Tuesday, May 30, 2006
Saturday, May 27, 2006
So a couple of days later it appears to have held. Well that is nice but what is next? The trend line I have pointed to in both charts seems to have some relevance. If so, it makes sense to think it can be relevant a little while longer.
If you are looking for a quick trade I don’t have much to offer. If you buy into the idea of gold as portfolio diversifier and you don’t have any exposure, I think this may be a good point to enter.
06 July 2006 - Franklin Templeton- Global Economic Perspective
Latest Articles on 30 Jun 2006
26 June 2006 - Aberdeen- Global Weekly update
26 June 2006 - Aberdeen- Emerging Mkts Weekly update
26 June 2006 - Aberdeen- Asian Mkts Weekly update
26 June 2006 - Schroder- Asian Bond update
26 June 2006 - All files this week zipped up
More from wilfred
19 June 2006 - Aberdeen- Asian Weekly update
19 June 2006 - Aberdeen- Global Investment Outlook
19 May 2006 - DWS - DWS Asian Small Mid Cap Presentation
19 June 2006 - Henderson - Asia-Pacific Property Equities fund
19 May 2006 - Henderson - European Property Equities fund
19 June 2006 - iFAST Financial PTE LTD - Monthly Morning Meeting on june 2006
12 June 2006 - Schroder - Asian bond update
I just recieved some pdf files from wilfred. Would like to share it with everyone.
19 May 2006 - Schroders - Russia Update: Increase Benchmark Weighting
27 May 2006 - Schroders - A Change in our US Interest Rate View
27 May 2006 - Henderson Global Investors - Why Technology
10 May 2006 - Aberdeen - India Update
10 May 2006 - Aberdeen - China HongKong Update
10 May 2006 - Aberdeen - Singapore Update
8 May 2006 - Aberdeen - Emerging Markets Weekly
8 May 2006 - Aberdeen - Asian Weekly
5 May 2006 - First State - First State Global Resources Fund Update
5 May 2006 - Henderson - Henderson Asia Pacific Property Equities Fund Final Brochure (12 pages)(1.5mb)
5 May 2006 - Henderson - Henderson Asia Pacific Property Equities Fund Placemat
5 May 2006 - Prudential - Prudential Asset Management is consumer's choice for most trusted brand
Sunday, May 21, 2006
We shall see whether SPX can hold 1230. I believe a break below that may herald the start of a down trend. but seriously, i think it has more to climb.
Finally, the hui looks the most scary prospect. Will it retest the lows of 250-260 or is this a pullback to move up to a higher high? We will find that out next week.
Unit Trusts and Exchange Traded Funds Part 4 : Performance of Emerging Market Equity Funds vs ETFs
The Problem With Vanguard VIPERs ETFs
I must admit that I recently became excited about the waxing competition in the ETF manufacturing business, writes Herb Morgan, President and Chief Investment Officer of Efficient Market Advisors, LLC. Barclays still has the lion’s share of the market for sure, but Vanguard has recently caught my eye. After all, Vanguard has a reputation for doing things right: low fees, honesty, and generally serving as a watchdog in a historically slick industry. But from what I can tell, it looks like the good guys are trying to pull one over on us this time.
As a money manager, I am constantly looking at data trying to find statistical relevance for asset classes which could justify their inclusion in my managed portfolios. While looking at Emerging Markets (which did not make the portfolio) I came across some information on the Vanguard VIPERs that surprised me. Vanguard decided to make their ETFs a share class of their existing open end index funds.
Why would they do this rather than file for a new fund?
The open end Vanguard Emerging Markets Stock Index Fund (VEIEX), with about $4.5 billion in assets, has unrealized capital gains of $4.41 per share on a $16.91 share price. This equates to an untapped capital gain of $1.2 billion dollars. Along comes the new share class Vanguard Emerging Markets VIPERs (VWO) which have raised just under $200 million in assets. Guess what? Anybody buying Vanguard ETFs may be buying a tax liability they had not planned on. The end result is a redistribution of not-yet-realized tax liability from open end fund holders to ETF holders. This may be one reason the Vanguard ETF’s have not seen as much success as some of the other players.
