Investment Moats – Stock Market Investing

Investing in the stock market

Book Review: The Greatest Trade Ever

I have the privilege  to read the book The Greatest Trade Ever. Thanks to bro who lent this to me.

The Greatest Trade Ever is a book by Gregory Zuckerman writing the behind the scenes look at how John Paulson, and a group of minor investors for saw the subprime and the subsequent crisis and made 15 billion in a single year for his hedge fund and himself.

this book ain’t the book you want to read if you want to learn how to pick stocks or how to analyze charts.

However, credit really to Gregory for writing it in such a simple to understand manner.

It is an easy read and from there, as a noobie you really can see from their experience what goes on behind those big money making trades. You would only see that they made alot of money but not the stories that people don’t hear about:

1. It takes convictions to make all these big trades. All of them based their trades on the idea that the housing market is a house of cards. But people and information is throwing them all sorts of signals that really you find it easier now that it has happen already, but for them, it was a heck of a ride. Any of them could have gotten off anytime and missed this one
2. You learn that you can be right that housing markets is a house of cards. but if you are too early into it, you just get killed when the market goes up instead of down.
3. You learn that all the insiders or all the so-called experts will keep telling you that they are the pro and their view of things will beat you because of it. Do you belittle yourself and think that they are right?
4. When the folks are throwing you all kind of signals, how do you go about justifying that your views of the direction of things?
5. You learn that you can be right, and your fund performs well, but because your bank is down 70%,  you are not gonna get much bonus (your big payout) even though you work so hard for it.
6. Understand the story of how devoted some analyst can be to their job, and in the search for truth how anxious they can get.
7. You learn the story of Micheal Burry, self taught value investor who is able to make money based on simple premises and clear analysis.
8. You also learn about the workings of a hedge fund, and if you get into a short position and you spend 2 years waiting, your investors will kill you this time, before you even see your results vindicated.
9. You learn that when your position is in the money, the psychology of things is to take money off the table instead of adding to it to locking in gains!

All in all, this book doesn’t gives you an answer, but asks yourself the questions that most likely you will need to make that is similar to these folks. Definitely recommended

Using ROIC to determine whether to buy

At Investment Moats,one of my criteria used for monitoring is to use ROIC. Why? Because i feel the demoninator is much more meaningful in the sense that debt like equity demands a measurement to determine whether lendin those money gives you a worth while performance.

Here is a nice article on MSN Money’ Jim Jubak that talks about it:

If I’m looking for a long-term investment, I don’t start with any of the usual measures, such as price-to-earnings ratios, P/E-to-growth ratios, earnings growth rates, or price-to-book or price-to-sales ratios.

I start with ROIC, short for return on invested capital. I don’t think there’s a single number that tells investors more about whether they want to buy and hold a stock. It’s also a good basis for lots of other investment decisions, such as whether a company acquisition is a good deal for shareholders. (For more on that, see my column of Feb. 25.)

Return on invested capital tells investors how good a job a company is doing at investing its money in profitable opportunities and how good the company is at finding those opportunities. Crucially for long-term investors, it also indicates how good a job the company is doing at compounding investors’ money through the rate of return the company gets on reinvested profits. (ROIC isn’t the most common of financial measures, but you can find an example of it here.)

One of the reasons stocks are such a great long-term investment — if you pick the right ones — is that companies generate cash from their operations that they then reinvest in those operations. Today’s profits compound over time to produce even more profits in the future.

You should own shares of a company with a high ROIC for the same reason you should put your cash in a savings account that pays a high rate of compound interest.

Let me explain how this works and show you how powerful it is by looking at one of the best ROIC stories in Jubak’s Picks, McDonald’s (MCD, news, msgs). (See my most recent update on the Golden Arches.)

McDonald’s is almost the perfect ROIC long-term holding:

• The company throws off a ton of cash. For example, in 2008, cash flow from operations came to $5.9 billion. It was $4.9 billion in 2007 and $4.3 billion in both 2006 and 2005.

• The company has found opportunities to invest a huge hunk of this cash flow. In 2008, the company recorded $2.1 billion in capital spending. In 2007, that figure was $1.9 billion; in 2006, it was $1.7 billion.

• It gets a huge return on this invested capital. The company’s most recent return on invested capital was 19.1%. That’s just a little bit better than your bank gives you on your savings account, right?

