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Posted

I have been thinking about the effect of the seemingly endless multi-trillion dollar bailout packages. At some point the economy will recover and the results of the huge deficits currently being run will come home to roost - likely in the form of 1970's style high inflation. So, what is the best investment one can make now (given the current economy) with an eye to the future? Oil, gold, or commercial real estate? I am leaning towards oil (WEB for example has bought COP) as you can earn a dividend (gold not so much) and the supply is being reduced as companies scale back on exploration. I also note that Prem has increased the holdings of ICO to around 37m shares or approximately 24%. Comments?

 

Cheers

Zorro

Posted

A wonderful business.  WEB

 

A wonderful business is a company that can expand volumes and raise prices in the face of inflation and not have to replace capital at the new higher costs. 

 

I am skeptical of the idea of rampant inflation.  Higher inflation leads to higher real interest rates which will cause further destruction of credit, and hence money.  A tremendous amount of credit is being kept afloat by the ability to refi at low short term rates.  Raise those short term rates and that debt goes poof very quickly.

 

I have no crystal ball into the future, but investors should be aware of the potential for further deflation.  Inflation in my opinion is not a given like so many seem to believe.  I have never seen such concensus regarding a future outcome which is why I am skeptical.  The concensus is usually wrong.

 

Nor is it bullish for equities.  The lowest point in equities came in 1981 on an asset replacement basis, even lower than the depths of the Great Depression.

 

The United States Treasury has an essay on its website detailing the economic risks posed by its stimulus packages.  The worry is it won't be financed on attractive terms.

 

http://www.treasury.gov/press/releases/tg10.htm

 

There are some businesses that do well regardless of economic conditions.  Generally companies that deal with cost sensitive consumers (recession / depression resistant) and benefit from credit driven asset inflation.  Think McDonalds.  During recession people trade down, during inflation the value of their real estate holdings grows while they have historically also enjoyed pricing power.

 

Make investments that prove profitable regardless of future economic outcomes. 

 

 

 

 

 

 

 

 

 

 

Guest ericopoly
Posted

I bought BAM this week for $12.50.  Their operating cash flow gives me about a 15% yield on the price paid.

 

They have a lot of long term debt that they utilize to finance their hard assets.  They own hydropower dams, transmission lines, timberlands, office towers, coal fields (altogether diversified across Australia, Europe, North America, Brazil).  Inflation will raise both their cash flows and the marketable price of their assets, but at the same time it will devalue the debts that they owe.

 

My general thinking is that the cash flows are safe in the current environment.

 

Without inflation I believe I am getting 15% return in year #1 over the price paid.  With inflation, I look at it like this:  when you are levered (relative to the price paid per share) about 4x into real assets, then you earn rougly 4x the rate of inflation in year #1 (in addition to the 15% from operating cash flow).

 

I probably am not entirely on the ball with my 4x numbers, but I think it is roughly correct.

 

 

Posted

My friend and I were discussing the same thing and that's why we were buying stocks right now. Don't you guys think that a good way to combat inflation?

 

 

Guest JackRiver
Posted

Investing is really easy.  Pick out 50 excellent excellent companies that trade for less than 7 times earnings and buy them.  

 

My cousin Sleepy Sales taught me that.  He also advocated buying real estate in CA just before it went pop.

 

For those who are more serious, maybe someone can post Buffett's article from the 70s that talks about inflation.  

 

The main point of the article as I understand it was:  Stocks have produced an oddly consistent 10 to 12 percent return on equity despite varied economic environments.  If this 10 to 12 percent holds going forward, then stocks, in aggregate, act just like a fixed investment with two caveats: 1.  this is fixed in perpetuity, and 2.  the 10 to 12 percent is based on book value (equity) and of course the stock market in aggregate usually has traded at some price premium above book value.  Again, this is all in the aggregate.  

 

The other point was bonds.  That they are actually less fixed than they appear because they pay interest and have a limited maturity.  

 

His argument in the end boiled down like so, If given sufficient yield in bonds, sufficient in comparison to equities with ROIs between 10 to 12 percent and prices sufficiently above book value, then it might make more sense from an aggregate standpoint to buy bonds and then reallocate the proceeds later.

 

Now this is partially what ole Warren is up to right now.  He's been on a tear lending money between 10 and 15 percent.  In the coming months and as the economic situation continues to knock around stock prices he will be able to reallocate both his interest income and eventually the return of principle.  I suspect he will continue to do this as long as he can get sufficient yield on fixed incomes and only alter it whenever he finds a specific stock or other investment class that offers something better.  I suspect Prem is up to the same thing too.

 

If I could find debt that I felt comfortable with (that I understood) at yields between 10 and 15 percent I would do it, and I would  reallocate all the proceeds into Burlington Northern.  Or you can do what my cousin Sleepy Sales suggest, find 50 excellent excellent companies trading a P/Es under 7 and buy them.  Or wait for home prices to double and buy them instead.