To be fair, index funds have a long tradition of having positive cash inflows into the funds, which serves to dilute capital gains to the remaining investors. Turnover is also very low, which means they probably won’t voluntarily expose investors to these gains. However, Vanguard has no control over flows into and out of their funds and anything can and does happen from time to time. If VEIEX were to experience significant net redemptions, the fund would be forced to sell securities and realize capital gains. ETF investors would get their share of these gains along with the traditional open end fund shareholders. What’s more, these gains would accrete to the remaining shareholders at the end of the year. While not highly likely, if the open end fund experiences substantial redemptions the remaining shareholders could well be stuck with a liability even greater than the $4.41 per share.
ETFs have multiple advantages over open end funds, one of which is the tax advantage gained by the funds unique creation and redemption process. Vanguard should have left well enough alone and stuck with the traditional ETF format.
Herb Morgan is President and Chief Investment Officer of Efficient Market Advisors, LLC, a Registered Investment Advisor located in San Diego, California.Prior to founding EMA Mr. Morgan was Sr. Vice President of Advisory Services for LPL Financial, the nation’s largest independent broker dealer where he was responsible for the firms $25 Billion dollar investment advisory business. Mr. Morgan spent time as a Senior Vice President with Pilgrim Funds (Now ING), and Dreyfus Funds. He also held positions with J&W Seligman and Dean Witter Reynolds. (Now Morgan Stanley) Mr. Morgan is one of the nation’s premier experts in the investment and brokerage industry. He can be reached at herb [at] efficient-portfolios.com.
I will be looking into this area. I am quite swayed into the idea of having an emerging mkt ETF rather than a unit trust. Some ideas for my thought process.
- Do I really require an eastern europe fund?
- Cost over exposure?
- Unit Trust vs ETFs: Which is more practical and efficient?
- Performance of emerging mkt managers over indexes
- Vanguard Emerging Vipers (VWO) vs iShares MSCI Emerging Mkt
Saturday, May 20, 2006
AEI Corp - Engineering of aluminium extruded products
Electrotech - European mechatronics and engineering
Elec - Mass production of HDI,microvia backplanes, high-end servers and up to 36 layer PCB
all three has taken abit of a beating during the recent correction. This may have presented a wonderful opportunity to get in.
except for Electrotech, all of them have yields in excess of 6%. electrotech is no slouch either at 5.36%
Below shows some key figures:
Judging from the above, it would seem that though AEI and Electrotech do provide reasonable high yields, they do not have the same payout history and sustainability as Elec.
However, i am quite particular about the negative free cashflow of Elec. with that kind of capital expenditure we would expect them to cut back their dividend. however they did not. I'm still thinking whether its a good move to do that or not.
I am leaning more towards Electrotech. Their free cashflow yield looks more sustainable and they are building its cash holding better than the other 2. However, this is only a screen of their balance sheet, much work has to be done to investigate the outlook for these 3 companies.
Some have mentioned some good stocks to have during this Great singapore sale. I look at it in 2 ways.
1) we have some pretty resilent second line counters.
2) we have some yielders who have dropped abit.
I must draw caution as to whether this is a good time to be vested in one of these. The best way to invest is to imagine that your capital can only buy one stock and which stock would it be.
I hope i can do some work today and find some really good ones.
Friday, May 19, 2006
It is not always that you read an article that touches some where close in the heart. I guess this article is one of them.
The article is written by Richard Russell. John Mauldin wrote a intro to this article:
What can one say about my friend Richard Russell without using a lot of superlatives? Richard has been writing and publishing the Dow Theory Letters since 1958, and never has he missed an issue! It is the longest newsletter service continuously published by one person in the investment business. Richard is now 80 years old, and writes an extremely popular daily e-letter, full of commentary on the markets and whatever interests him that day. He gets up at 3 am or so and starts his daily (massive) reading and finishes the letter just after the markets close. He is my business hero.
He was the first writer to recommend gold stocks in 1960. He called the top of the 1949-66 bull market, and called the bottom of the bear market in 1974 almost to the day, predicting a new bull market. (Think how tough it was to call for a bull market in late 1974, when things looked really miserable!) He was a bombardier in WWII, lived through the Depression, wars, and bull and bear markets. I would say that Russell is one of those true innate market geniuses that have simply forgotten more than most of us will ever know, except I am not certain he has forgotten anything. His daily letter is loaded with references and wisdom from the past and gives us a guide to the future. (You can learn more - and subscribe! - at www.dowtheoryletters.com .)