• The company looks to have lots of opportunities for investing its capital in the years ahead. Capital spending in 2010 is projected to increase to $2.4 billion from its $2.1 billion outlay in 2009. The company has ambitious programs to expand into China, refurbish existing restaurants and add items to its menus.

OK, McDonald’s isn’t perfect for a long-term investor. From that point of view, it distributes too much cash to shareholders in the form of dividends. A 3.4% dividend is nice, but I sure can’t find anyplace to invest it and get a 19.1% return. I can easily fix that problem by reinvesting my dividends, though.

[Read the rest of the article here >>]

I run a free Singapore Dividend Stock Tracker available for everyone’s perusal. Do follow my Dividend Stock Tracker which is updated nightly  here.

How wide is the moats in Warren Buffetts top holdings in 2010?

Business Insider gave a good breakdown of stocks that Warren Buffett owns at the end of 2009 and for some he have been holding for a long time and som el latest acquisitions.

A glance of this table will show that most of them have a wide economic moat, that will enable them to earn above average profits compare to competitors.

Another unique features that most of them have is that they have very valuable brands, which enables them to earn above average profits.

Coca-Cola (KO)
There hasn’t been a meaningful change in the number of shares Berkshire holds in Coke in well over a decade and yet it remains the top holding by market value in the insurer’s stock portfolio. Morningstar analyst Phil Gorham sees the company facing a dichotomy of prospects between emerging and developed markets, with the former offering the potential for strong growth as per capita income (and consumption) increases and the latter creating challenges as consumer tastes shift away from carbonated soft drinks. Having struggled to maintain positive relationships with key bottlers like  Coca-Cola Enterprises (CCE), it was interesting to see Coke agree to buy CCE’s North American bottling operations this past week (a transaction Phil believes may have been prompted by  PepsiCo’s (PEP) move to consolidate its own North American bottlers last year). Given all the flack Buffett gave Kraft during its pursuit of  Cadbury (CBY) this past year, we were curious to see what he might say about this deal in his annual letter to shareholders, but it looks like we may have to wait for Buffett to weigh in on this transaction.

Wells Fargo (WFC)
Berkshire owns about the same dollar amount of Wells Fargo it did at the end of 2008, with the largely unchanged value a product of a modestly weaker stock price and an increased number of shares. Our analyst Jaime Peters thinks Wells Fargo is well-positioned after it took advantage of the credit crisis to expand its national footprint through the acquisition of Wachovia. With the merger on track and Wells Fargo starting to achieve some revenue synergies on top of the cost savings it was expecting from the deal, the acquisition is looking better every day. Jaime expects Wells Fargo to see a strong rebound in earnings during 2010 and believes that a dividend increase will likely occur before the year is out.

Burlington Northern (BNI)
This was perhaps the most exciting story in the Berkshire portfolio this past year, in part because the stock is now off the market. Berkshire increased its stake in Burlington Northern early in 2009, and then made a bid for the entire business in November of last year (with the deal closing in early February 2010). While the move prompted the selling of both Union Pacific and Norfolk Southern from the portfolio, Berkshire will not be lacking for exposure to the railroad industry. Morningstar analyst Keith Schoonmaker believes Burlington Northern is well-positioned to thrive as a wholly-owned subsidiary in the Berkshire community.

American Express (AXP)
American Express was the top performing stock among Berkshire’s top-10 holdings last year, with its share price doubling during 2009 (albeit only after taking a drubbing during the collapse of the financial markets in 2007-2008). Our analyst Michael Kon believes American Express’s credit quality is on the mend, as losses on bad loans have been declining steadily since last April. While this should allow the firm to once again focus on growth, he expects it will be difficult for American Express to see a return to pre-recession spending volumes until cardholders start using their cards more frequently than they are currently. That said, the trend of replacing cash and checks with electronic payments should provide the firm with a tailwind in the years ahead.

Proctor & Gamble (PG)
While Proctor & Gamble’s shares rallied with the markets last year, Berkshire was selling the stock in the fourth quarter of 2009. Given that Berkshire was gathering liquidity for the Burlington Northern transaction, and the insurer had been trimming positions in both Proctor & Gamble and  Johnson & Johnson (JNJ) prior to the bear market to help fund other investment opportunities, we’re not going to read too much into this move. Morningstar analyst Lauren DeSanto believes that, despite a very challenging 2009, P&G remains focused on driving profitable market share growth in its categories. She expects new CEO Robert McDonald, who assumed the helm midway through last year, to continue to stress execution with retailers and customers, guiding P&G to operate like a smaller, more nimble company. Lauren thinks these initiatives, which augment increased brand investments and an improved new product pipeline, leave P&G well positioned coming into 2010.

