Why Cyprus May be BULLISH for the Eurozone

There has been a lot of discussion lately about the Eurozone bailout of Cyprus.  Many pundits have focused on the horror of the fact that the Eurozone is planning to tax/levy/whatever the deposits of depositors who have money on deposit with Cyprus’ insolvent banks, in amounts above the insured limit.  A lot of the bru-ha-ha arose because originally, the plan was apparently to tax even the insured deposits.

I think we can all agree that the insured deposits should not be taxed, levied upon, or in any way subjected to losses in the bailout of a country and/or banking system, and that no plan should ever have been floated that did so.  When a bank deposit is insured, that has to mean something, or the banking system can have no trust.

However, it is perfectly acceptable for the non-insured deposits with these banks to be taxed, levied upon, or otherwise wiped out.  And the fact that the Eurozone is willing to do so, indicates that there is a level of confidence in the system that has been missing, and that is often missing in the United States.

Here is what the populist depositnistas appear to be missing:  bank depositors are creditors of the bank.  The whole point of creating some sort of deposit insurance is to ameliorate the worst impacts of this.  But nowhere is it written that uninsured deposits should be de-facto insured by tax payers.  That is what people opposed to this are really saying.  In a normally-functioning economy, when any corporation fails, it is the shareholders who get wiped out first, but the creditors, usually bond holders typically get wiped out as well, at least in part, and often in full.

So in fact, the Eurozone and the government are taking nothing from these non-insured “whale” depositors.  Rather, by making them bear anything less than a total loss, the Eurozone is actually giving the “whale” depositors the remainder as a partial bailout, which they would not otherwise get as uninsured creditors of an insolvent banking corporation.  That the Eurozone is willing to do this is perhaps foolish, but is also perhaps a sign that markets, and governments’ perception of their fragility, is returning to a more pre-crisis, market-oriented posture.

Profit Margin Mean Reversion Doesn’t Mean Lower Earnings in a Boom

We have heard quite about about how the profit margins of US companies are at all time historic highs and that they will mean revert.  Lots of smart people believe this.  See here, here, and most recently here, which is the article that prompted this post.  I myself have worried a lot about it, and have spilled quite a few pixels on the issue in other blogs.  And they — we, are almost certainly correct.  But historical evidence suggests that even if and when profit margins mean revert, it does not follow ipso facto that profits will plunge. 

Wait.  What?  The reason, as with so many things, is contained right there in FRED data.  I owe Morgan Housel of The Motley Fool a credit for tweeting this chart to me in response to my tweet about the issue on February 14, 2013 in which I shared my instincts on this issue.

What Fred data shows on this chart, is that in the late 1990s, profit margins actually declined, and yet as we all know, profits boomed.  The answer I think is that in a booming economy, the increase in the magnitude of goods and services sold can overcome the decrease in marginal profit on each good, just when talking about the cumulative amount of earnings/profit that companies report.

Now of course there is an alternative reading.  Profit margins peaked in the final quarter of 1997, and the trend was of decline, then a rise through 2000, and then decline that lasted into the 2001-2002 recession.  So one can construe the falling profit margins of 1998 and 2001 as a harbinger of lower profits.  Still, it bears thinking about that profit margins basically declined for three years, from 1998-2000, while corporate profits nevertheless skyrocketed.  

Just think about it when people speak of the inevitability of falling profit margins immediately and automatically leading to instantly lower corporate profits.

Checking in on Microsoft

I have been a holder of Microsoft shares since the financial crisis in early 2009.  I have added to my position since then, and it is one of my four largest positions, along with ExxonMobil (holding and adding since 1998), Berkshire Hathaway (holding and adding since 2009), and Apple (holding and adding since 2011).  Unlike those three, most of my Microsoft stock purchases over the last three years have strongly underperformed the market.  

The issues are of course well-known.  First, Microsoft is the epitome of “dead money.”  The stock price has gone nowhere since July 1998, nearly fifteen years.  I was in college in 1998.  Bill Clinton was President.  AOL and Timewarner had not merged.  That is a long, long time.  Second, the Wintel monopoly on the corporate and even moreso on the consumer market is ending.  Duh.  Thematically, Microsoft doesn’t work.  It puts out crappy products like Zune, and overpriced (sorry, but it’s true) products like Surface.  

It’s CEO looks like a titanic oompa loompa.  He is anti-cool.  He is kryptonite to cool.  Worse, he does things like try to purchase Yahoo for too much money, pay tons of money for an ad company that leads Microsoft to the write-off billions of dollars.  And of course the attempt to compete with Google in search has largely been a failure.  Etc., etc.

