AndrewChia.com

Source:  Fortune

Highlights

Goldman Sachs Headquarters

1.  Buffett agreed Tuesday to buy $5 billion in Goldman Sachs preferred stock. The deal comes with a rich 10% dividend and the right to buy $5 billion worth of Goldman common stock at a discount.

2.  That’s a steep price for Goldman to pay to raise capital. Oppenheimer analyst Meredith Whitney said Wednesday the deal’s “exorbitantly expensive” terms “provide insight into how truly challenging current market conditions are.”

3.  Goldman marked Buffett’s second splurge during a September market uproar that has sent highly leveraged companies scrambling for fresh sources of funding.

4.  As at June 30, Berkshire had $31 billion in cash and cash equivalents.

Berkshire Hathaway Headquarters

5.  There is still risk in both the Constellation and the Goldman deals – perhaps more so in the case of Goldman, which despite its sterling reputation and deft handling of the mortgage crisis was under attack only last week and may yet meet more turbulence before the financial meltdown is brought under control.

Comments

1.  Cash is Emperor. Again.

2.  Companies with high debt equity ratio means they are highly leveraged.  And high leverage may lead to the results highlighted by this article.

Well, how high is high then?

Warren Buffett recommends a debt-equity ratio of 0.5.  That means if a company’s capital is  $1 million, he should only owe debts up to $500,000.  That is also one of the criteria I use to identify companies on the Bursa Malaysia that we could consider investing in (and also to eliminate those that we should not invest in).  It is in my book Bursa Winners.

However, most people, including some bankers, do not really know ‘how high is high’.  As mentioned in my first book The Final Winner, prior to the 1997 Asian Financial Crisis, banks found a debt-equity ratio of 4 or 5 as acceptable.  (A debt-equity ratio of 0.5 was scorned as ultra-conservative.)  They made lending decisions based on that.  The results were catastrophic.  Danaharta needed to be set up to house the ‘toxic assets’ created by such high gearing.  (Gearing is the term used locally.  It means leverage.)  You see, we had toxic assets even back then, though the term was not yet invented until the recent subprime crisis.

3.  It was not mentioned specifically how much Buffett paid for buying Goldman.  We only know from the article that the terms were excellent.  Let us take a look at Goldman’s chart.

We can see that trading was the most volatile in September 2008, compared to any other month on the chart.  (Look at the spike in volume.)  It ranged from about $85 to $170.  We can only guess that Warren Buffett must have bought between these two prices.  And, if we know him, he should have bought at the lower end of the range.

4.  Goldman’s shares reached a high of $250 in November 2007 in the greatest stock market boom ever, before starting its descent into potentially the greatest stock crash ever.  It went from $250 to $50 in exactly one year.

Learning message:  When the tide goes out, you see who is swimming naked. – Warren Buffett

Source:  Straits Times, Singapore

Highlights

1.   Banks gave poor advice.  Asian retail investors who bought structured products linked to the collapsed US investment bank Lehman Brothers are complaining about poor advice from banks and have urged authorities to save them from losses.

Investors in Hong Kong, Singapore and Indonesia have over the past week been outraged that the bond-like products they purchased were actually complex derivatives and they stood to lose most or all of what they had invested.

2.  Mr Tan Kin Lian, the retired chief executive of Singapore insurance firm NTUC Income, who advises investors through his blog, said many investors bought such products believing these instruments were relatively safe.

‘People who would not take the risk of buying shares have been asked to buy these structured products,’ he said.

He also said authorities should examine the design of such products, which were often ‘grossly unfair’ to investors in terms the risks and rewards.

‘The odds are not balanced. You have a chance of losing $1 million, but you won’t win $1 million. The structure would take away most of the profits and give you very little,’ said Mr Tan.

3. Singapore investor Archie Ong, who stands to lose the bulk of his investment in DBS’ High Notes, hopes authorities would force banks to compensate investors who thought they had bought low-risk products that paid steady dividends.

‘They had been marketed as a low-risk alternative to equities which are much higher risk,’ he said.

4.  The failed investments in structured products linked to Lehman has also affected investors in Indonesia who had bought such instruments from Citigroup, according to a report in the Jakarta Post on Monday.

5.  The Monetary Authority of Singapore did not immediately respond to queries from Reuters, while Hong Kong officials met with angry investors but did not pledge specific action.

Comments

Protestors like these in Hong Kong bring a tear to our eye.

1.  We expect (and certainly hope) that when the dust settles after a huge financial crisis, when the finger-pointing and passing-the-buck stops, when soul-searching begins, more people will come to realise the root of all money problems.

Money problems are not restricted only to the poor and middle-class.  They are also not confined to the uneducated.  In fact, the shocking truth is that education could have contributed to money problems.

It is also not limited to the working class who conveniently place their entire trust of their hard-earned money in the hands of so-called guardians of their wealth.  It infected some of these guardians, too.

The root of all money problems is financial intelligence, or rather the lack of it.