Kraft Foods (KFT)
While Kraft is a relatively new addition to the portfolio, with Berkshire starting to build a stake in the packaged foods giant in 2007, it has been far from boring. Our analyst Erin Swanson thinks Kraft’s recent acquisition of Cadbury makes sense from a strategic perspective, but the integration of the global confectionery firm is not without risk. Beyond melding disparate corporate cultures, Cadbury’s public dismissal of Kraft’s business model and management team over the past several months increases the challenges of integration. The good news for Berkshire, though, is that Kraft consummated the deal without overly diluting its own shareholders (one of several points of contention Warren Buffett had with some of the moves Kraft was making in an attempt to get the deal done). Better yet, Erin believes that fourth-quarter and full-year results, which were aided by ongoing investments in product innovation and marketing support, have positioned Kraft to continue producing solid cash flows for shareholders.

Wal-Mart (WMT)
Berkshire was buying more of this stock than it was any of its other top ten holdings during 2009, nearly doubling the number of shares in the Wal-Mart portfolio. Morningstar analyst Joel Bloomer believes the firm, with $400 billion-plus in annual revenue, not only dominates the U.S. retail landscape but is also growing quickly internationally. Wal-Mart has been redirecting capital spending from the U.S. to faster growing parts of the world, like Latin America and China. The firm’s fiscal 2010 results benefitted from this commitment to international growth, which more than offset consumer trade down and mild deflation in the U.S. With the international segment contributing 25% of Wal-Mart’s total revenue, Joel anticipates more of the same over the next few years.

Wesco Financial (WSC)
Wesco is the majority-owned affiliate of Berkshire Hathaway headed by Buffet’s long-time partner Charlie Munger. The firm has developed significant reinsurance operations, but also folds in Berkshire-like operating subsidiaries such as furniture rental and steel servicing businesses. We think Wesco has garnered a narrow moat largely through the financial strength of its insurance operations, which is derived from a high level of capital, underwriting ability, and investment success. Given how well its investment portfolio has performed in recent years, the firm’s financial strength has only improved on a relative basis, further cementing its market position. Wesco’s respect in the marketplace and its position in the Berkshire umbrella help attract quality reinsurance business at good prices.

Conoco Phillips (COP)
Oops. We’re all human and this looks like it could be Berkshire’s biggest error in recent memory. Buffett acknowledged as much in his letter to shareholders last year, when he apologized for the poor timing involved in building a stake in this firm (which occurred just as oil and gas prices started to collapse in the second half of 2008). Berkshire has spent the last year and a half unwinding this position, and even started selling a big chunk of its stake in ExxonMobil during the fourth quarter (which the insurer only started building in the third quarter of last year). Bad or unlucky timing wasn’t unique to Berkshire regarding ConocoPhillips in recent years, as our analyst Allen Good notes the firm has made aggressive capital investments itself (including acquisitions) at inflated prices in recent years. He believes that while ConocoPhillips is leveraged to natural gas production and refining in the U.S.–and, as such, dependent on a recovery in natural gas prices and refining margins–management is taking steps to improve returns even if a recovery does not transpire. The company is also in the process of divesting $10 billion of underperforming and non-strategic assets, with the proceeds going towards debt reduction.

Johnson & Johnson (JNJ)
Rounding out the top-10 holdings is the only stock on the list currently trading at a 5-Star price. Berkshire’s stake in Johnson & Johnson has ebbed and flowed over the years, with the company likely trimming its stake in the fourth quarter of last year to help raise funds for its purchase of Burlington Northern. Morningstar analyst Damien Conover likes the firm’s reliable, and significant, long-term growth prospects. Having already gone though a majority of its own patent expirations, Johnson & Johnson is not being as severely impacted by the patent expiration shock currently affecting the rest of the pharmaceutical industry. With the company in the midst of launching four new potentially blockbuster drugs, and the firm maintaining brand and quality leadership in medical devices and consumer products, Damien feels that Johnson & Johnson is well-positioned for long-term growth.

Good Article on Unit Trust Hidden Costs

Many investors will not know that like many, i started off with being interested in Unit Trusts, which i still think could be great investments had it not for their deficiencies.

Among them,costs. The main cost we know are expense ratio which is taken as a percentage of total assets which are a aggregation of management fees and a few other fees.

