Tangible Assets that Sweat

With so many things working against us in today’s volatile U.S. market, it’s easy to feel wary of putting your money into anything…Not to worry, Chris Mayer has the key to smart and profitable investing…

"Lightning seems to have lost its menace. Compared to what is going on on earth today, heaven’s firebrands are penny fireworks with wet fuses." – E.B. White

What is an investor to do? The investor today is buffeted by news of a weakening dollar, worried about increasing piles of debt and mounting fiscal deficits, faced with historic trade deficits, bombarded with deadening election year rhetoric – a veritable potpourri of nasty stuff. Is there anything an investor can do?

I think there is. Invest in tangible assets that sweat.

The concepts behind this idea are simple on the surface but profound in their application. They are culled from the thinking of some of the greatest investment minds in the pantheon of great investors, but also grow out of my experience lending money to businesses and the experiences of old American money.

But what are tangible assets that sweat?

Tangible assets are simply things we can touch and feel, things we can see and count. These investments include things like buildings, timber, cash, certain machinery, land, vineyards and other unique assets. Industries that are not going away and that are in no danger of the next generation of competitors making them obsolete.

Contrast this with the most exciting and best-loved investments of the boom years. Companies like AOL, Lucent, JDS Uniphase and a host of others that carried billions of dollars in intangible assets on their books – such as "capitalized software development costs" or "goodwill," among others.

These assets were on the books because accounting conventions required it, not because they represented value that could be sold or accessed in any direct way. Most of these assets were subsequently written down, leading to billions of dollars in losses for those companies and their shareholders as well.

Tangible Assets: Cash Flow Is the Sweat

Tangible assets seldom lose value like that. Most of the time an asset like timber or unique real estate only become more valuable as time goes on. That’s the general idea – I like to be involved in companies where time works in my favor and where the principal assets of the company are things I can touch and feel, that I can count and see.

Cash flow is the sweat, the streams of actual cash that a company generates. Cash flow is not earnings, although many investors are probably surprised to learn that fact. Earnings can be very deceptive, which is why a company like Enron was producing favorable earnings reports even while it stood on the precipice of bankruptcy. Enron was very good at manufacturing earnings. But the goal is not to make earnings; it’s to make money. Cash flow analysis follows the money.

There are many large items that go on outside of reported earnings and that can’t be captured in a single number like earnings per share. Businesses are complex and have many moving parts. It is a wonder that so many investors spend so much time worrying about one number on a quarter-to-quarter basis. I take a longer-term view and a more realistic view.

Cash flow gives companies options to pursue wealth-generating strategies, to reinvest in the business for future growth, to pay dividends or buy back stock, or to make smart acquisitions. Cash flow means that a company has options.

In addition to tangible assets and cash flow, I want to stay with businesses that I can understand. This sounds like a simple point, but so many investors buy companies in highly technical or complex businesses, with inadequate disclosures, and it winds up costing them a lot of money.

Warren Buffett has many famous sayings, among them, "Invest in your circle of competence." Buffett has made fortunes investing in very simple businesses, like See’s Candies, Nebraska Furniture Mart and The Washington Post. Candies, furniture and newspapers – we can all understand these businesses as opposed to, say, the next biotech drug research or semiconductor test instruments.

Peter Lynch is another famous investor who advised investors to buy what they know. Lynch made a fortune investing in companies like Pep Boys, Dunkin Donuts and Taco Bell. Again, no need to get fancy. Great businesses often lie right under our noses.

Tangible Assets: Don’t Fight the Company

This idea also extends to the disclosures the company makes about its business. If you read the 10-K for Enron during its bubble days, as I did, you couldn’t help but come away thinking that this was one complex business. There are plenty of fish in the sea, so goes the old saying. We don’t need to waste a lot of analytical effort fighting with a company to get at the truth.

The final leg of the stool, if you will, is the idea of buying these businesses on the cheap. Many businesses would meet our first three hurdles of owning tangible assets, generating cash flow and being in simple and transparent business – but would fail to meet this fourth crucial hurdle.

It is an old adage on Wall Street to buy cheap and sell dear. But it is often overlooked, as investors continually overpay for businesses that they have fallen in love with.

Peter Bernstein, famed economist and author, noted in an interview that, "the double-digit returns stocks were able to generate over the last century were due to equities starting cheap and getting richer over time…a part of those realized returns was unexpected windfalls from rising equity valuation multiples."

Or as he likes to say, "Starting price matters." You cannot expect to produce strong results in investing if you are continually overpaying for your investments. Special care must be taken to be sure that your "starting price" or your purchase price is at a low enough level to ensure a good profit even if things don’t go exactly as you hoped. There is another old saying on Wall Street, "Well bought is half sold," which I believe captures this sentiment.

That is it. The four criteria of sound investing: tangible assets, cash flow, simple and transparent businesses and cheap prices. There are other nuances to be sure, but that is the framework.

This investment philosophy, too, is timely. Investment returns move in cycles. The great legacy of the 1990s bubble and bust may be the rise of these enduring tangible assets at the expense of fleeting and bloated intangible assets, a reversion to the tradition of wealth that has created lasting fortunes for generations.


Chris Mayer
for The Daily Reckoning
October 28, 2004

The Dow popped up again yesterday – more than 100 points – and the race is on!

We were wondering how George W. Bush could win with the Dow dropping, economic indicators falling, the dollar sinking and the bond market signaling an economic slump. The polls show the two candidates neck and neck; Bush could not afford more slippage. He needed a rally. And here it is…at least for now.

