PHIL TOWN

RITUAL - 'RULERS' FOR RULERS

 

The concept of ritual is as old as man.  Rituals are designed to increase success.  There are religious rituals, of course, but there are also other types of rituals –a baseball player might go through a specific series of actions prior to stepping up to the plate, or a Green Beret soldier might go through a specific series of rituals to prepare for a raid.  As a river guide I conducted specific rituals every morning to prepare myself and my boat for the day.  I loaded the boat with gear in a very specific order and tied it down in a very specific way and above the biggest rapids I ritualistically sacrificed something to the river gods – maybe a shot of tequila or a beer.

 

Rituals also exist in investing.  We get a series of ritualistic exercises from Ben Graham, Warren Buffett, Julian Robertson and many other Rule #1 type investors.  An investing ritual is designed to focus the analysis on the critical things that a good investment must have to be a Rule #1 investment.  We know, for example, that we’re looking for a ‘wonderful company’ at an ‘attractive price’ because if we find it we are certain to make money.  We might not know when we’re going to make it but we know we’re going to make it as well as we know that if we buy a $10 bill for $5 we’re going to make money on it someday.  But it helps to define more clearly what a wonderful company is and what an attractive price is and we can do that with a ritual called Story.

 

A Story ritual was first started by Julian Robertson to require of his analysts a clear explanation for why a specific investment was a good risk.  The ritual is very important.  One has to stand before peers and present the Story and in the Story has to be all the elements that would convince a rational investor that this is a great investment.  It also has to take into account why others don’t see what you see, since others are not stupid.

 

We’ve taken the element of Story and applied to it an acronym: RULERS.  I’ll use the RULERS acronym to develop my Story in a coherent way.

 

Here is what RULERS stands for:

 

RATIONAL: The Story has to show us that fear has driven down the price of this company irrationally and why others who doubt our Story are wrong.

 

UNDERSTANDING: The Story has to develop the 4Ms: Meaning, Moat, Management and MOS.  In this part of the Story we should see that the company is a wonderful company and that it is on sale.

 

LEVERAGE: The Story can show how we intend to use leverage in this investment to increase our return on investment and lower our risk.

 

EVENT: The Story should include the Event that created the irrational fear.

 

REDUCE BASIS:  The Story will tell us what our expectations should be for Adjusted Cost Basis in 5 and 10 years.

 

STORY: The Story is the Story.

 

 

The value of the Story Ritual is three-fold:

1. It forces us to present our idea to others to critique
   1. Over-confidence in our own ideas is a nasty thing
   2. It gives us a blueprint for the future so that if the Story changes, our investment strategy should change as well
   3. Ritual removes the ego so that we can stand being challenged and we can initiate an exit if the story changes.

 

Apply RULERS to every long-term investment you make.  Make it a Ritual to do a Story to your investing partners or to your spouse.  Force yourself into the ritual.  The more important it is to succeed, the more Ritual becomes important.

 

Now go play.

Phil

Stephan Haller on 'Money'

Essay on Money by Stephan Haller

 

Table of Contents

1. Introduction
2. Origins of Money and Credit
3. Functions of Money
4. The Right Amount of Money
5. Origins of Money Part II
6. Interest Rates - The Price of Money
7. Foreign Exchange Value of a Currency and Trade Deficits
8. Public Debt
9. Printing Press = Devaluation of the Currency + Pauperization of breadth Parts of the Population

 

1.  Introduction

Peter D. Schiff wrote in his book “The Little Book of Bull Moves in Bear Markets“:

“A nation can create money and the individual cannot.“

This assertion is wrong. On the contrary the truth is:

“The individual can create money and a nation, a government or a central bank cannot.“

Of course I know, since Peter Schiff is a very smart man, that he is not talking about real money, he is talking about the colorful paper we call Dollar, Euro or Yen.

So his quotation is true regarding to fiat money.

But when I say only the individual can create money and a nation cannot, I‘m talking about real money.

 

In this essay I show you what real money is about, how it comes into existence and what tasks money undertakes in an economy.