 

BTW, Eric, I would suggest you get real comfortable with BAMs interest coverage.  Unlike my cousin Sleepy Sales, I don't think it's that easy to find even 5 excellent excellent companies trading at PEs below 7.  

 

Yours

 

Jack River

Guest JackRiver
Posted

Sorry, I'm not sure if the article by Buffett was written in the 70s it may have been in the 80s.

 

Second, for those worried about inflation, remember the world is fighting a massive deflationary force right now.  It will take some time before they overcome the deflationary forces, hence it will take some time before inflation rears up again.  I would place my bets with this delay in mind.  We are not going to wake up 6 months or even 2 years from now with heavy inflation.  I'm thinking at least 4 or 5 years, but it's anybodies guess.

 

Yours

 

Jack River

Guest ericopoly
Posted

BTW, Eric, I would suggest you get real comfortable with BAMs interest coverage.  

 

The interest coverage is low but I like the dependable nature of their income generating assets.  You might save me some money if you have some good negative things to say about that.

 

Guest Broxburnboy
Posted

"what is the best investment one can make now (given the current economy) with an eye to the future? Oil, gold, or commercial real estate?"

 

Commercial real estate investments are coming off the tops created by a perfect environmental storm:

low interest rates, booming economy, high levels of retail spending, lots of overseas as well as local investor interest.

It is now apparent that there has been substantial leverage in the sector as a whole.

It looks like that has turned and as the economy continues to contract, investors delever, consumers clamp up and

residential and commercial inventories grow, rents may decrease (or at least not increase) and returns lessen. Interest rates can't get any lower and eventually must go up. Not the greatest environment for looking for earnings growth.

 

The price of oil seems to be firming up after the bubble of the past year, which apparently was driven by speculation on the future price. The credit crunch and forced delevering seems to be the main factor in the price drop. But it is beginning to look like supply and demand fundamentals may send the oil price back up to a level more conducive to spur further exploration. There is already inventory reductions in  some specialty areas like jet fuel and diesel fuel. Last time I looked Decemeber oil futures were in the 60buck range.

Energy stocks have suffered a brutal (and probably overdone) decline since last summer, but technically are starting to indicate a rebound. They look pretty good right now.

 

My own favorite is gold. Prices have rebounded from the bull run and subsequent drop of last Spring. Current investor interest has driven demand to the point that all new production is being absorbed by the various precious metal ETFs. The big picture of continuing monetary debasement and currency devaluation favours gold as a store of value. Silver stocks should not be overlooked as they have not recovered from last year's precipitous drop in the silver price, even as that price has recovered somewhat and the forward trend is up.

 

my .02

Guest ericopoly
Posted

rents may decrease (or at least not increase) and returns lessen

 

 

This is a worry.  In the case of BAM their portfolio earns rents that are 30% below market -- there is a margin of safety here as leases expire and are renewed at market rates.  Their contracts, until they expire, cannot be wiggled out of by the lessee (excepting bankruptcy) and rents can only be adjusted upwards, not downwards (until expiry).  The rate at which their leased space comes up for renewal annually is 5%.  So, it's not like we're going to find out all of a sudden that their cash flow from commercial real estate is gone.

 

Their hydroelectric projects have the electricity rates already locked in for two years.

 

I think it is pretty safe, and I suppose I'm not the only one -- this one actually has only 1% of shares shorted (this during a time that everyone who is anyone knows that commercial R/E is toast).  For comparison, 1% short interest is in line with JNJ short interest.

 

 

Posted

If you look at what WEB is doing - investing in COP, Kraft, MidAmerican, Wrigley's - he is looking for companies that should do well in any environment. BAM seems to be a similar investment with their holding in real estate (long leases), utilities, timber.  I'll have to take another look at BAM, at first the real estate holdings made me a bit leary but management seems smart and has been buying back stock.

 

thanks for the thoughts.....a good discussion

 

cheers

Zorro

Posted

My main problem with commercial real estate is the supply demand picture.  Our local downtown here in a midwestern city will have 40% vacancy once the buildout is completed in the suburbs.  Many corporations locally built new headquarters because of the low interest rates and attractive financing terms.  Those buildings are not entirely completed hence the companies have not moved.

 

Even Mr. confidence is important Ben Bernanke said before Congress that commercial real estate will be 'a catastrophe'. 

 

Commercial real estate has sold at very low cap rates, often financed with short term bank loans, and priced at very high occupancy and rent levels.  Take out financings were all the rage, similar to housing flippers in California pulling out 'equity'.  There should be significant distress sales which will lead to competition from owners with buildings acquired at ultra attractive terms, hence downward pressure on rents. 

 

Speaking of Warren Buffett he has only bought one reit in his lifetimethat I know of, FR.  Look at the financials of that REIT in 1998 and compare it to most commercial RE firms.  He bought into a company that was able to turn a profit even accounting for depreciation, he did not buy based on Distributed Cash Flow.  He has always said that depreciation is a real expense, whereas most RE buyers tend to ignore it and instead allow for the assumption that a maintained building will not lose value over time.  But a building can only be depreciated at a rate of 1/39, that itself is a modest assumption.  Many buildings are either torn down or completely renovated in that time frame. 