When I asked Richard to contribute an article, I wanted his wisdom more than his actual market theory, and that is what he has given us. You (and your kids!) should read this again and again! Richard lives in La Jolla with his wife Faye.
Rich Man, Poor Man
By Richard Russell
Making money entails a lot more than predicting which way the stock or bond markets are heading or trying to figure which stock or fund will double over the next few years. For the great majority of investors, making money requires a plan, self-discipline, and desire. I say "for the great majority of people," because if you're a Steven Spielberg or a Bill Gates you don't have to know about the Dow or the markets or about yields or price/earnings ratios. You're a phenomenon in your own field, and you're going to make big money as a by-product of your talent and ability. But this kind of genius is rare.
For the average investor, you and me, we're not geniuses so we have to have a financial plan. In view of this, I offer below a few rules and a few thoughts on investing that we must be aware of if we are serious about making money.
I. The Power of Compounding
Rule 1: Compounding. One of the most important lessons for living in the modern world is that to survive you've got to have money. But to live (survive) happily, you must have love, health (mental and physical), freedom, intellectual stimulation -- and money. When I taught my kids about money, the first thing I taught them was the use of the "money bible." What's the money bible? Simple, it's a volume of the compounding interest tables.
Compounding is the royal road to riches. Compounding is the safe road, the sure road, and fortunately anybody can do it. To compound successfully you need the following: perseverance in order to keep you firmly on the savings path. You need intelligence in order to understand what you are doing and why. You need knowledge of the mathematical tables in order to comprehend the amazing rewards that will come to you if you faithfully follow the compounding road. And, of course, you need time, time to allow the power of compounding to work for you. Remember, compounding only works through time.
But there are two catches in the compounding process. The first is obvious -- compounding may involve sacrifice (you can't spend it and still save it). Second, compounding is boring -- b-o-r-i-n-g. Or I should say it's boring until (after seven or eight years) the money starts to pour in. Then, believe me, compounding becomes very interesting. In fact, it becomes downright fascinating!
In order to emphasize the power of compounding, I am including the following extraordinary study, courtesy of Market Logic, of Ft. Lauderdale, FL 33306.
In this study we assume that investor B opens an IRA at age 19. For seven consecutive periods he puts $2,000 into his IRA at an average growth rate of 10% (7% interest plus growth). After seven years this fellow makes NO MORE contributions -- he's finished.
A second investor, A, makes no contributions until age 26 (this is the age when investor B was finished with his contributions). Then A continues faithfully to contribute $2,000 every year until he's 65 (at the same theoretical 10% rate).
Now study the incredible results. B, who made his contributions earlier and who made only seven contributions, ends up with MORE money than A, who made 40 contributions but at a LATER TIME. The difference in the two is that B had seven more early years of compounding than A. Those seven early years were worth more than all of A's 33 additional contributions.
This is a study that I suggest you show to your kids. It's a study I've lived by, and I can tell you, "It works." You can work your compounding with muni-bonds, with a good money market fund, with T-bills, or say with five-year T-notes.
Rule 2: Don't Lose Money. This may sound naive, but believe me it isn't. If you want to be wealthy, you must not lose money; or I should say, you must not lose BIG money. Absurd rule, silly rule? Maybe, but MOST PEOPLE LOSE MONEY in disastrous investments, gambling, rotten business deals, greed, poor timing. Yes, after almost five decades of investing and talking to investors, I can tell you that most people definitely DO lose money, lose big-time -- in the stock market, in options and futures, in real estate, in bad loans, in mindless gambling, and in their own businesses.
Rule 3: Rich Man, Poor Man. In the investment world the wealthy investor has one major advantage over the little guy, the stock market amateur, and the neophyte trader. The advantage that the wealthy investor enjoys is that HE DOESN'T NEED THE MARKETS. I can't begin to tell you what a difference that makes, both in one's mental attitude and in the way one actually handles one's money.
The wealthy investor doesn't need the markets, because he already has all the income he needs. He has money coming in via bonds, T-bills, money-market funds, stocks, and real estate. In other words, the wealthy investor never feels pressured to "make money" in the market.
