Blessed by the Potato

I’ll jump on the active vs. passive investing posting spree. To sum up for those that don’t follow a hundred other blogs, there was something negative said about passive investing, in particular that it shouldn’t be attempted in a bear/sideways market. Well, how do we know we’re in a bear/sideways market? Passive investing is, IMHO, still a great choice then, as making that call on market direction is too difficult for most of us to even attempt (not that that stops us). So, good counters by Canadian Capitalist and Michael James.

I’m a bit torn on the whole matter myself. For one thing, I’m not entirely an active or passive investor, having my portfolio split into the active half and the passive half (though the halves aren’t quite equal, with the larger half belonging to the active part).

I completely see the logic of passive investing for the average person, and that’s all I recommend to people who ask what to do with their money. For the majority of people out there it is the right way to go: control your fees, be happy with “average” (though indeed, one can do better than the average investor with a passive approach), use your time to live your life. Or to put it another way, play to not make any errors.

But at some level 1) I think that superior returns can be attained (e.g.: the superinvestors of Graham-and-Doddsville) and 2) I don’t think that I am average, helped in part by 3) the fact that my dad is an active investor who has out-performed. The average investor/mutual fund has a short time horizon, lack of patience, chases returns, trades too much, over-values growth, under-values strong balance sheets, and is emotional. So I don’t think it’s a wonder that the average investor actually underperforms a passive portfolio, and moreover, I think that even a diversified passive portfolio can be improved upon. The problem of course is the Lake Wobegone effect: the average investor believes they are above average, and then makes mistakes that leads to underperformance.

There’s a tough line to walk there: value investors can and do underperform for long periods of time while waiting for the voting machine to turn into a weighing machine, so I want to be patient and stay the course if I have confidence in my analysis even when the market moves against me. But, I don’t want to brush away a lack of skill as a temporary underperformance. So I’ve created a set of rules for myself I call Potato’s Valve:

The money flow for the passive portfolio is like a one-way valve: money only goes in (until retirement). It gets first crack at new savings to at least make the registered account contributions.

The active portfolio started with most of my previous life savings, and can get a portion of ongoing savings as long as it’s performing. When out-performance stops (as it did in the first half of this year) the valve gets turned off and new savings go exclusively to the passive portfolio.

That protects me against the hubris of continuing to think I’m above-average when the evidence says otherwise. The passive portfolio will continue to grow and will be there in the background, a cushion when I fall down, and only a tiny drag if I do make it big. Since I’m still young and very much in the savings/accumulation phase of my investing career, my future contributions will be more than my current portfolio size, so even if I under-perform with my active portfolio (or even blow it up!) it won’t totally kill me, as long as I eventually put most of my assets into a passive portfolio that does work. Potato’s Valve should keep me investing in what has the best chance of giving me good returns in the future: my active portfolio if that continues to do well, or the passive if it doesn’t (assuming that active investing has any kind of chance — if it doesn’t, the valve will keep me from chasing that for very long with very much capital) while protecting me from myself.

Part of this comes back to what Michael James mentioned in the comments: an active investor has to pick a benchmark and compare how well they’re doing, and have some idea of what poor performance is. It makes no sense to spend the time doing active investing just to get a poorer result than you could get with a diversified passive portfolio, and not even know it! More to the point: if you can’t track your own past investment performance, what chance do you have of projecting the performance of companies in the future?

[Yes, this is the first time I’ve ever call that rule that, but I figure with a dumb name it might catch on]

Was just at Canadian Tire and saw all the back-to-school stuff out for sale, and realized that this is the first time I won’t be going back to school in September! :(

A member of the Church of The Flying Spaghetti Monster — a competing “fake” religion to the true quasi-religion of Potatoism — has won the right to wear a holy collander in his ID photos.

Some Prius owners sell their used cars for a profit, hopefully putting to rest for good the belief that hybrids are somehow doomed to face higher depreciation.

Michael James comments on cap-weighting vs. fundamental weighting. I wonder not only if fundamental indexing can provide enough return to cover the costs, but also if they’re not trading one problem for another. One example of the problems with cap weighting is that when you get big bubbly stocks like Nortel back in the day, those stocks end up taking up huge proportions of a cap-weighted index, and the more over-valued those companies get, the bigger their share in the index! But that problem of lack of diversification doesn’t seem to be fixed by fundamental weighting from a 1-minute look at the two indexes: instead of having giant stocks, now we have giant sectors, with the fundamental index putting a 45% weight on financials, when the cap-weighted index was already a pretty hefty 30%.