So why do I own?  Why do I continue to own?  It’s important not to check one’s brain at the buy button.  And it’s even more important not to check one’s brain once one has hit the buy button.  Is my thesis wrong?  What is my thesis?  My thesis is fairly simple:   The company still makes a bunch of money, will continue to make a bunch of money, and even as the Wintel monopoly ends, this is not the end-of-the-line for Microsoft.  And because everyone thinks it is the end-of-the-line and Microsoft is going to go the way of Research in Motion, it’s cheap as hell.

Even during the disastrous fiscal year that ended in June 2012, the company generated record free cash flow of $29.321 billion, and $3.44 of free cash flow per share, also a record.  And record revenue.  Against around $11 billion in long term debt, it was holding over $50 billion in cash and cash-equivalents.  

These aren’t really new facts to anyone who follows Microsoft.  More recently, earnings-per-share were down from $0.78 per diluted share in 11/2011 to $0.76 per diluted share in 12/2012.  The future is all that matters.  The trend is all that matters.  What’s the saying? — I’d rather pay up for a quality business than get a bad business for a good price.  Something like that.

Well, let’s see more concretely what this last year hath wrought.  I last checked in on Microsoft’s valuation in April 2012.  (I’m a long term kind of guy, I don’t follow the ticker every day.)  At the time, as you can see in that sheet, I assumed 4% yearly free cash flow growth for ten years and 1% thereafter.  I assumed a WACC of 9.2%, and a share count, then-existing, of 8.593 billion diluted shares.  I discounted the cash (less debt) that Microsoft was holding by 35% to assume Microsoft would eventually have to pay taxes on all of the cash it holds overseas, or else will blow some of its money on stupid acquisitions, and lose some to inflation.  That gave me a valuation of around $45/share, give or take.  (This isn’t a science, and anyone who tells you otherwise probably wants you to pay for some worthless subscription or newsletter.)

Note, by the way, that although I assumed 4% yearly free cash flow growth, in this actual first of my ten years from the above calculation free cash flow actually grew 19% from year-end 6/2011 to year-end 6/2012, from $24.639 billion, to $29.321 billion.  We can’t really expect to see that repeated this coming year-ending 6/2013, but we shall see.

Now this year, from the 6/2012 starting-point, we have only 8.444 billion diluted shares outstanding, because of share repurchases.  The WACC is still about the same.  Some sources say only 9%, but I’ll stick with 9.2%. Note that debt is now up from last year, to over $14 billion, because Microsoft has taken advantage of stupid-low interest rates.  And cash is up to $68.312 billion as of 12/2012.  I continue to just write-off 35% of Microsoft’s cash when making my analysis, for the same reasons as above.  The result I get is that Microsoft is now worth around $54.60/share, more than it was last year, and that it is nearly 50% discounted.  Even if you completely write-off all of its cash, it’s still way undervalued by this analysis.

Can this be?  Can Microsoft really be so cheap?  I think so.  That’s why it’s such a large position for me.  If you think its earnings are about to fall off a cliff, as is its cash generation, you may disagree.  But I’ve been covering Microsoft pretty extensively for four years now.  If you think that now, you have probably thought it for four years, and that time, during the advent of the iPhone and the iPad and Google Chromebooks, etc., Microsoft has grown its free cash flow from $15.9 billion at the bottom of the financial crisis, to over $29 billion, yo.

So what say you?  I still say it’s a buy.  And while I wait for the market to agree with me, and hope that my thesis is correct, I’m happy to collect the 3% dividend yield, and happy to see that so far its actual free-cash-flow generation confirms my thesis.

Beware of Companies that Loathe Their Regulators

This is not an ode to Big Government and regulation.  But I think most reasonable people recognize the need for some regulations.  And the more complex or larger a system is, the more regulation is needed.  It’s exactly like the difference between two country roads in the middle-of-nowhere, and an intersection in a city.  The two country roads do not need a stoplight.  There a stop sign is quite sufficient (still a form of regulation).  But just try to imagine New York City without stoplights.  It would be total bedlam.  The current situation with JPMorgan has me thinking about this.

Now JPMorgan is a great company, and a very profitable one.  And its CEO/Chairman, Jamie Dimon, has been in many ways wonderful.  But he has been slamming the post-Crisis increased bank regulations quite a bit as well for some time.  For example, he slammed the $1 billion cost of new regulations.

Of course, then his seemingly fake CIO, which really seems like it was a shadow proprietary trading desk, lost $5 billion.  For the record, $5 billion is more than $1 billion.  And JPMorgan lost that money arguably doing something the regulators prohibited.

There is a lesson here:  Companies that constantly complain about regulation and have antagonistic relationships with their regulators probably want to engage in behavior that is against the best interests of long-term shareholders.

A great counterpoint exists in Warren Buffett’s most recent (as of this writing) 2012 letter to his shareholders.   In it, on page 10, he wrote: 

  • “It is in the self-interest of governments to treat capital providers in a manner that will ensure the continued flow of funds to essential projects. And it is in our self-interest to conduct our operations in a manner that earns the approval of our regulators and the people they represent.”