The wealthy investor tends to be an expert on values. When bonds are cheap and bond yields are irresistibly high, he buys bonds. When stocks are on the bargain table and stock yields are attractive, he buys stocks. When real estate is a great value, he buys real estate. When great art or fine jewelry or gold is on the "giveaway" table, he buys art or diamonds or gold. In other words, the wealthy investor puts his money where the great values are.
And if no outstanding values are available, the wealthy investors waits. He can afford to wait. He has money coming in daily, weekly, monthly. The wealthy investor knows what he is looking for, and he doesn't mind waiting months or even years for his next investment (they call that patience).
But what about the little guy? This fellow always feels pressured to "make money." And in return he's always pressuring the market to "do something" for him. But sadly, the market isn't interested. When the little guy isn't buying stocks offering 1% or 2% yields, he's off to Las Vegas or Atlantic City trying to beat the house at roulette. Or he's spending 20 bucks a week on lottery tickets, or he's "investing" in some crackpot scheme that his neighbor told him about (in strictest confidence, of course).
And because the little guy is trying to force the market to do something for him, he's a guaranteed loser. The little guy doesn't understand values, so he constantly overpays. He doesn't comprehend the power of compounding, and he doesn't understand money. He's never heard the adage, "He who understands interest, earns it. He who doesn't understand interest, pays it." The little guy is the typical American, and he's deeply in debt.
The little guy is in hock up to his ears. As a result, he's always sweating -- sweating to make payments on his house, his refrigerator, his car, or his lawn mower. He's impatient, and he feels perpetually put upon. He tells himself that he has to make money -- fast. And he dreams of those "big, juicy mega-bucks." In the end, the little guy wastes his money in the market, or he loses his money gambling, or he dribbles it away on senseless schemes. In short, this "money-nerd" spends his life dashing up the financial down escalator.
But here's the ironic part of it. If, from the beginning, the little guy had adopted a strict policy of never spending more than he made, if he had taken his extra savings and compounded it in intelligent, income-producing securities, then in due time he'd have money coming in daily, weekly, monthly, just like the rich man. The little guy would have become a financial winner, instead of a pathetic loser.
Rule 4: Values. The only time the average investor should stray outside the basic compounding system is when a given market offers outstanding value. I judge an investment to be a great value when it offers (a) safety, (b) an attractive return, and (c) a good chance of appreciating in price. At all other times, the compounding route is safer and probably a lot more profitable, at least in the long run.
TIME: Here's something they won't tell you at your local brokerage office or in the "How to Beat the Market" books. All investing and speculation is basically an exercise in attempting to beat time.
"Russell, what are you talking about?"
Just what I said -- when you try to pick the winning stock or when you try to sell out near the top of a bull market or when you try in-and-out trading, you may not realize it but what you're doing is trying to beat time.
Time is the single most valuable asset you can ever have in your investment arsenal. The problem is that none of us has enough of it.
But let's indulge in a bit of fantasy. Let's say you have 200 years to live, 200 years in which to invest. Here's what you could do. You could buy $20,000 worth of municipal bonds yielding, say, 5.5%.
At 5.5% money doubles in 13 years. So here's your plan: each time your money doubles you add another $10,000. So at the end of 13 years you have $40,000 plus the $10,000 you've added, meaning that at the end of 13 years you have $50,000.
At the end of the next 13 years you have $100,000, you add $10,000, and then you have $110,000. You reinvest it all in 5.5% munis, and at the end of the next 13 years you have $220,000 and you add $10,000, making it $230,000.
At the end of the next 13 years you have $460,000 and you add $10,000, making it $470,000.
In 200 years there are 15.3 doubles. You do the math. By the end of the 200th year you wouldn't know what to do with all your money. It would be coming out of your ears. And all with minimum risk.
So with enough time, you would be rich -- guaranteed. You wouldn't have to waste any time picking the right stock or the right group or the right mutual fund. You would just compound your way to riches, using your greatest asset: time.
There's only one problem: in the real world you're not going to live 200 years. But if you start young enough or if you start your kids early, you or they might have anywhere from 30 to 60 years of time ahead of you.
Because most people have run out of time, they spend endless hours and nervous energy trying to beat time, which, by the way, is really what investing is all about. Pick a stock that advances from 3 to 100, and if you've put enough money in that stock you'll have beaten time. Or join a company that gives you a million options, and your option moves up from 3 to 25 and again you've beaten time.