However, that is not the end all be all cost. Many costs are not covered under them.

the WallStreet Journal have an excellent article on this:

By ANNA PRIOR

How much does it cost you to own a mutual fund? Probably a lot more than you think.

In selecting mutual funds, most investors know to check the expense ratio, the standard measure of how costly a fund is to own. U.S.-stock funds pay an average of 1.31% of assets each year to the portfolio manager and for other operating expenses, according to Morningstar Inc.

But that’s not the real bottom line. There are other costs, not reported in the expense ratio, related to the buying and selling of securities in the portfolio, and those expenses can make a fund two or three times as costly as advertised.

“These trading and transaction costs are very real,” says Stephen Horan, head of professional education content and private wealth at CFA Institute, a nonprofit association of investment professionals. “While it’s very important to look at that expense ratio, it’s just not going to capture” all of the costs, Mr. Horan says.

One reason trading costs go unreported is their complexity, which leaves the fund companies in disagreement about exactly how to calculate those costs. Trying to quantify a fund’s trading expenses can be about as easy as performing brain surgery.

Fund firms on the whole aren’t clamoring to disclose more information about these costs. The Securities and Exchange Commission seems to revisit this issue every several years without much happening. And investors are left trying to piece something together from snippets of information disclosed in a prospectus or other materials.

“The average investor can’t really even begin” to get a strong grasp on these additional costs, says Richard Kopcke, an economist at the Center for Retirement Research at Boston College who co-wrote a recent study about fees and trading costs of mutual funds in 401(k) plans. “There’s just not enough information. Not even close.”

Even experts come up with some very different estimates. Mr. Kopcke’s study looked at the 100 largest U.S.-stock funds held in defined-contribution plans as of December 2007 and found trading costs for the funds that averaged from 0.11% of assets annually in the quintile with the lowest costs, to 1.99% of assets in the quintile with the highest costs, with a median of 0.66%.

A study updated last year of thousands of U.S.-stock funds put the average trading costs at 1.44% of total assets, with an average of 0.14% in the bottom quintile and 2.96% in the top. Expenses are one of the most important things investors can look at, says study co-author Richard Evans, an assistant professor of finance at the University of Virginia’s Darden School. “We find that our estimates of trading costs” are an important predictor of performance. While “some trading actually adds value,” Mr. Evans says, high trading costs overall tend to have a negative impact on performance. On average, $1 in trading costs decreased net assets by 46 cents in this study.

While both studies generated trading-cost estimates for the specific funds they were looking at, the authors declined to identify specific funds and their estimated trading costs.

Mr. Horan, meanwhile, estimates that trading costs for stock funds total 2% to 3% of assets annually, though conservative estimates place them closer to 1%, he says.

Identifying Costs

What exactly are these costs?

There are four main components: brokerage commissions, bid-ask spreads, opportunity costs and market-impact costs.

The brokerage commissions a fund pays to buy or sell securities are the simplest piece to understand. The SEC requires three years of brokerage costs in dollars to be disclosed in a fund’s statement of additional information. Putnam Investments, for example, reported commissions of $21.5 million for its Putnam Voyager fund for the fiscal year ended last July 31. Doing some math, that was equal to 0.69% of the fund’s $3.12 billion in assets on July 31, on top of a reported expense ratio of 1.26%. A Putnam spokeswoman notes that the fund outperformed its benchmark by 17.1 percentage points, net of fees and expenses, for that period. Commissions for that period were also higher than normal, due to a new manager and volatile environment, she says.

A few fund groups, including Brandywine Funds and Selected Funds, do the math for investors by quoting their commissions costs as a percentage of assets.

But the SEC doesn’t require commissions to be factored into expense ratios. The commissions only tell part of the story and so could be misleading, the SEC explained to Congress in a 2003 memo, and the agency has not revised this position.

Commissions typically make up less than half of a fund’s total trading costs, says Mr. Horan. The other three components are much harder to quantify.

Bid-ask spreads deal with the difference between the lowest price at which a seller is willing to sell a security and the highest price a buyer is willing to pay. The gap between them—usually associated with thinly traded securities—is the spread. At any given moment, for example, a security may have a bid price of $96 and an asking price of $100. Say a fund bought that security for $100, and the security’s value later rises. If the fund decides to sell the security when the asking price is $110 and the spread has stayed the same, the fund will only receive $106. The spread thus cost the seller $4. Over time, spreads can be a significant cost for a fund that does a lot of trading in less-liquid holdings, such as very small stocks.

