Bring in the Bears!

I'm getting excited about the capital markets these days. I look forward to oil prices hitting new records and the Dow Jones Industrial Average dropping triple-digit points. The valuations are becoming increasingly attractive - especially the non-US financial institutions.

All of this is possible thanks to some smart investment bankers and incompetent ratings' agencies (like Moody's), risk managers and portfolio managers.

Why the investment bankers? Because they were able to "package" various sub-prime mortgages into a new type of investment and then sell it (usually to banks) for a profit. The people at ratings' agencies played their part by giving these new investments an "investment-grade" rating. It is now clear that they did not understand what they were rating. They figured the packaged investment was sufficiently diversified. I guess they did not understand the terms of the mortgage (i.e. low "teaser rates") nor the borrowers.

As the US homeowners started to default on their payments, the banks who bought these investments now have no idea what their investments are really worth - hence the write-downs. What were the people at "Risk Management" doing while these investments were being bought in the billions? Sleeping, of course! And last, but not least, the portfolio managers. How could they break one of the golden rules of investing - not to buy things you do not understand?

If this continues for a while more, I will be making some substantial long-term investments. I look forward to doing that.

Keep it up and bring in the bears (and sheep)!

Truth About Corn-Based Ethanol

One of the arguments supporting the use of corn-based ethanol as fuel is that when it is used as an automotive fuel, either by itself or in an ethanol-gasoline blend, the result is less carbon monoxide and lower emissions of hydrocarbons into the air.

However, the major flaw with corn-based ethanol is that the production process requires buring of 1L of petroleum to make 1L of ethanol! Thus, any benefit derived by using ethanol is fully nullified.

At least in Brazil, they are using sugarcane-based ethanol, which uses significantly less energy to make 1L of ethanol than corn-based ethanol.

The US/European politicians are doing a good job misleading the public about corn-based ethanol as a "green" alternative energy source.

As more and more corn is diverted for ethanol production, what will happen to the world's food supply?

My Take on Investing and Life

On Technical Analysis (TA):

Nothing but mumbo-jumbo. Makes enough sense that it is easy to fall prey for it - the lure of fast money, after all, is too much for most people. I myself have tried it and failed miserably. I learned my lesson. I think if you live by TA, then you will die by TA. TA is an art, rather than a skill. Most people cannot expect to make any money using TA. See A Tale of the Speculator and Technical Analysis for more.

On gambling:

I don't gamble in the stock market. Nor do I play the lottery. Taking some calculated risks in the market is not the same as gambling. I'm primarily a long-term investor with an investment horizon of 10 years or more. I won't be jumping off a bridge if the market drops 30% tomorrow!

On volatility:

I love market volatility. I think most people misuse that word; they use it without even understanding what it means. They think volatility is bad. In fact, volatility is what gives me the opportunity to make money in the stock market. Whether I actually exploit those opportunities is another story! One of my New Year's resolution is to have more courage to open doors when investment opportunities knock. I think I'm on the right track.

On Modern Portfolio Theory:

Not everything needs to be "measured" or "quantified". Security analysts these days are obsessed with measuring everything from risk to volatility. Standard deviation and variance are standard measures of risk, and volatility can be measured by beta. Small investors cannot be expected to know how to calculate these things and are therefore easy to entice to seek professional help. Nor can anyone expect small investors to know how to construct a portfolio in which the correlation of any pairs of securities is close to zero (this is one of the definitions of a "diversified portfolio"). The calculations involved here are indeed mind-boggling! I don't think one needs to know these calculations to make money in the market. The impression given to a small investor is that you cannot do it alone. I disagree. I think in most cases you can do better alone. In fact, I think you are better off not knowing these things!

On EBIT and EBITDA:

Analysts pay too much attention to useless numbers like EBIT (Earnings Before Interest and Taxes) and EBITDA (Earnings Before Interest Taxes Depreciation and Amortization). The problem with these numbers is that interest and taxes are "real" expenses that we cannot simply ignore. What is the purpose of excluding interest and taxes from earnings when both have to be paid? As far as non-cash expenses like depreciation are concerned, they too are very real. You will find out exactly what depreciation is if you buy a car today and sell it tomorrow, or if you've ever had to do repairs/maintenance on your home. Depreciation accounts for these expenses.

On analyst ratings and recommendations:

Analysts are constantly upgrading and downgrading stocks. They have to do this to justify their existence. Frankly speaking, I don't think it is possible to make money listening to analyst recommendations. Many times I have seen analysts upgrading a stock when it has hit a 52-week high or even an all-time high, and downgrading a stock when it has been beaten down by too much pessimism. Not that they're always wrong, but they're wrong enough times to blur the distinction between a professional and an amateur. Generally speaking, I tend to pay more attention to their research on a company (which can be insightful) than their rating or recommendation.