How about this real example of beating time. John Walter joined AT&T, but after nine short months he was out of a job. The complaint was that Walter "lacked intellectual leadership." Walter got $26 million for that little stint in a severance package. That's what you call really beating time. Of course, a few of us might have another word for it -- and for AT&T.
HOPE: It's human nature to be optimistic. It's human nature to hope. Furthermore, hope is a component of a healthy state of mind. Hope is the opposite of negativity. Negativity in life can lead to anger, disappointment, and depression. After all, if the world is a negative place, what's the point of living in it? To be negative is to be anti-life.
Ironically, it doesn't work that way in the stock market. In the stock market hope is a hindrence, not a help. Once you take a position in a stock, you obviously want that stock to advance. But if the stock you bought is a real value, and you bought it right, you should be content to sit with that stock in the knowledge that over time its value will out without your help, without your hoping.
So in the case of this stock, you have value on your side -- and all you need is patience. In the end, your patience will pay off with a higher price for your stock. Hope shouldn't play any part in this process. You don't need hope, because you bought the stock when it was a great value, and you bought it at the right time.
Any time you find yourself hoping in this business, the odds are that you are on the wrong path -- or that you did something stupid that should be corrected.
Unfortunately, hope is a money-loser in the investment business. This is counterintuitive but true. Hope will keep you riding a stock that is headed down. Hope will keep you from taking a small loss and, instead, allow that small loss to develop into a large loss.
In the stock market hope gets in the way of reality, hope gets in the way of common sense. One of the first rules in investing is "don't take the big loss." In order to do that, you've got to be willing to take a small loss.
If the stock market turns bearish, and you're staying put with your whole position, and you're HOPING that what you see is not really happening -- then welcome to poverty city. In this situation, all your hoping isn't going to save you or make you a penny. In fact, in this situation hope is the devil that bids you to sit -- while your portfolio of stocks goes down the drain.
In the investing business my suggestion is that you avoid hope. Forget the siren, hope; instead, embrace cold, clear reality.
ACTING: A few days ago a young subscriber asked me, "Russell, you've been dealing with the markets since the late 1940s. This is a strange question, but what is the most important lesson you've learned in all that time?"
I didn't have to think too long. I told him, "The most important lesson I've learned comes from something Freud said. He said, 'Thinking is rehearsing.' What Freud meant was that thinking is no substitute for acting. In this world, in investing, in any field, there is no substitute for taking action."
This brings up another story which illustrates the same theme. J.P. Morgan was "Master of the Universe" back in the 1920s. One day a young man came up to Morgan and said, "Mr. Morgan, I'm sorry to bother you, but I own some stocks that have been acting poorly, and I'm very anxious about these stocks. In fact worrying about those stocks is starting to ruin my health. Yet, I still like the stocks. It's a terrible dilemma. What do you think I should do, sir?"
Without hesitating Morgan said, "Young man, sell to the sleeping point."
The lesson is the same. There's no substitute for acting. In the business of investing or the business of life, thinking is not going to do it for you. Thinking is just rehearsing. You must learn to act.
That's the single most important lesson that I've learned in this business.
Again, and I've written about this episode before, a very wealthy and successful investor once said to me, "Russell, do you know why stockbrokers never become rich in this business?"
I confessed that I didn't know. He explained, "They don't get rich because they never believe their own bullshit."
Again, it's the same lesson. If you want to make money (or get rich) in a bull market, thinking and talking isn't going to do it. You've got to buy stocks. Brokers never do that. Do you know one broker who has?
A painful lesson: Back in 1991 when we had a perfect opportunity, we could have ended Saddam Hussein's career, and we could have done it with ease. But those in command, for political reasons, didn't want to face the adverse publicity of taking additional US casualties. So we stopped short, and Saddam was home free. We were afraid to act. And now we're dealing with that failure to act with another and messier war.
In my own life many of the mistakes I've made have come because I forgot or ignored the "acting lesson." Thinking is rehearsing, and I was rehearsing instead of acting. Bad marriages, bad investments, lost opportunities, bad business decisions -- all made worse because we fail for any number of reasons to act.
The reasons to act are almost always better than the reasons you can think up not to act. If you, my dear readers, can understand the meaning of what is expressed in this one sentence, then believe me, you've learned a most valuable lesson. It's a lesson that has saved my life many times. And I mean literally, it's a lesson that has saved my life.