Authors note: When I‘m using the term money in this essay, I‘m talking about real money and not Euros, Dollars, Yen, or Yuan, etc.

 

1. 2.   Origins of Money and Credit

The state cannot create money, but every time he tried to create money in the past, he destroyed it and brought major disaster over the economy and its people.

What the Federal Reserve Bank, the European Central Bank, the Bank of Japan and the Bank of England are doing at the present time is nothing more than a grand theft of the fruits of the labor of their people.

 

Our modern economy, just like the economy in ancient times, bases on trading goods and services for other goods and services.                                                                   

In a primitive barter economy without money, it is difficult to exchange goods, because very often some goods have a much bigger value than others and are indivisible.

Therefore credit came into existence.

Let‘s suppose a cattle farmer wants to buy some fish from a local fisherman, but one cow is worth much more than one catfish. So in order to settle this transaction one of the two parties must grant credit to the other party. The cattle farmer could give the fishermen one cow and the fisherman signs a contract to deliver a catfish everyday for the next 365 days or whatever amount of catfish they agree on. It is also possible that the fishermen delivers a catfish everyday for the next year and the cattle farmer delivers the cow in a year, when the calf has grown big enough.

Another option would be, that the cattle farmer trades his contract with the fisherman for other goods and then the new owner of the contract  - the commercial bill of exchange - has the right to claim the fish from the fisherman.

 

Every one of us is granting or using credit several times a day. For example we go to work everyday, but get paid once a week or once a month. So when you are doing your job, you are giving credit to your employer, payable in a week or in a month.

In other words, you are performing a service in the present and you get your reward in the future. By producing or delivering goods or by performing a service you acquire the right for the equal amount of goods and services, payable in the future. In order to guarantee your right to receive the equal amount of goods and services, we need a security: MONEY.

So money is just the documentation that you produced a good or performed a service, without receiving goods and/or services of the same value in reward.

 

Most of the time your employer can‘t pay you for your service with the equal amount of goods and/or services. Therefore he pays you with money.

After receiving your wage from your employer paid in the form of money, you and your employer are even. The transaction between you and your employer is closed.

But you still have a claim to receive a certain amount of goods and services. Not against your employer, but against the market. The money you received as a payment for the goods you produced or the service you performed, entitles you to receive a small fraction of all the goods and services, which are produced in an economy.

So the most important character of money is that it fully guarantees your entitlement to receive a small fraction of all the goods and services produced in an economy in the future.

 

Money is an entitlement to goods and services, which came into existence, because somebody has produced goods and/or performed a service, but hasn‘t received an equal amount of other goods and services, yet.

Let me clarify this with the help of an easy example:

Let‘s suppose I want to buy myself an excellent investor education.

Phil Town is selling such an education for the price of $4,995.

Phil wants to buy himself a new saddle for his horse. The price for a saddle is also $4,995.

So I buy from Phil a three day Rule#1 Cashflow Seminar. I pay him the $4,995 in advance and now I have a claim against Phil for three days of education. In other words, I grant Phil credit.

After the seminar has ended on day 3, Phil and I are even.

Now Phil can buy his saddle, but let‘s suppose he decides to buy the saddle not right now, but in a year.

In 2014 the price for a saddle is not $4,995, but $5,500.

Is this a sign that the money I gave him was of bad quality?

No. Not necessarily. Because the $4,995 I paid him did not entitle him to get a new saddle.

There could be several justifications, why the price for a saddle went up.

A shortage in leather for example. The rise of prices for certain goods, says nothing about the quality of money. When prices for a certain good rise in an economy with real money, the prices for other goods must go down.

Phil was not entitled to get a new saddle, but he was entitled to receive a certain percentage of all the goods and services, which are produced.

To make this easier, let‘s suppose the US GDP is 100 million dollars.

So Phil is entitled to receive goods and services at least worth ($4,995/100,000,000) x 100% = 0.004995% of the US GDP. Today, tomorrow, or in several years.

 

We know now, that in order to produce money somebody has to perform a service or produce a good. Everybody should also understand now, that Mr. Bernanke cannot produce money with his printing press. When the FED is creating new money, everyone   who receives this new money, owns now entitlements for goods and services, without having produced new goods and services before. Therefore everyone who owns old money is a bit poorer now. I call this outright theft.

