links for 12/2/07

• Good and lengthy discussion on how we arrived at the current environment including comments on how commercial paper fits into the subprime story. Part 1 – Part 2 – Part 3 – Part 4 – Part 5
• Unseen China – a documentary about the losers of China’s new economy. Almost an hour in length, with the first half focusing on the laid off workers of a former state-owned factory in Zhengzhou. Some of the stories, such as the police hiring thugs to punish protest organizers are so reminiscent of the early days of protest organization in the US. Some parts were just so pathetic that it felt very uncomfortable to watch. And the second half features Beijing families evicted from their homes to make way for Olympics-related construction. One such man took their case to court and was told by the judge even though his case was legally correct, the judge’s superior had ordered all such cases to be ruled against the little guy. What corruption!

links for 11/3/07

• 11 Useful Stem Cell Traits – Pretty good rundown of what makes a good stem cell and what the technological hurdles are.
• 5 Tips to Spot a Hot (or Not) IPO – I particularly appreciate tips #2, #4, and #5 since they are ways to “read between the lines” when reading IPO prospectuses. Many a Wall Street white-collar is highly paid to hide things between those lines.
• Red Flags at Terra Nostra Resources – The lack of scrutiny in the Chinese stock market is just wild. This is a pretty good writeup of one stock that is “a paper mill masquerading as a metal mill. The dilution is out of control, run by a family with serious history of securities fraud run out of a Bahamian holding company.” I always love a good drama!

Tax Fairness, and Who’s an Entrepreneur?

In past months, there has been a ridiculous congressional controversy brewing around the taxation of private equity salaries, particularly in how private equity managers are taxed capital gains for their take-home portion of the gains (instead of at the higher income tax rate that the rest of us pay). I have heard about hedge funds and buyout firms (what my friends usually refer to as “PE”) rising up in arms, and now venture capital are jumping into this circus too.

Throughout this all, I have frankly never heard any good reason why they deserve this advantageous tax rate. Among those reasons are:

1. Excuse: Because PE firms actually have negative years and that not every year is a profitable one, increasing the tax rate would make it harder for them to be profitable over business cycles. My rebuttal: that actually sounds like every other company in the world economy, which should not earn any special sympathy for one of the most lucrative industries in human history.
2. Excuse: PE/HF/VCs deserve special tax treatment because they provide amazing benefits to society, and that higher tax rates would discourage them from working so hard at what they do. Rebuttal: that’s explains why we tax teachers and law enforcement at normal income rates, right?
3. Excuse: Higher taxes would drive the PE industry would move overseas. Rebuttal: US-based VC and LBO will not move offshore, away from the companies they invest in, and as for US-based hedge funds… I somehow can’t imagine sophisticated hedge fund professionals moving from New York to some sparse island country.

One of the new tricks being used by the VC contingent is to call themselves entrepreneurs and to imply that taxing them would hamper the dynamism of the startup economy. One of the founding executives of my company has written a great response to a NYTimes piece that equated VCs with entrepreneurs. It’s a pretty thoughtful writeup and, actually, it also expresses how proud I am to have ended up doing what I’m currently doing.

links for 8/26/07

• A veritable insurance software opportunity: Key Health IT opportunity: Medicare Says It Won’t Cover Hospital Error

• These three articles helped me understand the subprime crisis: Subprime crisis: Greenspan’s Legacy, How Credit Got So Easy, and Hedge fund letter outlines how we got into this mess
• Why in the world are anti-gentrification forces stopping this Mission District mechanic from building an apartment next to his stop and renting to his mechanics? Anti-gentrification forces stymie housing development

Non-market capitalization weighted ETFs

I have recently been re-allocating my retirement funds and my parents’ retirement funds following these guidelines, buying diversified passively managed funds wherever possible and also diversifying between domestic and international stock funds. But what is disappointing is how most available ETFs are weighted by market capitalization. (What is even more frustrating is that I sometimes find that actively managed funds are the only options available for international investing in certain retirement plans.)

There are a myriad ways to index, and market cap weighting is almost the worst of them. At any given time, it systematically overweights overvalued stocks and underweights undervalued stocks, and since the overweighted stocks usually have more weight on the fund than the underweighted stocks, the fund is often more expensive than it should be. This runr counter to the commonsense of buying cheap and selling expensive; market cap weighted funds systematically hold more of the expensive and less of the cheap.

Statistically, there are better ways to index. I can’t remember exactly, but I have seen a volatility weighted or an inverse-volatility weighted fund plotted against the S&P500, and it outperformed the S&P index by a long shot.