Posted

I would think any company that can use debt without having the debt called in easily.  That would imply BAM, or some other equivalents.  They also need long term debt so they dont have to renew in a higher interest rate environment.  They also need to be in a business where they dont require debt to expand - this works against the oil business where more working capital is a constant requirement. 

 

Once inflation sets in it needs to be broken by high interest rates.  You wont see this until year 2 of Obama's second term assuming he gets that far.  Buying medium/long bonds during periods of high interest rates would work very well.  That is also conceivably the easiest (re: safest) investment to make. 

Guest ericopoly
Posted

I would think any company that can use debt without having the debt called in easily.  That would imply BAM, or some other equivalents.  They also need long term debt so they dont have to renew in a higher interest rate environment.  They also need to be in a business where they dont require debt to expand - this works against the oil business where more working capital is a constant requirement. 

 

Once inflation sets in it needs to be broken by high interest rates.  You wont see this until year 2 of Obama's second term assuming he gets that far.  Buying medium/long bonds during periods of high interest rates would work very well.  That is also conceivably the easiest (re: safest) investment to make. 

 

 

I will expand somewhat on my thinking with BAM.

 

1)  Their average commercial real estate rent is 30% below market across the portfolio, but these are very long term leases.  This implies that the most recent (not expiring for a long time) leases are the ones at or above market, and the ones that are coming up for renewal in the next few years are actually more than 30% below market.  Anyways, that's all there is to say about that.  We might see their income go up as a result of renewals, but I'm not counting on it.

 

2)  I mentioned that they have roughly 4x hard assets vs the price I paid, yet still make about 15% operating return (no inflation).  Now, if you structured a portfolio 25% into investments with same characteristics, then the other 75% of the portfolio could be constructed into investments that have a high yield but perhaps at the expense of not much inflation protection.  I am thinking of high credit spreads on long term corporates (I think the PIMCO corporate income fund, PCN, yields 19% at the moment)

 

 

You might find the recent conference call transcript for BAM to be useful (I did):

 

http://www.brookfield.com/newsroom/pressreleases/r2009/_resources/2008Q4Transcript.pdf

 

 

Guest JackRiver
Posted

Buffetts article was written in Forbes magazine in 1979.  I have attached it for you.

 

 

bg

 

the article you posted, forbes 79, is the wrong article.  The correct one is forbes 1977. 

 

Yours

 

Jack River

Guest JackRiver
Posted

Stike that, Fortune 1977.

Posted

The simplest and most direct inflation hedge for a USD investor in a tax-deferred account would be on the run TIPS or off the run TIPS close to par (below par would be even better in a deflationary environment). For a taxable investor, I-Bonds would do the same, but not at the current rate. You would only be getting a real return of 2-3%, but as long as you are looking for a hedge, I cannot think of a better one that gives the same level of certainity (as long as you believe the CPU measurement is not being fudged).

 

Vinod

Posted

Sorry about that, I have both saved to my computer and attached the wrong one.  That is why you don't post at one in the morning.

Posted

basically, the best anti inflationary investment would be buying a company cheap enough that the return on it would compensate for your inflation risk...

 

if the company is "fairly priced" then, I would say a company that provides a product or service that everyone needs and can pass its rising expenses along to the consumer.

 

Phil Fisher talks a lot about this in both of his books.

Guest JackRiver
Posted

As you say, as long as you believe the CPI number.  Plus you are limited to how much per year you can put into I Bonds.  I think it's something small like 30k.  Also, the fixed rate is low and has been low for many years.  I bought some years ago when the fixed part of the rate was a little under 4%.  They were so new then and I kick myself ever so often for not maxing out the purchase.  At that time they were only issuing the bonds in paper form, which reminds me, I need to check that I still have them.  

 

I firmly believe that there are dynamics with regards to Burlington Northern that are very powerful.  If you have a time horizon of 10 or 20 years or more, then this is the place to put large amounts of money.  I don't know what they will do next quarter or what effect the recession will have, though I believe it will be measured, but long run I am confident as one can get about these things that they will have the wind at their backs.

 

Yours

 

Jack River

Posted

I firmly believe that there are dynamics with regards to Burlington Northern that are very powerful.  If you have a time horizon of 10 or 20 years or more, then this is the place to put large amounts of money.  I don't know what they will do next quarter or what effect the recession will have, though I believe it will be measured, but long run I am confident as one can get about these things that they will have the wind at their backs.

 

Jack, can you expand on what advantages you expect BNI to have over the next 10 or 20 years?  I imagine fuel efficiency and lower cost (versus highway trucking), rail ownership (expensive for someone to build competing network).  What other aspects am I missing?

 

Thanks

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