What is financial intelligence?  Nobody taught us that.  I believe none of us ever had any lesson in Money 101 in school, or anywhere else.  That is why most of us hardly have any inkling what financial intelligence is.

Pay a visit to the first post of this blog and you may be surprised at the vast number of topics that fall under this subject.  You may also be surprised to see topics which most people may deem totally irrelevant to the subject of financial intelligence, such and emotional control and selling skills.

(By the way, did I tell you that you are supposed to read earlier posts first, and later posts last?)

2.  Banks gave poor advice, and the authorities are supposed to save them from losses.  Translation:  Authorities are at least partly responsible for banks giving poor advice.

3.  They thought they were buying bonds (now everybody knows that is safe), but instead they were buying derivatives (everybody says that is risky).  The banks’ staff who were merely salesmen perhaps could not have known better.  If their boss says it is safe for customers’ consumption they sold it without question.

We would not go as far as to say these executives were wolves in sheepskins; they are just salesmen in suits and ties.

For those who are more knowledgeable of the risks, they either stayed away or refrained from hard-selling customers.  My good friend, Mr Ang, who has been a bank manager for more than twenty years, has this to say.

“One day, a customer looked me in the eye, after I have completed a presentation of financial products which included offshore investments and local unit trusts.  He asked me, ‘Mr Ang, tell me honestly, I just need to know, if you were me, would you put in your money.’  I hesitated for a while and then said, No.’”

Honest-to-goodness Mr Ang has been my good friend for a long time and I am sure he has struck a right chord among his many customers, too.  But let  take our attention off good ole’ Mr Ang for a while.

Did you notice that his customer was very wise in asking that question?  Yes!  That is what I mean by financial intelligence.  It involves total emotional control as well as communication skills.  How many people do you know who have not gone greedy when a trusted bank manager recommends a high-return investment?  And, how many people do you think that would know how to phrase a question, in order to get the right answer?

That, my friend, is what you and I ought to learn and master.

Learning message:  The root of all money problems is financial intelligence.

Source:  Straits Times, Singapore

Highlights

1.  This is how much the US government’s financial bailout will now cost – after adding the latest and biggest US$700 billion plan to mop up all banks’ toxic debts.

2.  The best test of whether the government’s US$700 billion (S$999 billion) check will be enough to save the US economy is how much of that money flows back to consumers and companies.

3.  ‘Last week as the credit markets were frozen, the capital markets were frozen, we had a situation where American companies weren’t able to borrow money,’ Treasury Secretary Mr Paulson said.

4.  ‘This could ultimately affect small banks, loans to businesses, loans to farmers, jobs, people’s retirement.’

5.  Federal Reserve ‘Chairman (Ben) Bernanke said if you don’t solve the mortgage crisis, you’re not going to solve the financial crisis.

6.  ‘The US banking system needs a lot more capital,’ said Mr Jan Hatzius, chief US economist at Goldman Sachs. ‘Capital infusions are needed to avert a sharp contraction in lending.’

Comments

1.  This is a huge amount.  The cost of the subprime crisis was earlier estimated at less than $1 trillion.

Learning message:  The cost of the subprime crisis may be as high as $1.6 trillion.

Source:  Fortune

Highlights

1.  The billionaire investor and CEO of Berkshire Hathaway sprang into action with a $4.7 billion plan to acquire Constellation Energy, the energy wholesaler and utility operator whose shares have plunged this week as the company ran short on cash.

2.  Constellation – which operates 83 electric generators around the country – will be folded into Berkshire’s MidAmerican Energy unit.

3.  Berkshire will pay $26.50 a share for Constellation.

4.  Ratings agencies had earlier threatened to downgrade Constellation’s debt – which at triple-B already sat at the low end of the investment-grade spectrum. A downgrade could have forced Constellation to produce more than $3 billion in cash collateral on its trading positions – cash the company didn’t have.

5.  “Constellation is facing an acute crisis of confidence,” Standard & Poor’s analyst Aneesh Prabhu wrote.

6.  Berkshire has a $31 billion cash hoard ready for purchasing any good bargain.

7.  Constellation’s CEO, Shattuck, may see his paycheck shrink in size, under the no-nonsense Berkshire regime. Shattuck made $13.9 million in total compensation and $20.1 million in 2006, including at least $1 million in salary each year.

Buffett’s salary as CEO of Berkshire is only $100,000 a year.

Comments

1.  Cash is Emperor.  – Datuk Tan Chin Nam

2.  Noticed how powerful the rating agencies are?  If they downgrade a company, it may immediately run into cash flow problems.

3.  Warren Buffett already has an energy company, MidAmerican Energy.  He knows the business, otherwise he would not have put in his money.

4.  His formula for entering the market is very simple, a lot of people have heard of it.  It is no secret:  Be greedy when others are fearful, be fearful when others are greedy.

Simple strategies work.  Conversely, when strategies are complicated they are difficult to execute.

5.  What has happened since?  Let’s take a look…

The price that Warren Buffett bought was roughly at market price of $25.

