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  • "The market can remain irrational longer than you can remain solvent" - John Maynard Keynes

    Monday, August 25, 2003

    The 100 Top Brands
    Business Week (BW)published the top 100 global brands for 2003. They have interestingly valued the brands (not the market cap of the company but just the brand). Coke has the highest value brand at $70.5B, BW is effectively saying that buying the coke brand from coke would cost $70.5b, leaving $36Bn for everything except the name coke. Microsoft came in second with a brand value of $65Bn (their market cap is $282Bn). This pretty much confirms that coke is mainly the "coke brand", Microsoft is much more than their brand - $220bn more in fact.

    Great brands take so much investment that it is reasonable to say they provide a sustainable competative advantage. Therefore I looked if the top 10 brands of publicly traded companies (excluding ADR's) outperformed the S&P 500. I considered Coke, Microsoft, IBM, GE, Intel, Disney, McDonalds, HP, Citibank and Ford.

    Returns5 Year10 Year15 Year
    Exceed S&P679
    Underperform S&P431

    Nine of these companies also exceeded the S&P 500 average Return on Equity over 5 and 10 years. This shows that these companies can leverage their brands to turn retained earnings into even greater profits than their peers over time.

    Though I didn't really look at enough data, it seems plausible that over increasingly long periods of time, those companies with the highest value brands can earn market beating returns.

    Thursday, August 14, 2003

    The Oil Trade

    Having made a relatively good call on interest rates using the Profunds rising rates opportunity funds (up 13% in 36 days) I decided to investigate the other economic factor that appears historically mis-priced to me. Oil.

    It turns out that there are many different types of Oil and different prices for them. The type that I have analyzed is called light sweet crude. Futures and options on futures are sold on Light Sweet Crude at the New York Mercantile Exchange (NYMEX).

    Considering daily data from April 4th 1983 to yesterday, we are 1.5 standard deviations from the mean price of $22. Today’s close was $30.78. There have only been 366 days (7%) with equal or higher prices out of the 5108 in the period. If you exclude the two gulf wars by taking out the 1990 and December 2002 – August 2003 prices we are 1.7 standard deviations from the mean and there are only 5% of days that exceed today’s price.

    Historical oil prices have been even lower. From 1947-1998 the average price was 19.27 and from 1867-1997 it was 18.63. The 83-now data is closer to an average of $22.

    Additionally one of the significant problems with the economy right now is the additional “tax” that high oil prices create. This affects earnings and GDP. A similar presidential election was lost by the senior Bush due to the economy. This one is not going to make the same mistake. The tax cuts were a component as cheap oil will be shown to be. Looking back from the November 2004 election you will see at least 6 if not 9 months of much lower oil prices.

    The question is how can we formulate a trade to take advantage of this. You can trade both futures and options on futures on the NYMEX. A futures contract is one in which you agree to deliver to a contract (such as 1000 barrels of oil) at a set date in the future. The price, however, is agreed today. It is different to buying an option as delivery is not optional.

    There are then options contracts that are derivatives of the shortest duration futures contract on expiry. For example you can trade April ’04 options on the May ’04 futures. In April ’04 the options settle with delivery of the May ‘04 futures contract and then in May the futures settle with delivery of Oil. In reality the options are usually closed out before futures contracts are delivered and the futures are almost always closed out before actual oil delivery is required. To close out you either sell your contract if long or buy back your contract if short.

    On to the numbers. The March 04 futures are trading at 28.45. That reflects an expectation that in February the spot price for oil will be 28.93. Importantly in the statistical analysis, 130 days was the longest period between a price above $30.78 and $26 (the $26 will become important in a moment).

    You can buy options on the March 04 futures. As we believe the price will decrease we would buy a Put option. The March 04 Futures Contract Put at a strike of $28.5 costs $2.33 and expires in February 2004. That means we need the price of oil to be less than $26.17 for us to make money. That occurs 74% of the time (excluding gulf war times or 71% including). To double your money the March 04 future would need to trade at $23.84 between now and February ’04. 69% of trading days were below $23.84 (or 66% including wars).