Truer words were never spoken.  He was writing in the context of his utility-like businesses, BNSF and MidAmerican Energy.  However, the lesson is the same in banking.  Banking is far more of a utility-like business than Jamie Dimon would like to admit.  Most of the problems we have had with our banking industry in the last decade have arisen because bankers have succeeded in convincing many people that they are not utilities.  And of course then they subsequently torched themselves.  The lesson is not dissimilar to airlines, which used to be heavily regulated.  Their record since deregulation has been absolutely miserable for shareholders, though wonderful for consumers.

The lesson for JPMorgan is clear.  Stop whining.  You lost far more money on your CIO office in a few months than you had made in its entire previous existence, and you did it while engaging in activities that arguably were designed to circumvent regulations you were complaining bitterly about the cost of. It was ironic, and unnecessary.  It’s time to head Buffett’s advice.  Stop whining, deal with a regulatory reality that impacts your competitors just as much as it does you, and move on.

Taking an Initial Look at Parker Hannifin Corp: Another Lubrizol?

Every so often I literally just start plugging various letters into morningstar.com’s quote box.  I do this to help myself move beyond my cognitive biases, one of which is that I tend to focus a lot on the stocks of companies I already own, another of which is I tend to concentrate my energies in companies people are already talking a lot about, and still another of which is that I tend to focus on particular industries.  I was doing that a few weeks ago and out popped Parker Hannifin Corporation (PH).  This is a highly investable company, though my research is not yet complete.  Here are some rough thoughts:

What are some cool things and interesting facts here?

  1. This is a $14 billion company that people rarely talk about.
  2. It’s the self-described #1 motion & control company.  It makes things that go in other things, largely, and/or that are sold to other businesses instead of directly to consumers.  It makes 816,000 different products, and employs 60,000 people in 40-some countries.
  3. It’s clearly a cyclical company with some lag.  Revenue tanked hard in 2009 and even 2010.
  4. But revenue is more than double what it was nine years ago.
  5. Free cash flow is four times what it was nine years ago.
  6. Share count is down over 11% from nine years ago, including a big repurchase in the 2012 fiscal year.
  7. Earnings per share are up three-to-four times what they were nine years ago.
  8. During this time financial leverage has remained steady.  And now debt-to-equity is in the 30% range.
  9. Dividends have more than tripled in the last nine years.
  10. 2012 was a record year.
  11. Company is about 100 years old.

What are a few warts?

  1. Highly cyclical, to the extent this counts as a wart.
  2. Exposed to defense industry cuts.
  3. Exposed to currency fluctuations.
  4. Pension underfunding.  (Though see note 10 of the recent annual report, which indicates it has reduced the discount rate of its pension obligations significantly, to 3.91%.  This is in response to ZIRP and pension-related laws, and likely means it is is over-estimating its pension liabilities.)
  5. Dividend yield is only 1.70%, and recent dividend growth has stalled.

What do we think of valuation here?

  1. On my quick-and-dirty chart I derive a valuation estimate of $119.60/share, with a range from $95 all the way up to $145/share.  Current market appraisal is about $97/share, so it’s trading in the low range of my estimates.
  2. Assumptions:  I’m using a WACC of 11% as my discount rate, as I believe is most appropriate.  I’m assuming annual FCF growth of 6% for ten years, and 2% thereafter.  That 6% matches annual FCF growth since 2008, through the Great Recession, but is significantly lower than it has shown if you look back for nine years.
  3. Caveat:  There is no such thing as an accurate valuation of a company, and the future is unknowable.

Things I’d like to know:

  1. More about the individual business segments.
  2. How long the CEO has been in charge.
  3. More about compensation policies.

Conclusion:  This is a great company and warrants further research.  It is highly “investable.”  It is only wildly undervalued if growth returns to a higher rate.  But it’s a solidly-run shareholder-friendly business based in Ohio.  I would have no problem initiating a position today.  I may back-up-the-truck the next time we have a real cyclical downturn in this country.  If I were buying the whole company I might even pay as much as $120 or even $130/share today.  I think this is a “Lubrizol-like” company (and a similar market cap prior to acquisition) that just had a record year and is firing on all cylinders, and it would not surprise me at all if Berkshire Hathaway under Buffett bought it, assuming diligence on the management checked out.

Bill Gross is Wrong: QE is not Horsemeat, It’s More Hamburgers

PIMCO founder Bill Gross is out with a new Financial Times op-ed calling QE currency manipulation and comparing it to the adulteration of hamburgers with horse meat.  Far be it for a nobody like me to challenge such a gray-haired eminence.  But this is the internet, where the ignorant and misinformed may say whatever they like and often do.  So surely I can, too.  I think that not only is Bill Gross wrong, but I suspect he knows he’s wrong, and he’s really just irritated that central banks are interfering with the speculations of his firm and its ilk, making it harder for them to do their jobs.