Thursday, May 18, 2006
I would like to proceed with caution, knowing that many of what i have chosen in the past turned out to be lamers.
My screens for yield stocks has been naive at times. The yield stocks that i used to choose were stocks that give high dividend, but low promises of growth. That is normally what people expect from yield stocks, but as i come to realise, you can't really afford to have a full portfolio of stocks that pays out 100% of their dividends. By giving a full payout, growth might be compromised. The stocks that i should choose is a balanced between the 2.
Therefore i gather there are few things primarily that i should consider:
- Economics of business/Branding
- Operating cash flow nature
- Cash position relative to total assets
- Debt outlook / Gearing
- Free Cashflow Yield / Conservative free cashflow yield
- Improving dividend
- Maintaining and improving profit margin
- Interest coverage
- Dividend Payout ratio
- Past dividend history
- PE / NTA > share price
I will initiate my position:
- RSI < 30
- MCAD < 0
- After Ex Div
Tuesday, May 16, 2006
The worst hit were the big capped blue chips. Together they brought the index down 3 percent in the biggest one day decline in years.
I see quite alot of shouting over at SGFunds to take this opportunity to buy. I wonder how many of us are able to do that. Every one has an innate risk profile, one that you might not even know abt. Ask yourself if you are rolling in bed last night. If you are, it may mean that what you have do not match ur risk profile. It may be time to re-evaluate ur investments so that you can sleep better at night.
Sunday, May 14, 2006
Other than fixed deposit rates, one can gather information on credit cards, savings rates and loans as well.
Posted below are the latest rates for fixed deposit below and above the 50K mark.
disclaimer: The rates listed below may not be the latest rates. It can only be used as a guide. Please check with ur respective banks regarding the latest rates and any tie ins.
Thursday, May 04, 2006
P.S.: to a great colleague of mine: some of the hard work won't be found in banks or IFAs, its always those that are closer that will be much more dependable lol..
Tuesday, May 02, 2006
Why Buffett is buying utilities
The industry is consolidating, and a utility with low-cost financing is going to make a lot of money. Here are three stocks that will benefit and four more worth a look.
By Jim Jubak
On May 24, Warren Buffett bought an electric utility. Should you?
Buffett will pay $5.1 billion to buy PacifiCorp from Scottish Power (SPI, news, msgs). That's about an eighth of the more than $40 billion that Berkshire Hathaway (BRK.A, news, msgs) had in cash at the end of March. And the deal to acquire the provider of electricity to 1.6 million customers in the Pacific Northwest is the biggest for Berkshire Hathaway in the last eight years. When the deal was announced, Buffett said Berkshire Hathaway would be looking for more utility acquisitions.
All in all, it adds up to a pretty hefty endorsement of the electric utility industry from a legendary value investor. Which, of course, takes us back to my first question: If Warren Buffett is buying electric utility stocks, shouldn't you?
At first glance, this seems like an odd time for a value investor such as Buffett to invest in utilities. The Dow Jones Utility Index ($UTIL) has returned 11.5% so far in 2005 (as of June 1) after huge total returns of 25.4% in 2004 and 24% in 2003. Stocks such as AES (AES, news, msgs), up 9.15% in 2005 after returning 44.7% in 2004, American Electric Power (AEP, news, msgs), up 7.8% in 2005 after returning 17.4% in 2004, and Duke Energy (DUK, news, msgs) up 12.94% in 2005 after returning 23.8% in 2004, seem closer to the end of their runs than the beginning.
So why does Buffett think utilities are a good buy now? The answer lies in the long- and short-term potential for electric utilities.
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The long-term view: Consolidation builds profits
U.S. utilities are in the early stages of a long-term consolidation. Midsized utilities are buying small utilities, and big utilities are buying midsized players.
Right now, there's a mismatch in how the industry is structured. There are thousands of local companies that deliver electricity to their customers. Then, there are regional wholesale electricity markets dominated by a handful of efficient, large-scale electricity producers. The wholesale markets have emerged because local companies can often buy power from others for far less than the cost of generating it themselves. At the same time, some utilities have developed cost advantages that have turned generating and peddling excess electricity to other utilities into very profitable businesses.