Despite the respect he commands, the market did not gain much confidence in the company, as can be seen from the share price.  Today it is at the $20 level.  But you bet Buffett is holding on ‘forever’.

For beginners in technical analysis, you can see that the volume for the few days when Warren Buffett was taking action, spiked.  It is very conspicuous on the chart, isn’t it?  It shows that a lot of people were buying, and a lot of people were selling, too.  But the price did not move much.  It has since travelled sideways.

6.  If you have been a stock investor who has been grappling with the question, “How low is low?” you can take a lesson from Warren Buffett here.

The share price started off above $90 in April 2008.  How low would be low?  $80? $70? $60? You can see from the chart that it actually went down in that manner, before jumping off the cliff at $60.  Now, many people would have gone into the market at say, $70 or $60.  Not Warren Buffett.  He went in at $25.

So, the next time we see a share coming down from $90 to $25 we just buy right?  It is going to be safe and we are going to be rich.  Hooray.

DON’T !

There is more than meets the eye.  You need to fulfill one important criteria first.

Warren Buffett has a simple secret that is most talked about and least understood.  He learned it from his teacher, Benjamin Graham.  It is called intrinsic value.  Every stock investor worth his salt will be able to spell it.  But most of them will also tell you that they don’t know how to calculate it.  In fact, some are convinced that nobody on this planet can calculate it.

It’s simple.  The way to calculate it is found in the book How to make money from your stock investment even in the falling market. You may also find it in my ebook Bursa Winners.

Learning message:  Be greedy when others are fearful, be fearful when others are greedy. – Warren Buffett

Source: Financial Times

Highlights

1.  Among the worst hit was UBS, the Swiss bank that can claim the unhappy title of being Europe’s biggest subprime casualty so far. Many seem to believe that after the $43bn of writedowns made by the bank over the past year, the weakened UBS is likely to face further pain in the latest round of the subprime crisis.

2.  While it has suffered outflows, it is still the world’s biggest private wealth manager, although the new Merrill Lynch/Bank of America combination could overtake it.

3.  The Swiss did allow their airline, Swissair, to go bankrupt. But the thought that a country that relies so heavily on its financial services could let its biggest bank go under is practically inconceivable.

Comments

1.  UBS was one of the worst hit banks in Europe.

2.  We do not know when these revered institutions can restore their reputation as the cream of the banking industry.  Back in the 80’s, in Malaysia, we have many local banks and a few foreign banks like Citibank, Chartered Bank and Hong Kong & Shanghai Banking Corp.  Bank staff commanded a good status in society.  And if the worked in foreign banks, the respect garnered was another five percent more.

We had only a handful of bankers working for investment banks like JP Morgan or Merrill Lynch.  I still recalled one evening when we had the privilege of dining with a friend who worked at Merrill Lynch.  We arrived early.  The atmosphere was filled with excitement as we waited for our friend to arrive.  When he finally came we were thrilled when he told us stories from his workplace.  (He was still proudly wearing his name tag which hung around his neck.)

It seemed that they were privy to certain financial and political information that was not available even to the bosses of some local and foreign banks.  And this information, or foreknowledge, would help their clients secure huge returns from their investments.  It was awesome.

What a contrast!  Today, they have their tails between their legs.  With all the knowledge that they had at their disposal their could not predict their own downfall within a span of just two decades.

3.  Knowing what we know now, it doesn’t take a lot of education, high IQ, or insider knowledge to understand the concept of over-leveraging.  It just takes a bit of financial intelligence.

4.  Leverage is a measure of how much debt an enterprise carries in relation to its capital.  Even though it varies from industry to industry, it is easy to determine this ratio just by looking at what successful businessmen and investors are doing.  Study the accounts of their business (it is open to the public), and bring your magnifying glass – microscope would be better – to focus on their leverage or gearing ratio.

(Ask your accountant to help you if you do not know how to do this.  It is definitely worth your trouble.  This ratio is one of the most important pieces of information in a financial report.  In the final analysis, it may even be the only piece of information that matters.  Once you have got this right, start comparing with other players in the same industry and you would then possess an insight into the potential success, or disaster, of the enterprise.  Remember I mentioned in Money Secrets that super investors are great “shoppers”.  They analyse and do endless comparisons to uncover a good company to invest in.)

It is not wise to stray far from their practices; you would be in unchartered waters.  Successful people are often great copycats; they seldom reinvent the wheel.  Learn to appreciate the wisdom of these successful money men.  They may be outspoken businessmen, or they may be reserved and media-shy investors.  It does not matter.  It is their accounts that speaks in our money world.  They may not teach you, but they cannot stop you from learning.  Just as my favourite heroes in martial arts folklore discover their destiny in lost kungfu manuals, you may discover your own destiny in the financial reports of great patriarchs in our money world.

Oh, no!  Not again, Andrew.  What has this got to do with money?

Learning message:  Over-leveraging can bring down even the biggest banks and giant enterprises.