A little background will hopefully help illustrate what I’m talking about.  In early 2011 the Swiss Franc appreciated madly against both the Euro and, less famously, against the U.S. Dollar.  This happened because people like Gross, and Soros, and more ordinary folk, were fleeing to the Franc as a perceived “safe haven.”  (This coincided with the spike in gold prices, unsurprisingly.)  This by turn had the negative effect, among other things, of making Swiss goods more expensive everywhere else and hurting Swiss tourism.  

Were the Swiss thus to be punished for their fiscal prudence?  In August 2011 the Swiss National Bank (SNB) moved to fix the problem, and effectively pegged the currency to the Euro by buying foreign debt.  ”Experts” thought the SNB wouldn’t be successful at this, and yet here we are a year and half later and the peg has been pretty effective.  

Was the SNB putting horse meat in the burgers?  No.  Speculators were driving up the value of a scarce resource for reasons not entirely even connected to the fundamentals of that resource.  Speculators like Gross.  And it was hurting real people and real businesses in Switzerland.  Well done, SNB.

Gross’ ire is of course directed at the Yen and to a lesser extent at the Dollar, i.e., at the Japanese and U.S. central banks.

  • “The global economy, the phrase suggests, is using QE policies as currency bullets, with the central bank that can print the fastest being the ultimate winner in a race to the currency bottom.”

Well, here’s something interesting, don’t you think? — Even though Gross himself acknowledges that the ECB has been awol from this printing party, ever since QEs started in the U.S., the trend has nevertheless been appreciation of the dollar against the Euro!  You can literally draw a trend line straight through from June 2008 to today, of 1 euro buying fewer and fewer dollars, with lots of volatility of course.  Checking the Yen, one sees a similar trend, until the recent actions by Japan’s central bank, after which the Yen has only gotten back to March 2010 levels.

The reality is, worry about Europe’s structure — and its misguided policies, leading to more worry, have led to a flood of speculative money into other currencies, including the Dollar, the Yen, and, of course, the Swiss Franc.  This has little to do with the fundamentals in these other countries.  It is as if speculative cross-border money such as that wielded by PIMCO has decided that it will punish (yes, punish) those countries whose fiscal houses are, while still flimsy, in sounder order, by making their exports less competitive and travel to them more expensive.    In the U.S., the various QEs have somewhat checked, but not stopped, this trend.

So there are really two ways of viewing all of this.  Under Gross’ view, the central banks are intervening and each QE is a deus ex machina in a world that would otherwise be place full of speculative happiness and joy.  The other way of viewing it, the correct way, is that central banks are reacting to externalities caused by the curency markets.  They are saying, “yo, we have an unemployment mandate, or even if not, we will not let the citizens of our countries be punished by the ineptitude of the governments in other countries.  Free-floating exchange rates are great and all, but even a free exchange market can create externalities — via people like you, Mr. Gross.  It can impose costs on relatively sounder countries that are inequitable.”

It really is difficult for me to believe that Mr. Gross is actually such a one-dimensional thinker.  Maybe he is, but I doubt it.  So what I think he’s really doing is whining (respectfully, sir) and attempting to bully, attempting once again to be the bond vigilante of old, as he did when he disastrously predicted a few years ago that U.S. Treasuries were in serious trouble, and he expunged them from (if I recall) PIMCO’s largest fund.

But here’s what Gross doesn’t understand or will not admit.  Bond vigilantes can only exist when there is not enough demand for cash.  In the late 1990’s, sir, you could be a bond vigilante, because everybody wanted to put his or her money instead into Microsoft stock at a 60 P/E, and Coke (Coke!) at a 40 P/E.  That was where all the demand was.  ”Treasuries?  Yeck!” said people.  But not anymore.  Not now.  Because that’s the real issue now: there is simply not enough cash to absorb all of the demand for cash, Mr. Gross.  That’s what we get in a still-freaked-out deleveraging world.  And you can’t change it, Mr. Gross.  PIMCO is big, but the world is a lot bigger.  And central banks aren’t adulterating the hamburgers with more horsemeat.  They are making more hamburgers!

A Quick Check-In With Johnson & Johnson

I have owned shares of Johnson & Johnson ($JNJ) for quite some time.  I first bought during the financial crisis at about $55/share.  I doubled my stake in May 2010 at about $67/share.  In April 2011 I upped my position by 25% at just under $60/share, when I estimated an intrinsic value somewhere between $63 and $68/share.  In May 2012 I did another DCF analysis (which I freely acknowledge is largely bull) and found an intrinsic value of around $65.60, but since the stock was at $64/share then, I didn’t add.  I have sold nothing, and today the stock trades at $76.04, as of this moment in time.

