Market Review: Surrender, Christmas!

This Thursday, we had our monthly gathering of the fine minds that make up Agora Financial (i.e., our editorial meeting) and after, our monthly happy hour. We all crammed into George’s by the Washington Monument for their two-for-one drink special, and as your editors drifted in and out of conversations, something on the news caught our eye. It was too loud to hear anything, but the caption read: "The War on Christmas."

Hmmm…we’d heard about the War on Terror, the War on Poverty, the War on Drugs – but the War on Christmas? This was news to us.

But apparently, this wasn’t new to anyone who watches FOX News. The channel has been covering what they are calling "Christmas Under Siege" since before Christmas of 2004.

You may be wondering why people are up in arms. Well, as it turns out, this conflict has many layers, and many strategies. Some retailers, particularly Target and Wal-Mart, are telling their employees that instead of wishing their customers a Merry Christmas, they must use the non-denominational, non-offensive phrase, "Happy Holidays." According to Christian conservatives, President Bush is also involved in this crusade against the merriment; he recently sent out cards with a generic end-of-the-year message, wishing 1.4 million of his close friends and supporters a happy "holiday season."

And on the other side of the battle, at least 1,500 lawyers have volunteered to sue any town that tries to keep nativity scenes out of its holiday displays. And about 8,000 public school teachers stand ready to report any principal who removes Silent Night from the choir program, reports the BBC.

FOX News host John Gibson has even authored a book on the subject, The War on Christmas: How the Liberal Plot to Ban the Sacred Christian Holiday is Worse Than You Thought. FOX News’ Bill O’Reilly recently interviewed Gibson, and during O’Reilly claimed that the ‘war’ is "all a part of the secular progressive agenda to get Christianity and spirituality and Judaism out of the public square. Because if you look at what happened in Western Europe and Canada, if you can get religion out, then you can pass secular progressive programs, like legalization of narcotics, euthanasia, abortion at will, gay marriage, because the objection to those things is religious-based, usually."

We are not bringing up this so-called holiday battle to choose sides, or even dignify it with a response. As far as we’re concerned, if you want to say ‘Merry Christmas,’ go for it. If you feel more comfortable, dear reader, wishing friends and co-workers a ‘Happy Holiday,’ who are we to judge?

What we hope to point out by bringing up this controversy is what lies at its core – something that is a major theme in all empires: keeping the nation involved in wars on the periphery and bread and circuses at home.

"Between 1917 and 1971, the country was transformed from a simple republic that mostly minded its own business to a grandiose with imagined interests and real troops everywhere," write Bill and Addison in their NY Times bestseller, Empire of Debt.

"In normal places at normal times, people go about their normal lives earning a living the best they can. But an empire changes the way people think. The common householder turns away from his humble house and his spouse and begins to think about the fair world beyond his kith, kin, and ken. He looks outward and sees how much better the world could be if he and his fellow citizen could run it their way. He sees that he must play a greater role in global affairs…that he must walk on the world stage, not as a bit player, but as the main character – the hero."

Our stance on the "War on Christmas" is irrelevant. We just urge you to not get so distracted by the buzz from the imperial world-improvers that you lose sight of what’s really going on in our world.

Kate Incontrera
The Daily Reckoning

December 18, 2005

P.S. The bright minds of Agora Financial meet occasionally to debate and discuss the new trends in the financial world and investment ideas – among other things. This monthly gathering includes the cream of the crop of financial minds – and for a limited time, you can attend the Agora Financial Reserve meetings.

— Daily Reckoning Book Of The Week —

A Zebra in Lion Country
by Ralph Wanger

Maybe you buy stocks on your own, maybe you invest through mutual funds, maybe you do both. Whatever your way, you are still the one who is ultimately responsible for how your money is invested and what kind of return it brings you. Wanger will explain how he selects stocks and when he’s likely to sell them, which will be useful to direct investors. But even mutual fund investors have to understand what the managers they hire do with their money. What Wanger tries to do in this book is to take you inside one fund’s offices and one manager’s mind, to give you an idea of how Acorn’s merry band goes about its business.

There is little in these pages that is difficult to understand. There are no Greek-letter equations or directions for tearing apart balance sheets. What Ralph Wanger emphasizes are the principles, more than the details, of investing.

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THIS WEEK in THE DAILY RECKONING: Did you miss an issue of The Daily Reckoning this week? No worries – we have them all catalogued for you, below:

Evening in America     12/16/05
by Bill Bonner

"The codgers refinance their houses, pay with credit cards, and vote for whoever promises them the most of someone else’s money. In politics, and in money, the grumps go along with whatever is popular – just like everyone else."