    Iraq also plays into this. 75.7 Million Barrels of oil are consumed daily. Iraq can currently produce 2M barrels under the oil for food program. If this gets doubled to 4M then you could expect a 10% decrease in prices simply as a result. Additionally OPEC’s target is in the range of $22 to $28 a barrel. Again I think Bush is going to make sure that is at the lower end of the range for a while leading up to the election.

    Sunday, August 03, 2003

    Flipside on option expensing

    This comes from the EXPEDITORS INTERNATIONAL 8K posted in June 2003. They post an 8K monthly with replies to people that sent questions to their investor relations. These 8K make for very comical reading. This is part of a response to a question on the value of diluted shares, using the Mad Hatter's tea party for comparison:

    After all, once you allow yourself to descend “down the rabbit hole” into accounting wonderland where procedures are promulgated at the expense of principles, why shouldn’t things just get “curiouser and curiouser” and indeed they have. At this point, it is fair to say that we have answered your question as best we can, but we need to go on in order to blow off a little steam as we try to point out how silly this stock option expensing medicine really is.

    Recording an expense for stock options requires a certain amount of twisting, bending and molding of traditional accounting theory to distill a set of accounting entries that make sense. In the case of stock options, we want to record an expense on the books of the company to record a transaction that in essence is a transfer of value between the shareholders and employees (potential or actual shareholders) - an item for which there is no guarantee that any consideration will, in fact, ever change hands.

    Also, not to be forgotten is the fact that for the period in which expense must be recognized in the income statement, an offsetting credit must go somewhere in order to leave the books balanced. Since we are still doing double entry bookkeeping, debits (expense for employee stock options in this case) must always equal credits. Where can we put that tricky rascal as we record this expense for stock options? Putting it on the income statement would undo the expense so we know that can’t be the answer. That only leaves the balance sheet.

    In all the uproar over the need to expense employee stock options, the ridiculous accounting acts that must be committed on the balance sheet have been glossed over by those who are knowledgeable in accounting matters. They have likely been misunderstood, misinterpreted or otherwise not comprehended by those who aren’t. But, let us explain.

    Two paragraphs ago, we established that every debit needs a corresponding credit and that if we are to expense options, we have to put the credit on the balance sheet otherwise nothing happens. Now, ignoring stuff like contra-assets (accumulated depreciation for example), the balance sheet can be said to be made of assets, liabilities and equity. The asset side is the home of debits while the liabilities and equity generally carry credit balances. Trust us when we say that the credit we get with stock option expensing isn’t a liability so we need to shove this puppy into the equity section.

    In the name of the perceived greater good (stomping out exorbitant stock option grants to a small group of overcompensated management in a select group of firms), the expensing of stock options has made a complete and total mess out of the equity section of the balance sheet. Grossing up the stockholders equity section of the balance sheet (that is what that rascal credit does after all) in order to record an expense for stock options on the income statement (the debit we all seem to want) completes our journey down this accounting rabbit hole and it is about time for tea. Just as grossing up stockholders equity may make no sense, there was little rhyme or reason in Wonderland, tea was at 6:00 and according to the Mad Hatter, it was perpetually 6:00 for no other reason than the Mad Hatter said it was. At the Mad Hatter’s party, only one person got a clean cup, but that is a story for another day.

    Finally, we suspect that the reason things seem to work differently at the other companies you studied, has to do with the success of Expeditors and the fact that our unamortized option value is therefore fairly large according to Black Scholes. The more successful the company, the larger the likely unamortized value. The larger the unamortized value, the more options are initially excluded as anti-dilutive. “I want a clean cup,” interrupted the Hatter: “let’s all move one place on.”

    The most recent 8K tells an analyst that they don't like him and his investors are welcome any time, just not him.

    I don't believe in the end I agree with their argument and issuing restricted stock like Microsoft has, makes option expensing a non-issue anyway.


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    Disclaimer and Disclosure Analyses are prepared from sources and data believed to be reliable, but no representation is made as to their accuracy or completeness. I am not paid by covered companies. Strategies or ideas are presented for informational purposes and should not be used as a basis for any financial decisions.
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