The wholesale markets aren't going away -- in fact, they're gaining in importance. But they are undergoing a subtle transformation. The big low-cost producers aren't content with the profits that come from selling their electricity at wholesale prices. They'd like to capture more of the cash flow by eliminating the local utilities. Why sell bulk power to another utility if you can sell electricity at retail to the company's local customers? Since the electricity business is composed of regulated monopolies, the only way to be able to sell directly to the end users is to buy up the local companies -- lock, stock and customers.
That's exactly what's been going on in recent years. In 2000, American Electric Power bought Central & South West to create the country's biggest utility. Duke Energy plans to merge with Cinergy (CIN, news, msgs), and Exelon (EXC, news, msgs) has proposed the acquisition of Public Service Enterprise Group (PEG, news, msgs).
There's many a slip between projected and real cost savings, as investors know all too well. Even so, when Exelon talks about getting $400 million in cost savings in the first year of the merger by eliminating redundant operations at Public Service Enterprise -- equal to about 4% of PEG's annual revenue -- it's enough to get my attention.
Just one problem, though. There's this inconvenient law left over from the Great Depression when utilities did nasty things like water their stock and play "hide-the-assets" among related shell companies. Called the Public Utility Holding Company Act, the law prohibits nonutility companies, such as Berkshire Hathaway, from directly controlling retail electricity suppliers. The law also requires that utilities (if both are U.S. utilities) must be physically connected in order to merge. It's that latter requirement that led a Securities and Exchange Commission hearing judge to rule in early May that the American Electric Power-Central & South West merger violated the 1935 law. AEP's service area nowhere touched the Texas service area of Central & South West.
For a patient investor like Buffett, though, this is exactly the time to strike. The long-term consolidation trend is gathering speed, and efforts to repeal the 1935 law are making headway in Congress. The energy bill passed by the Senate Energy and Natural Resources Committee on May 26 would allow the large-scale utility mergers now prohibited. Passing a committee, however, isn't the same as getting through the full Senate and the House of Representatives, but the attempts to amend the Public Utility Holding Company Act will bear fruit one of these years.
It's quite possible, however, that Buffett may not have to wait even for that. Technically, Berkshire Hathaway isn't PacifiCorp's buyer. The formal buyer is Berkshire's 80%-owned MidAmerican Energy Holdings.
So, the deal works around the law's ban on nonutility companies owning retail electricity suppliers. (I should add the word "probably" here. This is an exceedingly convoluted area of the law.) Not only does Berkshire Hathaway own 80% of MidAmerican, based in Des Moines, Iowa, but Berkshire can only vote 9.9% of its shares.
The deal may also meet the requirement that the merging utilities be physically connected, since MidAmerican's transmission grid includes South Dakota, which is adjacent to PacifiCorp's grid in Wyoming.
(Of course, exactly what the 1935 act means by "physically connected" is a matter of legal interpretation. The two utilities are located in different regions of the national electricity grid -- what are called interconnects. It is, in fact, quite possible that this means the two aren't connected even if they do business in adjacent states.)
Three potential winners from consolidation
To profit from this consolidation over the long haul, I'd look for utilities with the ability to generate and transmit lower-cost bulk electricity. Three I like are Duke Energy, American Electric Power, and FPL Group (FPL, news, msgs).
* Duke Energy's merger with Cinergy eventually will create a utility with almost 4 million electricity customers and about 16,000 megawatts of unregulated generating capacity for the wholesale market.
* American Electric Power's position in the middle of the country and next to the Appalachian coal fields makes it a natural for expansion as the industry consolidates.
* FPL, formerly Florida Power & Light, is the industry's leader in wind-power generation. Wind power is a source of electricity that will gain a cost edge if oil and natural gas prices continue to rise. And it works well in combination with fuel sources with different patterns of peak electricity generation.
Cheaper capital equals bigger profits
Berkshire Hathaway has the one thing that every utility CEO dreams of: piles and piles of low-cost capital. One big reason that Scottish Power sold PacifiCorp was that the company needed to invest a minimum of $1 billion over the next five years to improve reliability in its service area. Some estimates run as high as $5 billion.