Now it’s time for a very quick check-up.  First, it’s important for you to understand something.  In my prior analyses, I used to always use a WACC of 10 or 11 for large companies, as my discount rate, period.  I no longer do.  Somebody famous had said that was the conservative value investor thing to do, so I did it.  Now I use the actual WACC for the particular company.  I think WACC for all its flaws is the most appropriate discount rate for a company’s future cash flows.  If you think I’m wrong, feel free to tell me so.  Here is a terrific old explainer from Morningstar that agrees with me though, which also refers you back to this.

You can get various analyses of JNJ’s WACC, but they all range between 6% and 7% these days.  I’m going with 7%, because it’s higher than what I have seen out there, and the higher the discount rate, the less the stock is worth, all other things held equal.  (I.e., that’s the conservative choice.)  Since JNJ’s WACC used to be around 8%, too, it makes sense to use a higher-than-current-day WACC, to account for possible upwards variation over time in my prospective DCF analysis.

As you can see on my sheet, this lower WACC means JNJ is worth more than I thought it was.  However, growth has sucked so much in recent years that I’m only assuming it can grow at a 1.5% rate for the next ten years, with 2% perpetuity.  (Yes, I realize it’s arguably absurd to include perpetuity growth in a calculation at all.)   I get an intrinsic value in the range of roughly $86/share, and a buy price at around $69.50, to assign a 20% discount to estimated intrinsic value.  If JNJ grows more than expected while maintaining a similar WACC (note that its WACC was correspondingly higher ten years ago when its growth was stronger), it could theoretically be more significantly undervalued.

So, I still don’t think this is a massive buy, but within the constellation of dividend stalwarts, it’s not exactly massively overvalued either.  I realize Buffett and/or his new young studs have sold off $BRK’s stake lately to fund other purchases, but they’re playing a different game than I am.  I think it’s a straight up buy at anything less than $70/share, and it’s a straight up sell over $100/share, and anything in between is a gray area where there are reasonable arguments either way.  

I choose to continue to hold because of my low cost basis, my desire not to pay taxes on a sale, the lack of compelling investment ideas (haven’t had tons of time to look at new companies), the dividend, the strength of the company notwithstanding recent hiccups, and the chance it may grow more than I expect it currently to grow.  I think there’s even a decent argument for adding, just as a place to park capital in relative low-beta (0.54 as of this writing) safety, and get a decent yield.  So there you have it.  And now, it’s time to go to work and do my real job.

Why AT&T is a Jerk and Radio Shack is a Tragic Figure

This is an anecdotal tale.  It’s not evidence.  But I had an experience in the last week which harmonized with my preexisting opinions of AT&T (T) and I hope gave me some insight into a company I have previously dissed, Radio Shack (RSH).  The former is a venal behemoth.  The latter could be something really cool, in a way that I did not really understand before, but it may not have the wherewithal to live up to its mission.

To begin, I have AT&T cable internet and land-line phone service.  Aside:  I feel I must justify having the land-line, given the age we live in.  When I was living in lower Manhattan during 9/11 and later the 2003 blackout, there was no cellphone service because everyone was on their cellphones.  The cell networks are not designed for that — they’re only designed for a limited number of people to use them at any given time, at least as of this post date.  It’s like a bank: no bank actually physically possesses all of the money we deposit.  As Jimmy Stewart said in It’s a Wonderful Life, “You’re thinking of this place all wrong.  As if I had the money back in a safe.  The money’s not here.  Your money’s in Joe’s house…right next to yours….”  Each depends upon only a limited number of its customers accessing its services at any given time.  This is built into the business model.  Anyway, since we live in Southern California now, we think it’s important to maintain a land-line, and keep a phone that does not need to be plugged into the wall, just in case in an earthquake, electricity goes out and 20 million people predictably and disastrously try to get on their cellphones at the same time. 

But I digress.  My modem stopped working properly last week at home, and our family was disconnected from the internet.  (Quelle horreur!!!)  We called AT&T and they told us we had to buy a new one, that this often happened, and that we were out of the 1-year warranty, oh, and they were so sorry.  $100, the rep said, two different reps actually.  Couldn’t just be any old modem, had to be compatible.  Oh, and they reminded us that we had purchased the modem when we signed up, and it wasn’t something we leased or that they just replaced, of course.

Well, that was irritating.  I was going to suck it up, once I got finished cursing and threatening to switch us to a new ISP.  But what my genius wife noted was the “often happened” language.  So she started googling, and quickly found out it does happen often — VERY often.  Not only that, it is: 1) a problem with the power supply, NOT the modem itself, and a new power supply costs something like $15; and 2) the problem with the power supply is one of the capacitors, which has a rep for going bad, and if you take apart your power supply you can replace that capacitor for as little as $2.  