Scott Adams puts out some quasi-serious ways for the US to get out of its budget crisis. For the carpool lane one, that’s actually a pretty good idea. Thanks to an experiment with hybrid cars, we know that being able to travel solo in carpool lanes is actually a valuable feature some people are willing to pay money for. You see, at one point LA (among other cities) gave a special sticker to hybrids to allow them to use the carpool lanes, as an incentive to get people to drive cleaner cars. Then, the quota for that program was hit and they stopped giving out the stickers. But the stickers were good for a few years and most importantly transferable, so what you saw happen is that cars with HOV stickers went for a premium over comparable cars — a few thousand dollars, perhaps as much as $4k. And that’s just for a few years of HOV access. So maybe there’s a group of people out there willing to pay on the neighbourhood of $1k/year to get solo HOV access, let’s ballpark it at 1% of a metro area’s population. Across a few major cities, that could hit a billion in tax revenue. Yes, a drop in the bucket for the problems facing the US budget, but a start. [And also, perhaps at the wrong level of government]

One of the Ford annoyances in Toronto commented on closing libraries, saying “And my constituents, it wouldn’t bother them because they have another library two miles one way and two miles the other way.” I’m all for eliminating waste in the city budget, but I’ve got a soft spot for libraries (and not only because Wayfare’s a librarian). Being no more than “two miles” (3.2 km) is about right — his ward is only about 6 km across, so assuming there are at least two libraries in it, that’s not far off. But 3 km is a long way to be from a library. Remember that the biggest users of libraries are not driving: the poor, the young, and I guess the cheap. Toronto has 99 libraries. Is that too many? It’s tough to say, but Toronto has 625 elementary schools (public, catholic, french catholic — not counting other private ones) and 135 high schools. Approximately one library branch per high school sounds about right to me. I’ll also just quickly say that the branches are more than just a place to check out books, so they are important to maintain, and maintain throughout the city.

I heard again recently the bit of reassuring spin from CMHC that they’re totally cool because the average equity of their mortgage portfolio is 45%. And note that that includes equity gained by price appreciation. To me, that average is nearly meaningless because it doesn’t break it down regionally, or bin it by equity. The defaults occur at the margin, and if the distribution of equity/LTV is large, then there will be plenty of people put underwater by even a modest correction that trouble will follow. Just for a point of comparison I tried to look up what a similar figure from the US would have been and found that in 2007, Fannie Mae’s average equity of the mortgage portfolio was 41%. That does not make me feel reassured that things are that much better here in the great white north, land of the conservative banks. I’d do a post on the “Canadian Moral Hazard Corporation” except it’s been done (with that exact title in several places). Maybe I’ll dig into Genworth later in the summer if I find some time (that one I can at least short if it comes up particularly spotty).

“Environment Canada now even has media officers in Ottawa tape-recording the interviews scientists are allowed to give.” Oh! I think I found where we can cut back on the budget!

Corning reported results and it was pretty much what I expected: display glass is facing troubles, but the company is expanding its other business lines to (partially) compensate. Given the price it looks like the display issues may be priced in, and allow for some upside if/when the other business lines grow enough to be meaningful. Still no position, but with it under $16 I’m becoming more interested, and have put in a bid at $15; let’s see what happens.

Cool random thing I learned: Saturn has two moons that share an orbit: Janus and Epimetheus.

I’ve seen OSG mentioned twice on BNN now as a value play and decided to have a look myself.

Briefly, it’s a tanker company transporting largely oil and LNG. There’s currently an over-supply of tankers in the world, with still more in the process of being built (due to orders placed years ago), so the rates tankers can charge are way down. OSG lost a lot of money last year as a result.

They continue to pay a high dividend (despite losing money) indicating either that management believes things will turn around, or that management is not being conservative. In reading commentary I have seen that this is supposed to be a cyclical industry, but looking back 10 years I only see one (small) negative year, so I don’t know what to expect in terms of the earnings improving. Assuming that it is cyclical and will return to something like their 10-year average EPS/CFPS then it’s pretty attractively priced.

The book value is quite high (I get $46, when its trading at $25). My big question there is how realistic is the balance sheet? If they could sell the ships for what they’re carried on the balance sheet then it looks like there’s a lot of margin-of-safety here. But if a glut of ships means that the ships should be marked down in valuing the company then that situation changes quickly. If they’re paying dividends while losing money then that means they’re having to borrow money from somewhere, and if the lenders turn pessimistic on the value of the assets, then that could be a negative catalyst.

I wasn’t sure how to go about looking up what the current value of the ships would be, so I turned to the security analysis group on reddit and was pointed to a helpful source on the prices of recent transactions for ships. I haven’t had the time yet to go through and try to value each ship, or if it’s even worth trying, but I can say that the ships are carried at about $3B, with an average tonnage of 100k, and an average age of 7 years. Looking up what that “average ship” would sell for it looks like the figure is $27M, which multiplied out by the number of ships does come below (but close to) well below the book value. However, that figure looks like it’s heading down even just over the last few months. So to be conservative I’d reduce that by some more, and once you put in another ~20% fudge factor it doesn’t look like the safety of that book value is there after all. Edit: I made a mistake and multiplied by the total number of ships in the fleet. But, if I understand correctly (and I may well not since I got this wrong once already) many of those ships are chartered from other owners. If I just multiply the average ship value by the number of owned ships, I get a figure that’s about half the current book value.