 

3.  Functions of Money

1. a.    Money as a medium of exchange

Money makes the exchange of goods more convenient.  But money isn‘t just a medium of exchange. You can use money for giving a loan or to pay down debt. In order to fulfill this function the money in use needs to be widely accepted.

1. b.    Money as a measure of value and unit of account:

Money is a documentation for the service you performed or the goods you produced in the past. It also expresses the value of certain goods and services.

1. c.    Storage of Value:

The advantage of real money is, that the buying and the selling of goods and services don‘t need to happen at the same time. For example if you trade eggs for fish, then the buying and the selling happens at the same time. You simultaneously sell eggs and buy fish.

If you are using money, you can trade your eggs today in exchange for money and buy fish or any other good or service with your money next week. Or if you don‘t need the money in the meantime, you can lend it to someone, who needs it and he pays you interest for it.

In order to fulfill this function, money needs to be an entitlement to receive a certain percentage of all the goods and services, which are produced in an economy and this entitlement lasts forever.

 

4.  The Right Amount of Money

Johann Nepomuk Nestroy: “The Phoenicians invented the money - but why so little?“

 

Most modern economist, especially the Keynesians, believe, that when the economy is growing, the amount of money (issued by the central bank) must grow, too. But this assumption is wrong.

In a free market economy with real money, there is always the “right“ amount of money circulating. The money supply in a country is equal to the total amount of claims for the produced goods or performed services that haven‘t been enforced yet.

 

5.  Origins of Money Part II

We have learned now, what real money is, what the functions of money are and what the right amount of money is. The way I described the origins of money was very abstract, though.

So how does money - such as a bank note or a coin - come into existence?

For the party who has sold a good, a new entitlement for goods and services has emerged and for the party who has bought a good, the entitlement has expired. But no new money has to be printed or coined, because the buyer just transfers his entitlement to the seller. So the entitlements - or that is to say money - just circulates in an economy.

But when and how did the first money emerge?

Somebody has to produce a good, which fulfills all the functions of real money, is widely accepted and functions as a guaranteed entitlement to the delivery of goods and services in the future. It is also important, that the value of the money can't be manipulated.

History has shown, that there is only one good, which has all this postulated qualities:

GOLD.

Only gold or paper money 100% backed by gold can function as real money.

I said before, that money comes into existence when somebody performs a service or to put it in other words, works hard.

Mining gold and minting it into coins is a lot of hard work.

Gold doesn‘t rot or rust and it is widely accepted.

So now we know how money, that we can use as a medium of exchange, as a storage of value and as a unit of account, comes into existence:

Somebody digs gold out of the ground, gives it to a goldsmith, who melts it down and molds it into bullion in exchange for a small amount of gold or paper money redeemable in gold. Now he gives the money to a commercial bank or a central bank. The bank stores the gold bullion into a vault in exchange for a small percentage of the gold and gives him paper money, redeemable in gold. With this new printed money the gold miner can buy a certain amount of goods and services, depending on the market price.

New money has entered the market and now circulates in the economy.

But who is controlling the velocity of money and how can the market make sure, that the money circulates instead of lying under a mattress?

I‘ll answer these questions in the next chapter.

 

6.  Interest Rates - The Price of Money

Our modern alchemists - the central bankers - keep telling us, that if the economy is in the state of a recession, you just need to drop money from a helicopter and the economy goes right back into growth mode and the unemployment rate comes down.

The enemies of these Keynesians are the savers. Because in the world of the Keynesians, when people pull their money out of the circular flow of money, then the economy can't expand or falls into a recession.

This is complete nonsense. If it were true, that the printing of paper notes makes a society richer, than there would be no poverty in the world and Zimbabwe would be the richest country in the world.

I said it very often in my past writings and I have to say it again:

" A society can't become richer by printing money. A society can only become richer by producing more goods and services."

When an economy expands, there is no need for a greater amount of gold or gold backed paper bills or fiat money. It is the velocity of money, which needs to speed up.