Our guess is that a good rally will push the neocon candidate over the top. Our guess is also that if the election were held a week or two later, nothing could save Bush. Each passing day brings more evidence that the chief executive has no idea what he is doing.

Each day, the U.S. government goes $1.3 billion further into debt. Our friend Gregor points out that in just three years, the new debt will come to more than the value of every ounce of gold ever pulled out of the earth since mining began more than 3,000 years ago. Each dollar of debt represents a claim on resources. One dollar’s worth of resources, to be exact. But there is no way of knowing whether you will get the same amount of resources for your dollar’s worth of debt next year as you would now. Heck, in a couple years, you might even get more. But if so, the world would have to be even wackier than we think it is.

People in the United States tend not to worry about it. And why should they? Their bills are in dollars, as well as their assets. But the foreigners have more to lose. They hold trillions of dollars worth of U.S. Treasurys and other dollar-based assets. If the dollar should go down – they’ll be out of luck.

And yet, the dollar already has gone down nearly 50% against the euro. On Tuesday, it hit its lowest point – against a basket of foreign currencies – in nine years.

Yesterday, the dollar rose slightly against the euro. But foreigners are increasingly edgy about the buck…and foreign purchases of U.S. government securities are slowing. When they will stop buying altogether – or even sell – is anyone’s guess. But when they do, the dollar will collapse. Gold…oil…everything that is currently quoted in dollars…will go up in price. America’s consumer economy will be ruined.

Of course, that will not be the end of the story. There will still be Iraq…and all the thousands of terrorists freshly minted by the Bush administration…
And there will be Bush’s expensive new medical benefits…and all the many expensive new programs and agencies…and all the expensive old ones, too. And of course, consumers would still have their home loan and credit card bills to pay. The U.S. government…and its citizens…will still have huge debts.

And the Treasury department would still have, as Fed Governor Ben Bernanke might say, "a technology…a printing press…" with which to pay them.

You do what you want, dear reader, but under the circumstances, we would much rather hold one of those ounces of gold than 425 dollar bills from the U.S. Bureau of Engraving and Printing.

More news, from our team at The Rude Awakening:


Eric Fry, reporting from Manhattan…

Waif-like inflation data…nothing is what it seems…Americans indulge in more delightful illusions.


And back at Ouzilly….

*** People in the housing industry provide places for others to live. People in the airline industry take others where they want to go. Plumbers plumb. Painters paint. Bakers kneed their sour dough.

But what about people in "finance"? Does their dough never go sour?

What doth the man in "finance" actually do?

We don’t know, but people seem to like it. Word comes from Bloomberg columnist Graef Crystal that the CEO of Countrywide Financial Corp. is paid handsomely for whatever it is he does.

"The 65-year-old [Angelo] Mozilo’s pay packages have been breathtaking, considering the size of his company. From 2001-2003, his total pay was, respectively, $21.2 million, $15.6 million and $31.8 million."

Never before was shuffling money such a big part of the economy…or so highly appreciated. GM makes its money not by making cars, but by lending money so people can buy them – and houses, too. In 1973, the financial industry provided less than 10% of the entire stock market’s profits. Today, it is more than three times that much.

What a great business to be in! You make money by lending money to other people. And so much of it! The more you lend…the more you make. At least, that is how it appears. As the amount of debt soared, so did the profits of financial companies…and the pay of the Mr. Mozilos of this world. What a spectacle! The more damage Mr. Mozilo does to the balance sheets of American households, the richer he gets.

Well, God bless them all. God bless all of us. And all our debts…wherever they may be.

*** And the debts just get larger…and larger…and larger. Thanks to the bond market. Bonds have been going up…signaling, we think, a weaker economy. But the effect has been to lower home loan rates. A year ago, you could borrow for 30 years at 6.05%. Today, it is 5.69%. No wonder house prices are still going up. No wonder people are still borrowing. No wonder the ships are lined up outside of Long Beach…full of new stuff for us to buy at everyday low prices.

The whole thing reminds us of a post hole digger we used to own. You would put it in the ground. The thing would turn and turn and slowly grind its way into the ground. Then, all of a sudden, it would cut into softer clay. The incline of the bit would pull the auger down so quickly it would screw itself all the way down into the dirt, so deep it was impossible to pull it out.

*** A July 13, 1915, letter from a French soldier in World War I tells how they dealt with shirkers:

"If I had known what was coming…I would have pretended to be sick. I would have gotten eight days of prison, but at least I wouldn’t have had to take part in a murder. They told us we would have reveille at 2 a.m….they said vaguely we were to attend a punishment. But I never imagined that we were to execute someone.

"We left camp about 3 a.m.; we were conducted to a park of some sort. There, they formed us into a rectangle, and seeing the post we understood, too late, what kind of thing we were supposed to do. It was to shoot a poor fellow who in a moment of madness left his trench and refused to come back.

"About 4 a.m., two cars arrived, one carrying the unfortunate soldier, the other a bunch of officers who read out a report condemning the man to death. The man came up between two policemen. He looked at the post. Then they put a blindfold over his eyes. Then, after they had read out the condemnation, they led him to the post and tied his hands to it, with him on his knees. He made no gesture, nor any remark.

"We presented arms and heard the sad commands – ready, aim, fire. Then, this poor man twisted up…and a sergeant went over and delivered the coup de grace, with a pistol to the head. The crime was done…

"We then filed past the man…who just five minutes earlier was full of life…"

The Daily Reckoning