield 4.2%, 42% Payout Ratio); my personal favourite, the Bank of Nova Scotia ($45, 4.1%, 40%); the TD ($64, 3.6%, 36%); and, to a lessor extent, the National Bank ($47, 5.3%, 39%). I think that buying a basket of these shares now, will look very good in two to five years. Odds are that the dividends will have been raised nicely over the period, and the shares are quite likely to have been repriced higher as well.

By comparison, the XIU ETF (broad Canadian market) is trading at $74 with a 2.1% dividend yield.

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: http://confusedcapitalist.blogspot.com/) for additional articles and exclusive content!


JW

The Confused Capitalist

Sub-Prime Slime Dirties CIBC

One of Canada's five big banks, CIBC, announced on Monday that it would be re-capitalizing its balance sheet with the sale of $2.75 billion in new equity. The bank, which has a penchant for poking itself with a sharp stick every two to three years, has already written off $3.5 billion in sub-prime exposure, which handily exceeds the $2.5 billion write-offs from the Enron fiasco.

The shares will sell at a headline price to the main investor group at $65.26 for the well-heeled billionaire, pension funds, and life-insurers who'll soak up about half the issue, and $67.05 for the great unwashed masses. After an additional 4% commitment fee is further soaked up by the main investor group, this reduces the actual price to $62.65 off of the $65.26 headline price, which is a steep reduction from the $72 level which the shares were trading at prior to this announcement.

Reaction from analysts has been widely positive, who generally point out that it's better to go to the equity well once, and dip heavily and deeply in case of further trouble. Most analysts appear to think that a good portion of the new equity won't be entirely needed for further write-downs.

Canada's best business writer, Derek DeCloet, thinks however, that the remainder of the new equity will be useful as all banks head back to their core roots - making loans with their own capital, as investors continue to shun repackaged loans of all sorts.

CIBC shares have been trashed by the market over the sub-prime mess; the further $2 drop to $70 since the equity infusion announcement means that their shares have now lost some 35% since achieving their 12 month high in May 07.

While conservative CEO Gerry McCaughey has, in my opinion, done a good job since his appointment, one can only wonder what stick CIBC will pick up and play with next year.

JW

The Confused Capitalist