But don't get me wrong. The rising velocity of money or an expanding money supply is not the cause of economic growth. It is just the opposite. The expanding economy causes the velocity of money to speed up and/or leads to a growth in the supply of money.

But how do we get the velocity of money to rise, or to put it in other words, how do we get the money, which is at rest, back into the circular flow?

The answer is very easy: Interest rates.

Interest rates are the price of money. If money is badly needed, because the businesses want to expand, then interest rates will go up to the extent, where the demand for money equals the supply of money.

So if the demand for goods and services is higher than the production of goods and services, the interest rates go up, because the businesses need money in order to expand their production. On the other hand falling interest rates are a sign, that the supply of goods and services exceed the demand.

 

7.  Foreign Exchange Value of a Currency and Trade Deficits

Every transaction is bartering, it doesn‘t matter if the transaction is taking place on a national or an international level. Goods and services are traded for other goods and services. Money is just a substitute for goods and services.

The foreign exchange value of a currency shows us if a country is exporting more than it imports or the other way around. The exchange rate of a currency shows us also, how much goods a country with a trade deficit must export to a country with a trade surplus in order to equalize the trade balance. The United States have a long record of big trade deficits with Japan.

Or put it another way, the United States buy more goods and services from Japan, than they sell to the Japanese.

In a free market without currency manipulation by the central banks, the currency of the country with the trade deficit should devalue until exports and imports are balanced.

 

So why doesn‘t the US Dollar devalue more against the Japanese Yen and the Chinese Yuan?

 

There are several reasons:

a.  All commodities are traded in US Dollar, therefore the US are able to spread a big chunk of the inflation created by excess money printing all over the world, because everyone has to buy US Dollar in order to pay for oil, iron ore, etc.

b.  When a car is produced in Japan and shipped to the US, the Japanese auto maker can either get paid in US Dollar or insist on payment in Yen. If he gets paid in US Dollar he can use Dollars for buying US goods and services or exchange his US Dollar for Yen and buy Japanese goods and services. If he insists on getting paid in Yen, the American importer of the car has to find another person who sells him Yen in exchange for US Dollar. Usually he does this with the help of his commercial bank which supplies him with foreign currency generally with the help of the central bank.
 The effect is always the same. The Japanese have excess US Dollar, because they sell so much to and buy so little from the United States. 
Because the US is still the best place in the world for investing, they ship the US Dollar back to the US and buy stocks and bonds, mostly US treasuries. 

So always keep in mind:

If a nation wants to keep up a big trade surplus with another nation, the only way of maintaining this trade surplus is to send money to the nation with the trade deficit.

Otherwise your own currency gets more expensive and the trade surplus declines, because your products are more expensive now abroad.

 

If you don‘t want to send your money back to the country where it came from, then the only way of increasing your exports is to increase your imports from the country you want to export.

 In a world with an international gold standard, foreign trade and exchange rates balance themselves. As soon as the exporter of a good gets paid in foreign paper money redeemable in gold, he goes to his bank and exchanges the money into his national currency. The commercial bank exchanges the foreign currency into national currency at the central bank, which finally exchanges the foreign currency into gold at the central bank of the other country.

Thus when a country has a trade deficit, gold is flowing out of the country, but when the supply of gold is shrinking, the supply of money is shrinking, too. Due to the shrinking supply of money prices and wages go down automatically. As prices and wages go down, the products of a country get cheaper and the other countries start to buy more of the country‘s products again and gold starts to flow back into the country.

Therefore big trade deficits or surpluses are not possible in an international gold standard.

 

8.  Public Debt

Paul Krugman: “Debt Is (Mostly) Money We Owe to Ourselves.“

Most of the time I completely disagree with Paul Krugman, but this statement is mostly right. But I have something to add. You can‘t pay debt or a trade deficit with money. Yes, money is the medium of exchange to pay down debt, but in reality you pay debt by delivering goods, so you owe the debt to the future generations who will have to produce the goods to pay down the debt. Therefore it doesn‘t matter where your creditor is located. It doesn‘t matter if the Chinese are holding the US debt or if the treasury bonds are owned by US citizens. But in contrast to Paul Krugman I think that by piling up big public debt you are enslaving the future generations.