Market-impact costs, and the resulting opportunity costs, are often the largest component of trading costs—as much as 1½ times brokerage commissions, says Mr. Horan. These costs occur when a large trade—say, unloading a big stake in a thinly traded stock—changes the price of a security before the trade is completed. Similarly, opportunity costs are when the impact of a trade inhibits a fund manager from filling an order on his or her desired terms, resulting in either a less-favorable price or fewer shares purchased or sold, says Steven Stone, a partner and head of the investment-management practice group at law firm Morgan, Lewis & Bockius.

Funds do factor these costs into their returns, just like the costs stated in the standard expense ratios. So why should investors try to quantify these costs? Because the higher the costs are, the more value the manager will need to add in his or her security selection and trading decisions to make the investment worthwhile compared with, say, a passive index fund. And when the costs are not all broken out for investors to see, it’s harder for investors to tell where that performance bar lies.

When a fund has high trading costs, that’s “a higher hurdle to clear when coupled with the expense ratio,” says Russel Kinnel, director of fund research at Morningstar Inc.

Debating Disclosure

Trading costs other than commissions aren’t required to be disclosed by funds. Trying to include all trading costs in the expense ratio, the SEC told Congress in 2003, could produce a number that is “not comparable because it would be based on estimates and assumptions that would vary from fund to fund.” Last week, an SEC spokesman said: “We continue to analyze portfolio transaction costs as the agency focuses on enhancing disclosure to retail investors.”

At the fund industry’s Investment Company Institute trade group, Chief Economist Brian Reid said “mutual funds work hard to quantify their total transaction costs.” But there isn’t an “agreed-upon methodology on how to quantify implicit transaction costs, such as market-impact costs.” Thus, he says, “requiring funds to disclose total trading costs would not provide adequate means for investors to compare trading costs across funds and could result in investor confusion.”

In addition, quoting estimates in a prospectus can get into dicey territory, says Mr. Stone, the lawyer. “A mutual fund has to stand by information in its prospectus. Factual information should be clearly and objectively established and confirmable,” he says.

But Mr. Kinnel of Morningstar says that investors are “really entitled to that information,” and that some methodology should be developed. Not having a standard “doesn’t mean it’s not worth doing and not worth coming up with one,” he says.

For the past several years, Morningstar has been trying to develop a “trading cost ratio” to complement the standard expense ratio; there’s no date or timeline yet for when the project might be completed.

Meanwhile, “a lot of fund companies pay trading-cost consultants to estimate their trading costs,” says Mr. Kinnel, so it would be a “piece of cake” for those companies to make these estimates known to investors.

Not so fast, says Gus Sauter, managing director and chief investment officer at Vanguard Group. “While many of the larger firms might attempt to do these calculations,” making it mandatory would be almost impossibly difficult for midsize and small investment managers that can’t afford consultants, he says.

‘Turnover’ Clue

While you can’t find a fund’s total trading-related costs, you can get a clue from a standard and imperfect measure of how much trading the fund is doing, called “turnover.” Turnover, expressed as a percentage, shows at what rate stocks in the fund have been replaced. A stock fund that sold half its stocks and replaced them with an equal value in new stocks would have turnover of 50%. But in an extreme case, say there’s a fund that’s getting a lot of new money coming in from investors and it doesn’t have to sell anything to generate cash. The turnover rate would be 0%, even if the fund has been buying stocks, because it didn’t sell anything.

The SEC voted last year to require fund companies to disclose one year of turnover in the front of a prospectus, in the summary, in addition to the previously required five years of turnover disclosed in the financial-highlights section sometimes found near the back of the document.

Turnover of more than 100% can indicate trading costs may be on the high side, Mr. Kinnel says. In a Morningstar list of the 200 largest U.S.-stock funds, the funds with the highest turnover ratios were CGM Focus, at 504%, and American Century Equity Income, at 296%. Of the 32 funds that had turnover above 100%, 11 were from Fidelity Investments, topped by Fidelity Advisor Mid Cap, at 244%.

Officials of CGM Focus’s management firm, Capital Growth Management LP, did not respond to requests for comment.

American Century Investments product manager Shawn Connor says the Equity Income fund managers may buy and sell the same securities repeatedly when they believe them to be undervalued or overvalued. The company has sought to lower trading costs by using electronic trading systems and other means to lessen market impact, Mr. Connor says.

