Property “Flipping” That’s Good for the Soul

Below is a guest post by Frank Bateson.  This is a continuation on our discussion on real estate investing.  If you would like to write a guest post, please contact me.  Click on the About Me link for my contact info.

Frank Bateson is a retired appraiser who is now dipping his toes into blogging. He is considered an expert on Windham NY real estate.  When he's not plugging away at his keyboard, Frank enjoys tracking the stock market and lowering his golf handicap. 

When the great subprime mortgage crash broke in the fall of 2008, I doubt there was anybody working in real estate, banking and finance, development, construction and contracting or any related fields (which means just about everybody) that didn’t feel at least a little sick. For many of us that sensation was the result of several concurrent reactions: anxiety/fear/panic, bewilderment, a mistrust of government and private sector financial prognosticators and experts, apprehension and insecurity about the future, and perhaps the most pervasive (apart from worry) – anger.

In the months that followed a flurry of blame swept through the media and population in general. Who was responsible? Was it Alan Greenspan and his support of deregulation or his replacement Ben Bernanke’s failure to see it coming? Was it President G.W. Bush for likewise backing and pushing deregulation or supporting his Treasury secretary Henry J. Paulson’s 2007 prediction that the subprime crisis was “contained”? Was it the banks and/or Fannie Mae and/or Freddie Mac? Standard and Poor’s, Moody’s and the other rating agencies’ apparent good-ratings-for-profit racket must have played some role in the collapse, right?

All of these entities and individuals mentioned no doubt contributed to the collapse, of course. However, for months if not years after the crisis there was pretty much a 100% chance that any story you encountered on the Great Recession would inevitably contain or close with a high-handed critical rebuke from the story’s author that really, when you got down to it, we were all to blame. If we’d just been a little more responsible maybe we wouldn’t be in this mess. The lion’s share of that blame often seemed to find its way to a particular breed of everyman- the property “flipper”.

Although there are several different subclasses, the species of flipping practitioner most people are familiar with, and the sort that now populates about a dozen television shows (with at least two more reportedly planned by CNBC), is the “fix and flip” artiste. The fix and flipper buys a property listed for less than that property’s value would be if all things were equal. Those unequal things include a house that’s in bad shape or looks like it is, is being foreclosed on, has been seized for whatever reason or often some combination of those. The flipper then fixes the house up and sells it for a profit.

Flippers got a bad rap for a few reasons. They were often considered a predatory symbol of the real estate market’s woes- flash in the pan slicksters who leeched off of honest people by artificially ratcheting up the value of properties that “honest” homeowners would have to pay more for. And unfortunately, there were indeed some scammers who’d work in collusion with each other and either dishonest or inexperienced mortgage brokers, appraisers and loan officers to inflate a property’s real value for shady flipping schemes.
Plus, it’s certainly not unheard of for underhanded hustlers to buy a property with major issues, make some superficial or cosmetic repairs or additions and sell a faulty product as a sound one. One of the most common admonitions of the fix and flip investors, however, was that a house just wasn’t a product meant for the making of a quick buck like doing so with other commodities like electronics, clothes, jewelry or even cars. Houses are meant to be homes and long-term investments that pay off when you move.
There’s something to be said for that perspective, certainly. That being said- even nowadays, with the market the way it is, prospective flippers can buy properties and turn them around for a profit without sacrificing one’s ethical deportment, spiritual commitment, moral code or integrity. In fact, when done right, flipping can do a great deal of good while turning a profit. The keys to doing it right is: having patience, being discerning, being honest and forthright with everyone involved in the process and making a commitment to legitimate property improvement.

Once you’ve gotten into property sales that aren’t costing you sleep at night (at least not because of your conscience) you’ll start to see the positive impact a good flip can have on your community and pocketbook. For instance, every successful real estate turning entrepreneur has an established network of subcontractors and maintenance people in their rolodex. That’s a huge link in the profit chain and obviously you’ll want to establish connections whose credentials, work ethic and honesty you’re sure of. Whenever rehabilitating a property everyone you employ in that network makes an honest buck; and an honest buck that contributes to the quality of a neighborhood.

There’s no neighborhood on the planet that would balk at a house on their block being improved. Improving and beautifying any house, particularly if it was something of an eyesore, raises the property values for everyone in the area. Not to mention that a distressed property has been made livable. Finally, and most importantly, when the house is put on the market an individual and/or their family has a home waiting for them.

