Demographic Investing

I wish I could boil it down to a nifty list of "The Top 10 Demographic Trends to Supercharge Your Portfolio". Alas, such attempts made by populist business publications do one thing: they use sound ideas, only smattered with gimmickry, to sell magazines. Real 'trends' are often over-priced, as the saying goes, if it's in the news, it's already priced in. So do yourself a favor, ignore the next cover of Fortune and BusinessWeek.

This is not to say long term demographic trends don't matter. The key is what to avoid. As Keynes poignantly stated: “The difficulty lies not so much in developing new ideas as in escaping from old ones.” Avoid the trendy demographic stocks trading at 40x earnings. However, Warren Buffett has used reasonably priced, out-of-favor companies with idiosyncratic risk, to make deft long-term demographic bets (think of human thirst and the psychological power of Coke; men's shaving habits and Gillette; aging and his recent purchase of stock in GlaxoSmithKline).

On to an interesting trend. The increase in Hispanic/Latinos is a demographic worth mentioning which includes the following characteristics: high birth rate; relatively young; increasing economic clout; less likely to use formal banking; and, while not working extremely hard, enjoys lots of Spanish television. If you want lists, Texas has been less impacted by housing. Here are Texas banks with strong Hispanic/Latino population exposure: SBIB, PRSP, CFR. Check 'em out. Another compelling company to research is Televisa (TV). TV trades at 8x Ebitda, has a reasonably clean balance sheet and generates a lovely 28% return on equity. The women on the telenovelas aren't too bad either.

Imperial Sugar Co: more than a thousand words

Thoughts and prayers go out the families involved in this horrific event after an explosion killed 5 and injured dozens at an Imperial Sugar refinery near Savannah, GA.

That said, the prudent investor asks, "and then what?" The Georgia refiner is one of only two of IPSU's facilities and has a production level of 14.5 million hundredweight or just under 1.5 billion pounds of sugar. This amounts to 57% of the firm's refining capacity and $482M of the company's $851M of '07 refined sugar sales. The question stands. For an interruption in refining that will likely come due to this tragedy, is a market value drop of $20.3M, or 2.4% of sales, commensurate with the underlying risks of production disruption and possible litigation?

The company faces further battles as Mexican sugar is now duty free as of 1/1/08; also, the Farm Bill (subsidies) expires on "September 30, 2008 and is currently under review by the U.S. Congress. The current version of the Farm Bill passed by the U.S. House of Representatives has several key factors which may negatively affect the Company's ability to purchase its raw sugar requirements (fiscal year 10k, page 10)."

All that goes into the sugar you enjoy with your morning coffee.

Emile: or, On Investing

In his classic treatise on education, Emile: or, On Education, Rousseau extols the virtues of a responsible, natural, and deliberate education with a particular emphasis on maintaining one's natural qualities in a corrupt society. Surprising to some, this work, which Rousseau believed to be the "best and most important of all my writings" has parallels to financial markets. This is fitting. Many investors are obsessed with multi-disciplinary training, and often rightly so. Investing could be seen as the ultimate intellectual exercise which incorporates, among other fields: math, psychology, philosophy, and history. Below are points to consider.

On developing an investment thesis:

“The spirit of my education consists not in teaching the child many things, but in never letting anything but accurate and clear ideas enter his brain.”

On financial analysis:

“It is a question not of knowing what is but only of knowing what is useful”

On circle of competence:

"Thus we are reduced to a very small circle relative to the existence of things”

On contrarian investing:

"Take the opposite of the practiced path, and you will almost always do well."

This Week's Market Moving Earnings Calls

It's a difficult task to narrow down this week's list of earnings calls/reports from 280 to a manageble 5; however, each day of the upcoming week has reports critical to short to near-term markets. The picks below are concentrated in financials, consumer goods, residential construction, and energy due to their impact on the consumer (consumer spending equals 70% of GDP)--notice the aversion to tech, though AMZN's numbers should be important. The five companies have an equally-weighted return of -33.4% for the period 1/1/07 to 1/25/08. vs. -6.1% for the S&P 500.

Monday - American Express	AXP
Tuesday - Countrywide Financial	CFC
Wednesday - Kraft	KFT
Thursday - Pulte Homes	PHM
Friday - Exxon Mobil	XOM

Merger Arb Plays

BofA put it's $4B+ offer on the table for beleagured mortgage lender Countrywide Financial.

Terms:
-.1822 shares of BofA (40.57) = 7.39 per share for CFC holders
-2Q2008 closing target according to BofA CEO
-Spread: 23.4% for a 3-5 month closing.

Bottom line:
-Faro outlook is positive for small portion of current cash position


FCC and shareholders approved the Bain/Thomas H. Lee buyout for Clear Channel Communications; pending DoJ's nod.

Terms:
-$39.20 cash per share
-Feb 2008 closing target
-Termination fee of $500m or 12% of equity commitment
-Spread: 21.7% for 1 month closing

Bottom line:
-Faro outlook is positive for small portion of current cash position

Reading Expectations through Stock Prices: Discover Financial Services

DFS is a company that generates ~$1B per year in free cash flow and currently trades at book value. Of the underlying drivers of firm value (i.e., top-line growth, ROIC, and cost of capital) the most concerning to me is ROIC. This begs the question: at today's price, what is the market's assumption for free cash flow growth over the next four years? If we assume a near worst-case scenario (widespread fraud and bankrupcty would be the worst--though my opinion does not support this) of 4 consecutive years of only $500m in free cash flow--a fifty percent reduction driven mainly by a huge increase in the current charge off ratio of 5%, followed by a return to $1B of cash flow generation followed by a valuation of 10x cash flow in year 10, the value of the company would be ~$10B vs today's current value of $6B. Clearly, the market is seeing a longer period of uncertainty since the implied cash flows out 4 years are being valued at zero! Or, DFS is being overly discounted during the current economic crisis. My guess it that the charge off ratio will grow as high as 10% but in the end most folks will pay their bills.

Quick Snapshot
Pricing Power: yes
Oligopoly: yes
Recurring Revenue: yes
Brand Strength: so-so
ROIC > Cost of Capital: yes
Balance Sheet Strengh: A

Faro Portfolio Performance

Faro: (9.8%)
S&P: (8.6%)

Highlights: positions have been reduced and shift to cash has slowly occurred throughout Nov. and Dec. 2008 economic stance is flat to slightly down.


inception date: 10/15/2007