 

9.  Printing Press = Devaluation of the Currency + Pauperization of breadth Parts of the Population

The creation of new (fake) money by the central bank is like a hidden tax on the fruits of our labor. The central bank is robbing the people‘s wealth, but they keep telling us they do it for our own good. But when the FED prints money, breadth parts of the population are losing, big time. But there are some profiteers, though. Artificially created money always drives up prices. Sometimes housing prices, sometimes the prices for stocks or commodities and in the long term always the consumer prices.

 

But who are these profiteers of money creation and how does the FED create new money?

At present the FED keeps buying mortgage backed securities and treasury bonds worth $85 billion from the banks every month.

By propping up the housing market and keeping down interest rates, the FED helps the debtors and hurts the savers.

Government is the biggest debtor, so if price inflation his higher than the interest on government debt, the public debt gets “inflated“ away over time, because when prices and wages rise, the taxes the IRS collects also rise.

The next winners are the commercial banks.

 

Because the FED prints new money and buys assets from the commercial banks with this new created money.

When the banks get the new money they can buy other assets at the old prices, because nobody has noticed yet, that new money was created. If they invest the money, they drive up asset prices and most of the time commodity prices.

The commercial banks are also happy to lend out the new created money to their friends in the big businesses. These big businesses drive up prices even more. The little guy is the last one who receives the new created money, if he ever gets it. When the little guy receives the new money (e.g. through a pay raise), prices are way up. Price inflation is the main reason for the widening gap between rich and poor.

In the long term a small elite gets richer and richer and the rest of the population stays poor. Another longterm effect of the money printing is that the value of the currency disappears.

 

So what can we do?

I think there is no way to change the system in the short run. The central bankers won‘t change their monetary policies, until the whole financial system collapses.

So our only chance is to make money on a faster pace than the Bernankes and Draghis can inflate. Rule#1 investing and Rule#1 Cash Flow strategies are our only chance to stay afloat in a rising tide of fake money.

                                                Stephan Haller, Landshut/Germany, April 6nd 2013

MONTIE CARR WEIGHS IN ON APPLE MANAGEMENT

One of my long-time students, Montie Carr, just posted up a good article on Apple Management on SeekingAlpha.com.  I love it when you guys leave the nest and go pro.  Here it is:

Apple (AAPL) has been a fantastic company to follow since it was created in 1976 by Mr. Jobs and Mr. Wozniak, providing students with multiple case studies and career motivation. Apple is the perfect example of what the American Enterprise System can create. Apple's product successes drove the stock from the 2009 bottom of around $90 to a high of $705 in 2012.

Pessimism around the stock and the company has risen dramatically with the fall of the stock price. At this point, it doesn't seem as though Apple can do anything to please any of their analysts. I read as many of the analysts' reports as possible and find the analysts to be financially brilliant. Their knowledge however, of product development, product marketing or manufacturing in the consumer electronics space, I find is quite deficient. Therefore, many of the conclusions they reach in regard to what products should be created, what their competitive deficiencies or advantages might be or what a future build plan portends to be naively inaccurate.

Estimating Apple earnings has also been problematic, and Apple has missed analyst estimates the last three quarters, resulting in a decline in price of some 35%.

So how can we be absolutely sure that Apple is still performing at world-class standards and not careening into oblivion as many analysts and writers would lead us to believe?

I decided to turn to the acknowledged expert on what makes a great company, Jim Collins. Mr. Collins has a research lab and consulting practice based in Boulder, Colorado. Four of his six books cover this subject: Good to Great; Built to Last; Great by Choice; and How the Mighty Fall.

One of the persistent criticisms of Apple is that it is no longer an innovator, its last product innovation being the iPad. Mr. Collin's research does not support the premise that 10X companies, as he refers to them, are any more innovative than their less successful comparison companies. The 10X companies, in some cases, were clearly less innovative than their comparisons. Other researchers support this same conclusion as well. This doesn't mean that innovation is unimportant but that the combination of creativity/innovation and discipline are important. Apple's creativity is clearly evident in their product design and their prolific patents. Their discipline to do things the Apple way often drives their critics to distraction.