These two possible solutions are incredibly well-documented across-the-web.  In fact there is even an 18-month-old Youtube video showing how to replace the capacitor in the power supply!  It has gotten nearly 6,000 views as of the date of this post, and 12 comments.

Yet, AT&T is still telling people when they call in that their modem itself is dead and we need to buy a new one for $100.  That speaks either to the company’s disorganization, or to an intense level of contempt for its consumers’ intelligence.  Either way, it does not speak well of AT&T.  AT&T showed itself to be precisely what I imagine it is:  a backwards (at best) behemoth,  or (at worst) a company that deliberately will deceive its customers to make what I can only imagine is a tiny amount of extra profit.  I’m assuming the former.  But still, boooo.

But moving on.  Naturally, I decided I was going to take apart my power supply and fix the capacitor.  (Because that sounded much more fun than simply buying a new power supply, to be honest, and it was a Sunday afternoon.)  So I did.  And here’s the thing.  Radio Shack sells capacitors!  If you go into your average Radio Shack, along with its sad forays into cell phone covers, and its even sadder forays into selling the kind of electronics you might see in a Brookstone store, Radio Shack stores apparently carry a few things you might actually imagine them carrying, like weird cables you’ve never seen before if you don’t play Dungeons & Dragons, and also, a couple of drawers of capacitors.  I was elated.

The store employed three people, one of whom was helping another customer.  I asked one of the others to help me, and it very quickly became clear that she did not have the faintest idea what a capacitor was; her knowledge extended basically to knowing where it the drawers filled with them were located in the store.  In fact, she seemed shocked that somebody would actually come in and seek to purchase one of the things.  This is not cool.  Radio Shack is supposed to have people working for it who used to design ham radios as kids or take apart their computers and turn them into popcorn poppers.  When Radio Shack has people working for it who don’t know anything about electronics, it is not Radio Shack.  Calling itself “The Shack” and trying to sell more studded iPhone covers is never going to fix that problem.

Long story long, The Shack also did not sell the capacitor I wanted individually.  I had to buy a pack of about ten different ones, which still only cost about $4.  Then I bought a very basic soldering kit (because you need that to replace a capacitor) for $12.  I thought it was cool that Radio Shack sold the kits.  I came home and very quickly and successfully cracked open my power supply and replaced the offending capacitor.  I sit here today typing on a computer whose internet is delivered over a perfectly functioning model (contrary to AT&T’s representations) that is plugged into the wall utilizing a power supply that has been re-capacitor-ized and taped back together.

What did I learn?  Well, I learned that cylindrical capacitors bulge at the end when they go bad.  I also learned that AT&T kind of stinks, which I already knew (though I’ve owned a few shares since Fall 2010 — hey, I’m a capitalist, and they make money).  

But I think the most interesting thing I learned is that there is a place in the world for Radio Shack.  That place is helping people cheaply fix the crap that other crappy tech/phone/cable companies sell us.  It could be the Autozone of electronics, if you will.  It could even come up with videos like the one I linked to above, or endorse them, or place ads on them to get people into its stores.  Unfortunately, Radio Shack is not doing this, and just as importantly, it is not hiring people who add value.  I sought out Radio Shack because I had a dim almost tribalistic or buried cultural memory of what it used to be when I was a kid in the late 80s and Christian Slater did that movie about he high school kid who is a ham radio rebel.  I figured out how to apply the lessons in the Youtube video.  And I could have simply bought that capacitor on Amazon, and perhaps should have, because going to an actual store added almost no value.  At the very least, Radio Shack needs to try to hire people who can add value, who can help, whose contribution is more than showing you what drawer to look in and making you show them your ID when you make a $16 credit card purchase.  As it focuses more on selling those frigging studded iPhone covers, it has instead lost its nerdy little soul.

The Pensions Crisis That Isn’t

There is a lot of talk about unfunded pensions, both in the public sector, and with regard to companies.  For example, here is Forbes from 2010.  Here is TIME from 2012.  Here is a website that looks like the design was last updated in 1996, called “pensiontsunami.”  

Now despite my deliberately-provocative title, I’m not saying everything is peaches and cream.  But the situation is a LOT less worrisome than you think.  It’s important to understand how ideology comes into play in such arguments.  It is no accident that conservatives are the ones typically screaming about such issues.  Conservatives more commonly hate private corporate pension plans (they prefer 401ks).  And conservatives loathe government pensions for “public sector union” employees.  Ideology.

How does it impact analysis?  Well I wish to speak of corporate pensions today.  Here’s a recent NYT article about how AT&T took a huge earnings hit because of its so-called underfunded pension.  But why?  Why? 