I feel the same way about market cap weighted indices as Churchill felt about democracy as a form of government: it is the worst way to invest very-very-long-term money, except for all the other ways. And I will continue to feel this way until I find some promising non-market cap weighted ETFs. Actually, I think that if somebody founded an ETF company that promotes non-market cap weighted ETFs and successfully wins the trust of investors while charging low service fees, that person will have performed a tremendous service for Americans everywhere.

My Personal Finance Guide

I have thrown together a personal finance guide based on common questions I have heard friends and coworkers wonder about. It was actually a lot of fun to write as it made me think through stock option tax issues, which I had found very confusing, and about portfolio investing strategies.

Note that this guide is very informal advice of the sort that I would give friends, not something to yell at me for if you lose money following anything in these pages. The information is also selective in that, although much more can be written on each topic, what I have written reflects the information that I found important to myself and my peers.

Samsonite – Where all the Turnarounds be at?

I wish I could find more turnaround stocks. Turnaround investing is the ultimate form of value investing: finding a company that has a decent brand but has fallen on hard times but is potentially on the verge of becoming successful again. Oftentimes, the stock is deeply undervalued since the market doesn’t expect much at all from these companies.

SAMC has been my best stock so far. This stable luggage maker had been puttering along but in the last year had hired some executives from Louis Vuitton and was releasing a luxury line of luggage. One of these new Samsonite stores had opened in Union Square, so I checked it out, spoke to the managers about how things were selling, thought “hmm… conspicuous consumers would like expensive luggage” and decided that Samsonite’s margins would soon improve at least modestly and maybe dramatically. I accumulated SAMC at $1.00 and again at $1.25 before some private equity firm decided it was worth $1.49. Shame, I think it had an even brighter future than that. The only thing I didn’t like about SAMC at the time I bought was that it had lots of debt on its balance sheet, but given the stable nature of their business (luggage sales don’t fluctuate all that much) the credit risk seemed reasonable.

Now I’m holding MOT, recently one of the most maligned stocks. It’s pretty funny, but when Motorola last reported earnings way below its initial projections, its stock price didn’t even drop, meaning that Wall Street already had abysmally low expectations for this company, so I knew I was holding a cheap stock. Hopefully that discount means it has a greater chance of outperforming the market in the coming few years, unless of course it doesn’t.

SIRF – Betting on Growth is High Risk

I just sold my first stock, SIRF, and it was for a 30% loss. The company makes semiconductor chipsets for GPS devices and is the market leader in this relatively young and booming industry.

The reasons I initially bought this stock were because:

• I saw all the devices that use GPS chips, like personal navigation devices for your car or many new cell phones, and convinced myself that it was a booming market. I selected SIRF to gain exposure to this market trend because it was the “Intel of GPS chipsets.”
• Balance sheet looked fine. Almost zero debt and decent cash balance.
• Earnings were coming out the very next day when I bought, and I was in a rush to profit off positive earnings announcements.

Unfortunately, SIRF [something about earnings tanking] and I lost 10% of my investment right off the bat. I continued to hold because I believed that the stock would eventually bounce, but it continued to slide gradually, then precipitously in the past few weeks’ subprime-related jitters.

Here are the lessons I learned:

• I did not recognize it at the time, but the price I bought at was already super-optimistic about the future performance of the company. While most growth stocks often trade at high multiples versus its peers, I should have viewed this with more caution.
• I ignored negative signs. The SIRF management had recently sold shares at an even higher valuation than when I bought, which should have raised a red flag. Later at the end of July we would find out that Motorola, a major customer, would stall on its contract, thereby delaying revenue to SIRF. If I had been paying any attention to the news in May about how much trouble Motorola was having, I might not had been caught so by surprise in July.
• I don’t know the market. I have little real insight into this semiconductor market, or any semiconductor market, so I must have somehow convinced myself that I was more savvy than I am. In this respect, I would have been better holding GRMN because I could get a feel for how many friends are buying Garmin navigators for their cars, but with SIRF I have no real way of knowing more than Wall Street about SIRF’s business.
• Beware of any company called the “Intel of this market” or the “IBM of that market.” When I heard the buzz about SIRF as “Intel of the GPS chipset market” and confirmed that SIRF was the market share leader, that was sadly the end of my analysis on this respect. The reality is that SIRF faces much stiffer competition from a whole range of smaller companies as well as larger companies like Broadcom that are getting into the game. In fact, this whole semiconductor industry is ridiculously competitive. Other things being equal, I would have been better off investing in a company in a much less competitive industry.