Another concept that Mr. Collins introduces in Great by Choice is that world class companies fire bullets before cannon balls. The object is to turn small successes into larger successes. The definition of a bullet is: an empirical test aimed at learning what works. One that costs little or that is low in risk and a test that imposes little distraction for the company. What the market seems to want from Apple is the next big thing, an iTV or a huge acquisition like Netflix or a large cash payout. Bold moves like this (cannonballs) fired indiscriminately, is what dooms good companies to failure. We have seen Apple make multiple acquisitions of small companies (bullets). We have recently seen Apple fire a bullet in the form of Apple TV. I suspect the next bullet they may fire might be an SDK for Apple TV. I would suggest that when Apple has the empirical validation they need, they would then fire the cannonball the market is expecting.

Another symptom of decline can be the failure of a leader to develop a strong successor. Tim Cook has received his share of criticism from outsiders. Like other CEO's, Mr. Cook must prove himself to employees, board members and stockholders daily. We cannot, however, accuse Mr. Jobs of not carefully grooming and choosing his successor. In fact, if we refer back to Mr. Collins' book Good to Great, he has carefully researched the leaders of great companies and Mr. Cook nearly perfectly fits the personal and professional profile Mr. Collins has developed for great corporate leaders. Mr. Cook has great promise. Only time will tell if he develops into a great leader.

In an earlier book How the Mighty Fall, Mr. Collins researches formerly great but failed companies, why they failed and how some companies recovered and returned to greatness. Apple, like IBM has already recovered from past near failures. Mr. Collins' research identifies five stages of decline that are present in failing or failed companies.

The first crack in a company's armor is overconfidence created from past success. Demonstrable hubris manifests itself in different forms. It might be demonstrated by getting into a business that they know very little about. It might be rushing a product to market, pursuing growth that they cannot support, risky decisions that appear to have conflicting evidence or just plain neglect born of arrogance. Apple has clearly been successful since Mr. Jobs started his second tour of duty. Mr. Cook has said, "The most important thing to Apple is to make the best products in the world that enrich customers' lives." Outsiders are frustrated by the limited flow of information from Apple but at this point the term hubris (excessive pride) does not seem to apply to Apple.

The second stage of decline is the undisciplined pursuit of more. It is commonly understood that most companies fail or falter because they become complacent and failing to innovate, an allegation we often see in the media regarding Apple. Mr. Collins' work demonstrates that complacency is seldom the cause for decline but over reaching is more often the problem. Growing the company too fast, not being able to hire enough highly qualified people or acquiring companies that they are unable to absorb efficiently or in a timely manner are indications of over reaching. This is the area that probably least applies to Apple, demonstrated by their conservative use of a very large cash position and the constant calls in the media to spend that money in some spectacular way.

The third stage of decline is the denial of risk. Companies can characterize this state when they make big bets concurrent with mounting evidence that appears to be contradictory to their success. Mr. Collins identifies a common corporate behavior in this stage when leaders begin to blame others or external factors as they decline. Another manifestation of this problem is obsessive reorganization. So far, we haven't seen this type of behavior from Mr. Cook or his lieutenants.

We do have some warning flags that deserve careful scrutiny. Financially, the deterioration in gross margins is the most disconcerting. Their debt is not an issue but there might be signs of mediocrity. Declining customer engagement, inventory issues (most of these have been related to the inability to meet demand) and any potential pricing power issues.

The final two stages of decline identified by Mr. Collins are management grasping for salvation and finally capitulation, which results in a sale or cessation of business. These two final stages are clearly not in play.

We can conclude that by studying Mr. Collins' work we see little evidence that Apple has symptoms contained in stage one or stage two of corporate decline. The description provided of stage three provides us with areas to watch that might determine Apple's future direction. The bottom line, as is often the case, will Mr. Cook and his management team lead Apple to even greater success? They certainly have that opportunity!

http://seekingalpha.com/article/1296141-is-mighty-apple-really-falling