Fidelity spokesman Vincent Loporchio says “there may be any number of factors impacting turnover during a given period, and turnover can vary over time.… As we have many large funds, it’s not surprising that we would show up frequently on a list like this.”

Two other factors to consider in gauging a fund’s trading costs are size and style. Small funds usually aren’t big enough to move markets, Mr. Horan says. An exception is when the fund trades in a low-volume segment, such as for small stocks or a thinly traded international market. Large funds, too, incur higher trading costs when they delve into less-liquid areas such as small or microcap stocks.

Style comes into play in terms of bid-ask spreads, says Mr. Horan. “Aggressive growth funds tend to have higher spreads [which increase costs], while income funds tend to have lower spreads,” due to the types of securities in which they invest.

Marc Faber looks for a 20% correction in US Market

Speaking to bloomberg, Mr Faber, the bear that he is, thinks that we should be selling on strength:

Words of Advice in investing from Warren Buffett

From the wallstreet journal, great general advices you should keep in mind when thinking about your next investment:

Stay liquid. “We will never become dependent on the kindness of strangers,” he wrote. “We will always arrange our affairs so that any requirements for cash we may conceivably have will be dwarfed by our own liquidity. Moreover, that liquidity will be constantly refreshed by a gusher of earnings from our many and diverse businesses.”

Buy when everyone else is selling. “We’ve put a lot of money to work during the chaos of the last two years. It’s been an ideal period for investors: A climate of fear is their best friend … Big opportunities come infrequently. When it’s raining gold, reach for a bucket, not a thimble.”

Don’t buy when everyone else is buying. “Those who invest only when commentators are upbeat end up paying a heavy price for meaningless reassurance,” Mr. Buffett wrote. The obvious corollary is to be patient. You can only buy when everyone else is selling if you have held your fire when everyone was buying.

Value, value, value. “In the end, what counts in investing is what you pay for a business-through the purchase of a small piece of it in the stock market-and what that business earns in the succeeding decade or two.”

Don’t get suckered by big growth stories. Mr. Buffett reminded investors that he and Berkshire Vice Chairman Charlie Munger “avoid businesses whose futures we can’t evaluate, no matter how exciting their products may be.”

Most investors who bet on the auto industry in 1910, planes in 1930 or TV makers in 1950 ended up losing their shirts, even though the products really did change the world. “Dramatic growth” doesn’t always lead to high profit margins and returns on capital. China, anyone?

Understand what you own. “Investors who buy and sell based upon media or analyst commentary are not for us,” Mr. Buffett wrote.

“We want partners who join us at Berkshire because they wish to make a long-term investment in a business they themselves understand and because it’s one that follows policies with which they concur.”

Defense beats offense. “Though we have lagged the S&P in some years that were positive for the market, we have consistently done better than the S&P in the eleven years during which it delivered negative results. In other words, our defense has been better than our offense, and that’s likely to continue.” All timely advice from Mr. Buffett for turbulent times.

Prudential Agrees to buy AIA!

Biggest news of the day. I’m sure many of you having AIA policies will now belong under the umbrella of Prudential!

March 1 (Bloomberg) — Prudential Plc, Britain’s biggest insurer, agreed to buy an Asian life insurance unit from American International Group Inc. for $35.5 billion in cash and stock to gain more than 20 million customers in the region.

Prudential will pay $25 billion in cash and $10.5 billion in stock and other securities for AIA Group Ltd., the London- based insurer said in a statement today. The insurer said it plans to raise $20 billion in a rights offering and sell about $5 billion of bonds to finance the cash part of its offer.

The purchase is Chief Executive Officer Tidjane Thiam’s first since he took over five months ago, and is the biggest announced by any company worldwide this year, according to data compiled by Bloomberg. Prudential is trying to boost sales in Asia as growth in the U.K declines. By acquiring AIA, Thiam gets a business with more than 90 years in Asia and more than $60 billion of assets in 13 markets in the region. The price is about 50 percent greater than Prudential’s market value.

“It shows the company is very bullish on the Asia market,” said Luo Yi, a Shenzhen-based analyst at China Merchants Securities Co. “The Chinese market has vast potential.”

Prudential shares fell 13 percent to 525.5 pence as of 12 p.m. in London trading. The stock has more than doubled in the past year, giving the insurer a market value of 15.3 billion pounds before the purchase was announced. AIG advanced 9 percent to $27 in early trading at 7:01 a.m. in New York.