On EPS:

Assuming all else is equal, is a company that earns $5.00/share a better value than a company that earns $2.50/share? Yes. What about a company that earns -$5.00/share compared to one that earns -$2.50/share? Which one is a better value? It is not necessarily the company that earns -$2.50/share. An understanding of how EPS is calculated will clarify why this is so. EPS is calculated by dividing net income by the number of shares outstanding. The fewer shares a company has outstanding the more income is attributed to each share (and therefore, each shareholder). This means that if a company has a large loss, then it can make its loss appear smaller, in EPS terms, by simply issuing more shares, which is bad for existing shareholders. This is why a negative EPS is not always very meaningful.

On charity:

If I donate, I want to donate because I want to. If I volunteer, I want to volunteer without expecting anything in return. It's sad to see some people who volunteer because they want a prestigious 'certificate of recognition'. Donating a suitcase full of clothes from Canada to a remote mountain village in India is probably the best thing I have ever done in my life. I think I was inspired by Dr. Prakash Amte (son of late Baba Amte).

On mountains:

Why do I love the mountains so much? They give me immeasurable peace of mind and happiness. There's a certain excitement in hearing and watching a bird swoosh past you. Watching an everyday phenomenon - a sunset - is a much-anticipated event and a real treat for the eyes. Every time I'm there, I say to myself, "what a wonderful world!"

Besides that, I have learned so many things about myself because of mountaineering - that I have an incredible amount of energy and will power. Now I just hope to harvest some of that energy and will power for other things.

My life ain't promised but it'll sure get better... until then, you'll find me in a cubicle!

Daylight Saving Time

Does the environment really benefit from Daylight Saving Time? In theory, an extra hour of daylight will replace an hour of electrical light. However, for all practical purposes, more energy is conserved by moving the clock forward by one hour. Energy-hungry air-conditioners are used an hour longer by adding an extra hour of sunlight to evenings. Most of the energy comes by burning climate-warming coal.

In 2007, U.S. President George W. Bush touted enacting earlier starting dates and later ending dates for daylight time in the name of "energy conservation".

But who really benefits by starting daylight saving early? It's certainly not the environment! The retailers lobbied strongly to start daylight saving earlier. An extra hour of daylight in the evening means more time for shopping after work.

After all, nobody likes shopping when it's dark outside...

Raj Thackeray and MNS

I just have one thing to say about Raj Thackeray and his MNS – put those idiots in prison where they belong and throw away the key!

CFA

After several anxious weeks, I finally found out yesterday that I've passed the CFA Level 1 examination - in my first attempt. It feels good, especially after knowing that only 39% of all candidates who wrote the exam passed it!

To the uninitiated, CFA - Chartered Financial Analyst - is a worldwide recognized designation conferred by the CFA Institute (http://www.cfainstitute.com/). It is earned after passing three exams (levels) and by having some minimum working experience in the Investment industry.

With the latest passing rates of about 40% for Level 1, 40% for Level 2 and 50% for Level 3, simple math shows that only 8 out of every 100 candidates pass all three levels!

It is practically a requirement these days to be a CFA Charterholder to be considered for a position of an Investment/Portfolio Manager. I think I will be a good portfolio manager.

The only reason the exam is difficult is because of the depth of the material that is covered. There are 6 text books; about 700 pages each!

I will start preparing for Level 2, which is considered to be the hardest, later this year. I will write the exam in June 2009. I don't think I have enough time to study to write the exam in June 2008.

I still don't know what I want to do in my life. There are many uncertainties - I guess we all do. I just hope to make a little, give a little, and just be happy and contented! :)

Discover Yourself

Last December, I went mountaineering again in India - to "discover India", so to speak. However, everytime I go back to the Sahyadri mountains, not only do I discover India, but I discover myself, or I should say more about myself.

It's an amazing feeling! To know that you are capable of more than you thought you were; more than your own family thought you were. Every drop of sweat is worth it when you reach the summit and feel the cool air while you indulge in the most beautiful of sights.

It doesn't take a lot to make you happy when you're in nature. Just the sight of a butterfly or kids playing a game of cricket in the countryside brings a smile to your face. What a wonderful world!

It is not too often that one gets to live in the present. We constantly think about our past and the future ... while taking a shower, commuting to work, or sitting in our little cubicles thinking we're doing important work. Mountaineering allows me to live in the present. It is a state when there is nothing but now in my mind. To live in the present - what a rare treat that is!

TSX-MX Merger Freebee

The Toronto Stock Exchange (TMX) and Montreal Exchange (MX) announced today that they are merging to form Toronto Montreal Exchange (TMX).

I had purchased shares of MX a few months ago in anticipation of this event. Given the consolidation in the world exchanges (e.g. NYSE Euronext), it was plain to me that this merger was inevitable.

I thought MX would either merge with TSX or get taken over by New York Mercantile Exchange (Nymex) which already owns 10% of MX. This has yielded an almost risk-free profit of nearly 30% in less than 4 months (or 123% annualized).

I don't think TMX can stay independent for too long. I wouldn't be surprised if TMX eventually gets taken over by private equity groups or other larger exchanges. However, I don't think this will happen in a matter of few months, but rather a couple of years.

TSX will pay me $13.95 in cash for my MX shares, plus 0.5 share of TSX Group for every 1 share of MX. I will keep the new shares for another freebee when TMX gets taken over :)