The profitability of that kind of investment, when the return that you earn on your investment is set by state regulators in your service area, hinges on what the company pays for the money it invests. Thanks to Berkshire Hathaway's insurance business, the company generates a flood of cash internally and enjoys access to the capital markets at extremely low rates. Also, since Berkshire Hathaway doesn't require units like MidAmerican Energy to pay a dividend to the parent company, MidAmerican will be able to put all of its own internal cash to use. So, in my opinion, MidAmerican should earn a bigger profit on its investment in the PacifiCorp system than Scottish Power could hope for.
And let's not forget the advantage that Buffett gets from taking on $4.3 billion in PacifiCorp debt. Think that it's just possible that MidAmerican Energy will be able to lower the interest cost on that debt thanks to its access to cheaper capital?
4 companies that can win with low-cost capital
So, how to profit from the short-term view of this deal? Look for capital-strapped utilities with lots of customers. A plus would be a credit rating low enough to be easily improved and/or sizeable debt that would let an acquirer quickly reduce interest costs. If the target utility owns assets such as coal mines or fiber-optic networks, so much the better. Utilities to research, in my opinion, include TXU (TXU, news, msgs), TECO Energy (TE, news, msgs), Pepco Holdings (POM, news, msgs), and Sierra Pacific Resources (SRP, news, msgs).
Of course, any decision to invest in utility stocks -- which, because of their high dividend yields, tend to rise and fall with interest rates -- requires that you consider where U.S. interest rates are headed. Utility stocks shine when interest rates are falling or are already low and stuck at low levels.
So, in my next column I'll tell you why the "no" vote on a new constitution for the European Union in France and the Netherlands means that lower U.S. interest rates will be with us for a while.
New developments on past columns
6 winners for tech's hard times
Everything seems to be falling into place for Yahoo! (YHOO, news, msgs). On April 19, the company reported first-quarter earnings two cents a share above Wall Street expectations. In the conference call, Yahoo! raised its guidance on revenue for the year to a range of $3.546 billion to $3.71 billion from the previous guidance of $3.5 billion. Since then, the company has introduced new product after new product: in-store (in partnership with Target (TGT, news, msgs) photo-prints delivery, built-in Yahoo! e-mail on Nokia (NOK, news, msgs) handsets, and video search. That's all led to a revival of momentum in the shares -- critical for investors hoping that this stock will strongly participate in the current technology rally. Relative strength (a measure of Yahoo!'s price performance versus that of all other shares on the market) has jumped to 94 in the last three months from 52 in the last six months. Our StockScouter rating for the shares has moved up to a current 8 out of a possible 10 from 6 just 90 days ago. Wall Street analysts raised their estimates for 2005 earnings per share to 57 cents from 52 cents 60 days ago. Yahoo! is set to report second-quarter earnings on July 19 and the shares are likely to follow their historical pattern of running up into the earnings report. As of June 3, I'm leaving my target price at $45 by July 2005. (Full disclosure: I own shares of Yahoo!.)
5 stocks that could soar if rates stay low
Sometimes Wall Street gets more than a little ahead of itself. That's exactly what happened to shares of Engineered Support System (EASI, news, msgs) on June 1. The stock dropped more than $3 a share after the company lowered earnings guidance for 2005 by 9 cents a share or about 4.5%. (The company actually raised revenue guidance for the year by about $50 million.) The punishment was so severe because going into the earnings announcement, several Wall Street analysts had projected that Engineered Support Systems would actually raise guidance. The problem seems to be with production delays and performance issues in a single military program, the deployable power generation and distribution system. Fixing the problems has pushed out full production and added costs that took about 7 cents a share -- accounting for most of the decrease in earnings guidance for 2005 -- out of earnings for the quarter that ended in April 2005. I think the recent quarterly miss is a one-time problem well within the power of management to fix on the schedule that the company has outlined. As of June 2, I'm keeping my target price at $45 a share but moving the timeline to October 2005 from September. (Full disclosure: I own shares of Engineered Support Systems.)
Editor's Note: A new Jubak’s Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at email@example.com.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: American Electric Power, Engineered Support System and Yahoo!. He doesn't own short positions in any stock mentioned in this column
Its always nice to see some of your favorite stocks trend lower. That is the case for some of the stocks taht i am looking at right now. ElectroTech has retreated from its high of 0.63.Good entry point now that MCAD and RSI weakening, but i feel its better to stay in cash for the near future. The market risk is high enough to warrant such a defensive position. One needs to learn to be more patient, knowing that in time a much more favorable scenario will unfold.