Faster Than IPO

The sale would be AIG’s largest since it received a U.S. government bailout in 2008. AIG had planned an initial public offering for the Hong Kong-based unit to help repay its $182.3 billion rescue. AIG will own about 11 percent of Prudential following the transaction, Thiam told reporters today.

“We decided that a sale to Prudential enables AIG to realize value on a faster track to repay U.S. taxpayer,” AIG CEO Robert Benmosche said in a statement today.

The insurer is paying about 1.69 times the embedded value of AIA in 2009. Chinese insurers are trading for about 2.9 times embedded value, and Axa Asia Pacific Holdings trades at about 1.7 times, according to Thiam. Embedded value estimates a company’s net worth excluding new business.

‘The Right Move’

The acquisition of AIA, founded in Shanghai in 1919, gives Prudential a business with 20,000 employees and 250,000 agents in markets spanning China to Australia. AIA sells life, accident and health insurance policies, and private retirement planning and wealth management services, its Web site shows. McKinsey & Co. has estimated Asia will deliver around 40 percent of global life insurance premium growth over the next five years.

“Strategically it’s probably the right move” for Prudential, said Justin Urquhart Stewart, who oversees about $3.3 billion at 7 Investment Management in London, including Prudential shares. “It puts them into a different league.”

The insurer plans to list its shares on both the Hong Kong Stock Exchange and the London Stock Exchange following the transaction. It will keep its headquarters in London.

Thiam said in a Feb. 17 interview that he wants to raise the proportion of sales from Asia to 80 percent by 2015 from 50 percent now. Prudential and AIA combined would have had about 60 percent of new business profit from Asia in 2009, he said today.

‘One-Off Opportunity’

“This transaction is hugely exciting and a one-off opportunity,” Thiam said in a statement. “It puts us in a strong leadership position in all the critical growth markets in the region.”

Credit Suisse Group AG, JPMorgan Cazenove and HSBC Holdings Plc agreed to underwrite the $20 billion rights offer in full. The shares are likely to be sold for 40 percent less than today’s price, Thiam told reporters today. Prudential will pay about $1 billion in fees and other costs related to the offer.

The offering would be the biggest since Lloyds Banking Group Plc’s 13.5 billion pounds ($20.4 billion) sale in December, still the U.K.’s largest.

“If you’ve got backing from a few banks and a few major shareholders, there will be a way to make this deal happen,” said Marcus Barnard, a London-based analyst at Oriel Securities Ltd. with a “sell” rating on the stock. “The question is the cost and the risk involved.” The insurer may be forced to sell assets in India and China to comply with local foreign-ownership regulations, he said.

India, China Talks

Thiam said Prudential is in talks with regulators in India and China. The insurer intends to keep its stake in a joint venture with China’s Citic Group, he said. In India, where both Prudential and AIG have separate joint ventures, regulators have told the company it can’t have two licenses, Thiam said.

AIG said last May that it would pursue an IPO of AIA after an auction of the business failed to turn up bids that matched what AIG executives thought the company was worth. That included a bid from Prudential that valued AIA at about $15 billion, one of the people said.

The sum raised in the sale would exceed the total of more than 20 other asset sales announced by AIG, which has struck deals to raise more than $12 billion by selling units, including a U.S. auto insurer and equipment guarantor.

AIG had a fourth-quarter net loss of $8.87 billion, narrower than the insurer’s $61.7 billion loss the previous year, which was the biggest in U.S. corporate history.

Alico, AIA

AIG gave a $9 billion stake in American Life Insurance Co., known as Alico, and $16 billion in AIA, its biggest non-U.S. life insurance units, to the Fed in December. AIG will redeem the Fed’s $16 billion interest in AIA with proceeds from the sale and repay about $9 billion more on the credit line, the insurer said today.

The $10.5 billion in securities obtained from Prudential will be sold “over time, subject to market conditions, following the lapse of agreed-upon minimum holding periods,” AIG said in a statement. “All net cash proceeds from the monetization of these securities will be used to repay any outstanding debt” to the Federal Reserve Bank of New York.

AIG owed about $25 billion on the line as of last week. The insurer had drawn more than $40 billion before reducing the sum in December.

The Fed agreed last year, as part of AIG’s fourth bailout, to allow the company to pay down its debt with an equity interest in the life units before completing a sale. The plan reduced pressure on AIG to sell in early 2009 when potential bidders were hobbled by losses and the inability to raise funds.

Fed Plan

AIG’s bailout includes a $60 billion Fed credit line, an investment of as much as $69.8 billion from the Treasury Department and $52.5 billion to buy mortgage-linked assets owned or backed by the insurer.