Because interest rates are low.  Because of the Fed’s so-called ZIRP policy.  Altria gives a perfect example of this on its 2011 annual report, available here.  On page 33 it notes how it reduced its discount rate on its obligations from 5.5% in 2010 to 5.0% in 2011.  Because interest rates have dropped.  Because of the Fed’s actions.  

As anyone with even a passing familiarity with discounted cash flow analysis knows, when you drop the discount rate at which you discount the future cash flows of a company, you increase the value of those cash flows, and the value of the company.  That is why *estimating* (there is no such thing as knowing) a correct discount rate is so important.  Go on, you can try it here, with this spreadsheet I put together in May 2012 for pre-spinoff Abbott Laboratories.  Just mess around with the number in field C-16.

The corollary is that when a company reduces the discount rate at which it values its future obligations, the value of those obligations rises.  That is exactly what companies (and municipalities) have been forced to do over the last four or so years because of ZIRP.

This matters.  This matters to you if you are a long term investor.  Many of the same people who are screaming about ZIRP are also screaming about pension liabilities.  And they are wrong on both accounts.  I have explained elsewhere why ZIRP is necessary during a private deleveraging (and like 95% of actual economists agree), and here above I explain, hopefully, why the second point is wrong.  But let me state it as clearly as a possibly can:  when ZIRP ends, and interest rates rise, unfunded pension liabilities are going to drop, because the discount rate used to calculate those future decades of obligations is going to rise.  When that happens, it will positively impact corporate earnings, and municipal finances.

What are the criticisms of this idea?  Well, the one I most commonly hear/see is: (hands over ears) “MAH-MAH-MAH-MAH!!!!  I can’t hear you!  Ideological dissonance…., can’t….take…ideological dissonance….!”  

But another more intelligent criticism is that because corporations are being forced to hold cash in such low-interest bearing Treasury bonds now, they are permanently reducing the amounts they have available to pay for those future liabilities, so it evens out.  

Here is some math that doesn’t quite prove I’m right, but shows I’m more right.  Holding other things constant, assuming 2% growth in liabilities. $10B starting liability, a reduction in the discount rate from 5.5% to 5% increases discounted liabilities by over $2.05B!  By contrast, a reduction in the rates a company can earn on equivalent starting pension assets for five years (dating from 2008-2013) is only $0.85B.  

Now obviously its more complicated, because if the company had that $0.85B it could earn a non-linear amount of additional money in the future, by compounding.  But by turn, I only assumed a 2% growth in liabilities on the negative side.  Up that, and the difference becomes more stark.  And, moreover, I think I’m accounting for that missed asset-compounding by discounting the obligations to present value, since what I’m talking about in both instances are present values.  (Happy to hear if you disagree, since I threw this whole post together in about 30 minutes.)

Even if there is some evening out, ALL we hear about is the bad side.  The point is, if you are a long-term investor, you need to strip out ideology.  Daily traders (some of whom are quite good) can afford to be ideological.  Fund managers who trade constantly can afford to be.  But if you are thinking about what the true value of a company is, you need to know that the pensions crisis is just not as bad as people are telling you that it is, and make some attempt to calculate what the real story is.  This matters.

Your Hybrid is a CO2 Polluter And You Should Offset Instead

I recently had an exchange on Twitter that prompted me to convert a series of tweets I have been making into an honest-to-goodness post.  It has been awhile.  

The crux of the matter is this: if our real motivation in making “greener” car purchases is to reduce our carbon footprint, hybrids do a relatively bad job.  You are probably better off simply keeping your “dirty” pure gasoline vehicle, and voluntarily paying a company like Terrapass for carbon offsets.  These offsets cost about $5.95 per 1,000 pounds of CO2 emissions, and are pretty well verified.  What hybrids are really about is convincing people they are doing more good for the world than they really are.  And there is an argument that because the purchase of one removes the psychological incentive to offset CO2 emissions, they may actually be harmful from a global warming perspective. 

So what’s the math?  

Well, let’s take a Toyota Highlander.  The hybrid starts at about $40,000.  At that same link you can see that the SE starts at $34,400 and the Limited starts at $37,800.  The base hybrid has features other than the hybrid power-train that put it in between those two models.  For example, it does not have the smartkey system, three-zone climate control, or 8-way power driver’s seat with lumbar support, which the non-hybrid Limited has.  So basically, Toyota has set the features/pricing up to make a direct comparison either to the SE or the Limited difficult.  That’s probably not an accident.  But let’s split the baby and say the hybrid is roughly equivalent to an upgraded SE valued at maybe $37,000.  That’s a $3,000 price difference from the hybrid, yo.  

Here is what you could buy with that $3,000.  First, it costs about $105 per year to offset the 2WD non-hybrid Highlander’s emissions per year, as you can calculate here.  So assuming you paid for all of your offsets today, you could offset $3,000/$105 = 25.57 YEARS of CO2 emissions with the amount you are paying extra for the hybrid version.  Or you could offset the entire lifespan of your SE/Limited-mix Highlander and the entire lifespan of your family’s second car.