Gold Stocks and Burning Matches    12/15/05
by Doug Casey

"I hope you won’t fall in love with them. Although I’m a philosophical gold bug, I’m not always a gold bull. I always keep in the back of my mind that gold shares aren’t heirlooms; they’re burning matches."

The True Greenspan Legacy    12/14/05
by Dr. Kurt Richebächer

"If Alan Greenspan jettisoned all inherited rules, he nevertheless chose one predominant rule, actually, his only rule: a strictly asymmetric policy pattern."

Popular Delusions    12/13/05
by Addison Wiggin

"So what do you do? You stick to the old chestnuts like ‘buy low, sell high.’ How do you know what’s low? Well, you have little help in making that determination, except for what has happened in the past."

Those Rich Guys and their Precious Metals    12/12/05
by The Mogambo Guru

"The best part – and this is why you should be buying gold – is that the price of gold is being held down by governments because it reflects so bad on them, giving you a bargain."

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FLOTSAM AND JETSAM: How can you separate the solidly run small-cap companies with bright futures from the companies that will end up as Wall Street road kill? James Boric explores…

Wall Street Road Kill
by James Boric

Of the 5,877 companies that trade on the AMEX, NYSE and Nasdaq, there are only 784 large-cap beasts with a market cap of $5 billion or more. (Note: My guess is in the next year that number will decline as behemoths like GM, Ford and Kodak are added to the "extinct" list of publicly traded companies.) By comparison, there are 3,804 small-cap companies with a market capitalization of $1 billion or less. And while not every small-cap company will be around this time next year, the best returns will come from this list. They always do.

So how can you separate the solidly run small-cap companies with bright futures from the companies that will end up as Wall Street road kill?

One of the best ways is to look for businesses with a high return on invested capital (ROIC).

Joel Greenblatt, the Gotham Capital founder who made 50% a year for an entire decade, succinctly described ROIC like this in his latest masterpiece, The Little Book That Beats the Market:

"Buying a share of a good business is better than buying a share of a bad business. One way to do this is to purchase a business that can invest its own money at high rates of return rather than purchasing a business that can only invest at lower ones. In other words, businesses that earn a high return on capital are better than businesses that earn a low return on capital."

Translation: Companies that spend, manage and invest their money well are companies you want to own. Those are the companies that are growing. Those are the companies that are creating new, innovative products that command high profit margins. And those are the companies that add to shareholder wealth over time.

So what is a healthy return on invested capital?

A recent study by Bin Jiang and Timothy Koller of McKinsey Global Institute found that from 1963-2004, the average ROIC for all publicly traded companies (excluding financial companies) with sales of at least $200 million was nearly 10%. In other words, over time, the average company on Wall Street will earn 10% for every dollar it invests in its business. But they are quick to point out that "companies that drive innovations in technology or business systems may earn above average returns…"

Investing in those "above average" companies is exactly how the greatest investors have always made their fortunes.

So where are those innovative companies located today?

To find out, I ran a screen for every company on Wall Street with an above average ROIC of at least 30%. There were 165 companies (after excluding financial companies) that fit the bill. And after sorting through the data, here are some observations I made:

– 87 of the companies with a high ROIC were small caps with a market cap of $1 billion or less
– 51 were mid-caps with a market cap between $1-5 billion
– And 27 were large caps with a market cap above $5 billion.

Curiously enough, the textile (specifically, the footwear and clothing sectors), steel and iron, oil and refining and business and software services industries had the largest pool of companies with high ROICs – those above 30%.

Of the 165 companies on the list, seven were from the textile industry…seven were from the steel and oil industry…seven were from the oil and refining industry…and 17 came from the business services and software services industries.

Small-cap companies are the squirrels of the market. They are wily, nimble and creative. As an investor, those are the kinds of businesses you want to put your money in. In fact, they are exactly the same kinds of companies a guy like Wanger might look for as candidates for his Acorn Fund.

"A squirrel is…an interesting animal," said Wanger in a 2000 interview. "It’s not the strongest or smartest animal in the forest, but it is a very successful animal. There are squirrels in every country, because they are adaptable and opportunistic. For a small-stock manager, that’s a good symbol.

"Tigers are brave and beautiful, but they’re nearly extinct. And bulls are strong and powerful, but they wind up as a beef patty between slices of bread. But squirrels are all over the place."

James Boric
for The Daily Reckoning

P.S. In weeks and months to follow, I’ll explore why those industries are so rich with well-run, innovative companies. And if you are a Penny Stock Fortunes reader, I’ll be recommending several companies from these industries in the months to come.