MetLife Inc. has said it is in talks to buy Alico, which operates in more than 50 countries outside the U.S. The insurers are discussing a price of about $15 billion, according to people with knowledge of the matter.

Citigroup Inc. and Goldman Sachs Group Inc. advised AIG. Prudential Plc has no relation to Newark, New Jersey-based Prudential Financial Inc. and operates in the U.S. through its Jackson National Life Insurance Co. unit.

Cerebos Pacific: Dwindling Cash Position

I took a further look when i have the time on Cerebos Pacific this week. Great Stock that consistenly gives 25 cents dividend payout. They have been doing that for the past 4 years. That gives a yield of around 6.5% currently.

Cerebos business is in health products and food products used daily. It is a resilient business and pretty defensive during downturns. The eye catching  driver of this stock have to be its Brands chicken essence which alot of Singaporeans are familiar with.

Here is a price chart from 2007 to 2010 of Cerebos since going from 2005 $2.54 to $4.40 at the height in 2007, its earnings and cashflow have been growing steadily. Sounds like a good deal for a yield investor.

Althought the share price took a beating in the bear market, it rallied back strong.

Free Cashflow vs Dividends Paid

What i wanna bring to your attention is probably the free cashflow vs the dividends given out.

I have a google spreadsheet here for free viewing on Cerebos past 5 years, and quarterly results and ratio analysis [Link Here >>]

Here is a chart on the quarterly free cashflow minus capital expenditure for Cerebos from 2005 to 2009:

It would seem i sorta remember Cerebos paying out twice per year for dividends but on DBS clarity, it only showed once. But the general idea is that there will be one quarter where they need to pay out 75 mil in dividends. The reset of the quarter they should be able to have a positive FCF – capex.

However, FCF – capex were not consistent. We can observe at least 3 quarters where it was negative. Thats generally OK since CAPEX should translate to better future operating cashflow or net profits.

Here is another view, this time Free Cashflow and Dividend paid out yield

Here the dividend paid out is consistently high at greater than 6% of that year’s share price, but the free cashflow was not keeping up.

The logical way to finance this is through debt

However, Liabilities during this period have been going down steadily.

The reason why its sustainable now is due to its cash holdings:

Cash have been going down steadily, and have almost halved since 2005.

Conclusion

When we invest for yield we want the dividend to be sustainable by Free cashflow. Certain quarters of negative free cashflow can be tolerated as business may find cash not paid to them yet so they would have to borrow to fund dividend or capex.

A falling free cashflow in this case shows clearly that the 25 cents div may not be sustainable. Cerebos may want to deliberately reduce their cash holdings but if you are an investor investing for 6%, watch out.

Watch Ron Paul take on Bernanke

It would seem everybody thinks he got his points correct, but he didn’t put it across very well such that it made him look paranoid. Here is the video

A thorough article on peak oil in Europe

Here’s a nice article on Business Insider on the developments of oil and the future production of it around that region:

It seems that the NPD also accepts that Norwegian peak oil production has passed and it is the nature of the post-peak decline that is the subject of this discussion.

The upper gold band charts Norwegian gas production which is set to grow. The blue band charts NGL which together with oil (green) are forecast to rise in volume in coming years. Chart from the NPD (in Norwegian)

The NPD forecast from 2006 to 2010 is as follows:

Conversion factors given by BP have been used to normalize to mm bpd.

Norwegian average daily production since 2001 (source BP statistical review) was as follows:

The simple, top down approach (Hubbert) to forecasting future Norwegian production is to presume that the established decline rate of around 7% will continue. The NPD approach is more complex and this produces a very different outcome for forecast Norwegian production by the year 2010, less than 5 years from now.

Hubbert linearisation for Norway using BP data (crude+condensate+NGL). It will require a super-human effort to modify the decline curve established since 2001. NB – this is my first HL – but not my last. Thanks to Khebab for assistance.

Two very different forecasts for future oil production in Norway. The difference between the 7% decline model and the NPD forecast is 700,000 bpd by 2010 – the equivalent of two giant fields.

By the year 2010, the NPD are forecasting 2.8 mmbpd while the 7% decline model implies daily production of 2.1 mmbpd. The difference of 700,000 bpd is equivalent to the production from two giant oil fields and is therefore both hugely significant, and difficult to explain away by different forecasting philosophies. Where does the truth lie?

[Read the full article here >>]

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