And keep in mind that when you buy the hybrid you are offsetting NO CO2, zero, and, wait for it, you are only getting a bump up from 18/24 city/highway mileage to 28/28.  28 mpg.  To offset the hybrid highlander’s CO2 for an equivalent 25.57 years would cost you an additional $2,300 or so.

People.  I realize you’re going to save money on gas, too, but at 28 mpg, not much, and if your motivation is to cut CO2 emissions, DON’T BUY A HYBRID.  Get an offset.

You can do this math all day.  EVs are even worse.  Let’s just assume the lithium batteries do not exacerbate environmental problems.  The Chevrolet Volt retails for about $39,145.  Let’s be generous little devils and just assume you can cut the price to $32,000 using tax subsidies.  (So we’re talking about your cost, though keep in mind that everyone else is implicitly paying for the $7,000 extra, to GM, that paragon of virtue, and that this remainder could also be used to pay for CO2 offsets instead, but is not being so-used, by the government.)  

For that you get a small car that only seats four people and does not come standard with leather seats.  Let’s assume you drive it only in EV mode.  

Well, a similar Chevrolet Cruze Eco is actually both longer and taller than a Volt, and seats five because it doesn’t have a massive battery pack in it.  The automatic Eco version gets 42 mpg on the highway and retails for $20,875.  I’m going to use that price, though I have in front of my face a newspaper advertising a brand new one on sale for $15,999 after a $3,786 dealer discount and $1,000 factory rebate.  

So that list price on the Cruze Eco alone is about $11,000 less than the SUBSIDIZED version of the Volt.  Assuming you drive 12,000 miles per year, the Cruze Eco costs about $75/year to offset.  By getting the Cruze Eco instead of the Volt, you could use the difference in money to offset…ONE HUNDRED AND FORTY SIX YEARS of the Cruze Eco’s CO2 emissions.  And keep in mind that after you have bought that Volt, you are doing nothing to offset all of the CO2 emissions from any coal or natural gas power plants that it is drawing juice from.

Similar math applies to all hybrids and EVs.

Now I’m not saying never buy a hybrid.  My family owns a Prius, which my wife uses on a very long commute.  But we also own a giant 8-person SUV, as to which we pay $110/year to offset all of its CO2 emissions.  Is my SUV worse than your Volt for which you pay zero to offset any of your power plant’s CO2 emissions?  I don’t think so.

The point of this post is to get people to think differently about the economics of getting rid of CO2.  There are a lot of companies out there that do offsets, and there will be more in the future.  I think Terrapass is pretty reputable.  

Allow me to anticipate some criticisms:

Yes, I get that some people are motivated by reducing dependence on foreign oil and/or not supporting fracking.  But buy a hybrid and you are still supporting foreign oil though, and at 28 mpg, in a Highlander Hybrid you are supporting it quite heavily.  And in most states in a Volt you are supporting a significant amount of coal power plant emissions, which is not healthy.

Don’t think the Cruze Eco is a good comp for the Volt?  Why?  Same size.  Many similar features and in a Cruze Eco you can actually maybe seat five, which is impossible in a Volt.  A standard Volt doesn’t come with leather either.  Step away from the Eco and the Cruze LTZ has similar economics and comes with leather and lots of other goodies.  The fact is that companies have done a great job of selling hybrids as luxury cars.  Thus, people who drive them can still feel like they have some of the prestige of driving a BMW or a Cadillac.  Scarlett Johansson and other stars famously started being driven in a Prius and other hybrids to the Oscars around 2005 or so.  Which is typical of the marketing and perception of hybrids as high-end.  

But the performance is just not remotely comparable overall to a luxury vehicle.  And the standard features are just not remotely equivalent either.  It’s a bit of a scam, friends.  It is green-washing.  Buy a hybrid and people will think you are a good person and give you business, have sex with you, seat you at a better table, etc., etc.  Though it’s better than a non-offset, non-hybrid to be sure.  They’ll think you’re actually rich and COULD buy a BMW 7-series, but you just choose to be virtuous person.  People won’t think that if you drive a Chevy Cruze Eco and pay $80/year to offset, bub!  So accordingly people drive the hybrid.  It’s perception.

I also get that you are saving money on gas by buying the hybrid.  But do you know what?  Not MUCH more than by buying a Cruze Eco getting 42 mpg on the highway.  Not MUCH more if you are still (maybe) getting 28 mpg in a Highlander Hybrid.  And again, the point is that if we really care about the environment and global warming, the appropriate question is not what your gas costs are (though you can also incorporate that into the total economics), it is what is your remaining carbon footprint?