I am being terribly inexact with that single “average ship” value, since seven 40 kT ships aren’t the same value as one 280 kT ship. If it came out closer I’d probably take the time to go through the exercise of trying to value each of the ships (or at least binning them into 5 or so more representative bins). Since the earnings will be released in just a few days, I’ll wait to see what happens there. If the stock slips more, it may be worth looking at in more detail.

Oh, and since most of this post was about determining just what the reality is from the numbers on the balance sheet, check out this thread on CMF on that very topic!

San Francisco does a lot of crazy things: banning happy meals, yellow pages delivery, and even made an attempt to ban puppies. Yet somehow only one of those wacky ideas has stock analysts quaking in their boots — and it wasn’t the owners of McDonald’s.

I’ve held on to Yellow Pages (now Yellow Media) for over 3 years now, and I’ve lost too much money on it already to consider averaging down again. But YLO is once again under attack.

10 years ago if I had much interest in investing, I would have scoffed at owning YLO. Google and the internet will kill off that business model in a year or two, my internet-savvy Google beta-testing younger self would have said. But it didn’t happen like that: sure, some businesses put up a website, and even got indexed by search engines so you could find them. Larger chain stores had enough of a budget to ensure they had a decent site, maybe even an online storefront… but many didn’t, and weren’t in a hurry to get one. For smaller businesses, the website would often be something the owner’s kid put together in his spare time, and may or may not have looked like the mess Geocities left behind.

So there was still a strong demand for ads in the local Yellow Pages, and YLO even started offering to make mini-websites for these local businesses on YLO’s servers. Restaurants could get not just their name, address, and phone number in the directory, but also a copy of their menu, a short video ad showing the premises, and anything else they cared to include. Though a tech-savvy person or 3rd party web designer could maybe have done a better job with an independent site, for a small business owner that one-stop-shop for advertising with YLO didn’t look too bad. And heck, for local results, Google bought the data from YLO in the first place, so you couldn’t get around giving YLO their due.

And I realized that YLO wasn’t going to die off overnight. It wasn’t going to maintain its former glory, for sure, but the print directory has been in a slow decline these past few years, while the internet side has been picking up.

Now maybe a turning point has been reached, and it’s finally going to go over the edge like people were saying a decade ago. Perhaps all at once rather than slowly, like I thought. Maybe Google has opened the web up so much that there’s no room for paid listings and basic sites (some businesses just get a blogger account, put up a single post, and call it a day). Maybe their debt is looking to be so massive that there’s no value in the equity.

It’s certainly being priced that way.

But I still hold on: the directory business revenues were down single-digit-percent each of the last 3 years, and it just looks so cheap. Maybe it’s a value trap. Maybe it always was. It’s hard to pound the table and call it a screaming buy when there are so many legitimate concerns about its future. I think it’s too cheap to give up and let my shares go, but at the same time I can’t say with confidence that it’s a good buy (and perhaps I’m making an emotional attachment error of judgement).

And I said it when it was $5, and when it was $4; I’ll say it again at $2: as a contrarian, it’s hard to get much more negative sentiment than there is for YLO right now.

Also, I looked at a few other stocks lately:

The Data Group Income Fund could be yet another Yellow Media: it’s involved in dead-tree printing, and doesn’t even own RFD. DGI prints material like reports and advertisements for a wide variety of other companies. The yield is beyond juicy: at 13.5%, it’s signalling trouble somewhere. And maybe I have a blindspot for obsolescence, but I don’t really see it. The cashflow has been looking pretty stable, and can support the distribution. The debt levels are higher than I’d like, at something like 5X cashflow, but it’s not exactly facing imminent bankruptcy. This is one I need to think about longer, because the logical part of me is saying this looks like a pretty good risk/return, but the other part is screaming it’s YLO all over again.

Corning (GLW) is a US large-cap that makes glass. All kinds of glass, but in particular the glass that goes into LCD screens. That’s where they make most of their profits from these days, and I honestly don’t hold out high hopes that that particular business line will continue to be as lucrative for the next few years as it was for the last decade when the HDTV upgrade spree was in full swing. However, the stock is starting to look cheap enough that those risks are likely priced in. The balance sheet is strong, and moreover, the company has a strong history of reinventing itself as needed (from lighting to bakeware to fibre optics to LCDs). It was just under $17 recently, and that’s starting to look attractive to me, but I’m going to wait for a while and hope it comes down a bit more to give some margin-of-safety. But I will be watching it.

AvenEx (AVF) was an income trust that was too weird to look at before, a tiny company acting like a large conglomerate, chasing multiple unrelated business lines. It has since converted to a dividend-paying corporation and focused in on oil and gas production. It’s about 50/50 oil and gas (slightly more gas), but if I’m reading the reports right (and I’m still trying to build an ability to analyze O&G stocks, definitely not there yet though) then the dividend (>9%) is covered by just the oily half of the business, which is good because they still have significant hedges rolling off from when natural gas prices were much higher. If natural gas prices move up in the next few years, then they should probably do fine, and that’s kind of how I’m framing the story in my mind: a dividend player where the dividend is covered by the oil, with the natural gas side as a bonus if/when NG prices recover. However, capital spending also has to be made, and if NG prices stay low, then in ~2 years as those hedges roll off, they may be in a tight spot and have to cut the dividend to keep up capital spending. Another issue may be reserve life. I don’t have the geology skills to know if I’m reading this right, but it looks as though they have ~11 years of reserves, which is fine, but their reserves are growing at only about half the rate they’re depleted, and I’m pretty sure for stability the replacement rate should be closer to 1:1. Anyway, attractive dividend yield which at least for the next few years is covered by cash flow, with well-managed debt. Not sure whether to buy in though since it is still a bit outside my circle of competence, and I have no idea what to think of the management (esp. if they’re switching over from managing what was halfway to a REIT into an O&G company).

A new frozen yogurt place opened up called Kiwi Kraze, and they have the guess the weight of your sundae and get it for free deal. So I did, and I did :) That may have been related to the fact that despite officially moving the goalposts back from the “don’t gain” to “lose weight” objective now that vacation is over, I gained weight this week. Grrr. It may be because I had a number of real Cokes enter my inventory (free > calories).

Then there were a tonne of fireflies out tonight on my walk home. It’s truly magical once you realize you’re not having a stroke.

I’m starting to turn negative on my BB. I like the keyboard, and between email, calendar syncing, and the omnipresence of the hivemind, I’m finding a smartphone to be just ever so handy these days, but I think my next one might be a droid. I like BBM, and I want to be patriotic, but I really don’t know anyone who said “hey, I really miss the days of trying to carefully manage system memory in DOS. I wish there was a phone that let me relive that experience.” I’ve got 4 GB free for photos and music, I don’t know why my cache of 160-char SMSes and apps has to stay in the shallow end… Recently, my ringer just stopped working. The little message light would still flash, and most of the time the vibration would still go off to alert me to a call or message, but no audio. From searching online, this is a frightfully common problem with the BB, and there are a host of zany solutions, including turning it off and on, pulling the battery out (which is a different off and on), and yes, trying to clear out the pathetic amount of “application memory” available. Some combination of that and doing this to the part near the speaker ended up fixing it.

Random hilarious conversation snippets:

“What are wild Popples called? Armadillos?” I’m eternally amazed at how the mind works sometimes. Like when trying to think of an animal that balls itself up at a sign of danger, one goes first to Popples, and from there to their wild equivalent, armadillos (though I would have also thought Popples had a strong hedgehog influence). Actually, I’m amazed anyone remembers Popples at all.

Links:

A surprisingly good read on whale poop. (HT: Barry Ritholtz)

John Hempton describes the problem auditors of Chinese RTO frauds faced, that may let them off the hook: in some cases, the banks were in on it. If the banks have lost credibility, what are the implications of that?!

An excellent real-world application of Mathematica. Stupid brownie nuts. “I hate nuts in Brownies.” “Who does that?” “I don’t know, old people?”

The Globe has another article lamenting the limitations of electric cars, this time moaning that the cars can’t handle the all-day all-out testing of an automotive press junket. The author seems to be a bit misinformed, or got his tenses wrong: “pure electric vehicles will be glorified golf carts, useful for short distances, in good weather conditions.” Depending on what you mean by short distances, that’s true: they’re good for commuting within the city, but I wouldn’t count on one for trips to the cottage. But most families in urban areas have two cars (and pretty much all the ones with cottages do), so there is a market for an electric commuter as a 2nd vehicle. But I’m not saying anything new for you guys. Most outrageous was the closer: “The infrastructure necessary for the next generation of volume-produced passenger vehicles will determine their success. […] My money is on fuel cells and hydrogen stations.” I’ll take that bet.

Yet another bank housing analyst turns bearish on Canadian real estate.

And Canadian Business has a bearish article out as well.

A 3D printer using… chocolate. It makes so much sense: it’s a self-binding polymer-type product, so it can form complex 3D shapes (like bunnies), and is well-suited to being put down in layers. Plus, it’s chocolate!