As my wife and I bought our first house from a flipper, I know exactly how comforting it is to know that the house you’re buying has recently been inspected, touched up, certified, improved upon and often brought up to code. Had my wife and I bought the house as-is before the flippers had and attempted to hire the various contractors, about whom we’d have known little, and/or work on fixing the house’s quirks and shortcomings on our own, I have no doubt that the money we put in (especially if the hours of labor we’d have spent are included) would have been far more than the final closing cost of the house itself. So all in all, house flipping investors saved us money on the house we bought. Not a bad way to make a buck.

FaithShares Catholic Values: The Only Catholic ETF Out There

So you've read my series on the US Conference of Catholic Bishops' investment guidelines and figured you are just a little too lazy to go through all of that research.  Or you've done all the research and made your picks (good for you!), but you wanted to hedge your bets and buy something that performs a little more like the market.  Well, do I have something for you!  It is the only Catholic ETF out there: the FaithShares Catholic Values ETF (Ticker: FCV).

First of all, if you don't know what an ETF is, the acronym stands for "Exchange Traded Fund".  What that means is it is like a mutual fund where it's run by a fund manager and has many different holdings, but it trades like a stock, where you can buy and sell it within fractions of a second on the open market.  There are also no sales loads, redemption fees, exchange fees, etc.  In other words, it's got all of the advantages of a mutual fund, but not many of the disadvantages.  It does have management fees, however, but really, what funds don't?

I did not feel like boring myself with reading its prospectus (you should if you're thinking about buying it), but I did take a peek at its fact sheet.  From there, I found out what their strategy is.  They take the 400 largest US stocks and apply a screen of them based on the USCCB investment guidelines.  This filters out a number of companies that violate the guidelines.  They then rank the remaining "good" companies based on the same USCCB guidelines.  Once they have a ranking, they take those stocks, and perform sector allocation so that the fund matches the MSCI USA Index, which, for all intents and purposes is equivalent to the S&P500 index.  In short, the FCV mimics the market but invests only in companies which have been screened for Catholic values.

Figure 1: FCV's Performance (Blue) Compared to That of S&P500

Looking at Figure 1, it appears FCV mimics the S&P500 index pretty well.  If you're looking for market returns but want to adhere to Catholic values, this ETF is for you!

I also looked at its top holdings and was quite happy to see 2 of my 4 holdings, Google (Ticker: GOOG) and First Solar (Ticker: FSLR).  My other two, Synaptics (Ticker: SYNA) and True Religion (Ticker: TRLG) were too small to even make it on the radar for the fund to consider.  I had written earlier that I was concerned by Google's leanings to the political left.  I had eventually worked that out and concluded that it was likely ethically acceptable to invest in Google.  I'm glad I've gotten confirmation here.  I will sleep well tonight!

Another thing to mention is that FaithShares donate 10% of the fund's net income to a Catholic charity/organization.  This is excellent!

Overall, I think this ETF is not a bad investment vehicle for those who are lazy, but ethically conscious, or for those who want to hedge their bets.  Do be aware that someone is making an investment decision on behalf of you, and he/she may be wrong!  Factor that into your investment decision.  Lastly, if you're not Catholic, FaithShares does have other Christian oriented ETFs as well.  Do check them out!

USCCB Socially Responsible Investment Guidelines - Part 7: Encouraging Corporate Responsibility

The sixth and last area covered by the investment policies of the USCCB is "Encouraging Corporate Responsibility".

This category is in fact a summary and also a catch-all.  What does it mean to be a good corporate citizen?  It really boils down to a company behaving in ways that are acceptable to the society in which it operates.  Largely, it is a question of morality.  Therefore, this category should not be new to us by now.  By looking at the previous 5 categories of protecting human life, promoting human dignity, reducing arms production, pursuing economic justice, and protecting the environment, we would know what a good corporate citizen looks like.

In my opinion, there are 3 main categories of corporate citizens: the bad, the questionable, and the good.  The bad is an easy one; the company is really all about making money.  If corners could be cut, you can be sure they'd be cut.  If they screw up something, they will try to cover it up.  A good example would be Johnson and Johnson (Ticker: JNJ), with its recent drug recall fiascoes.  The questionable may include Google (Ticker: GOOG).  Google's got some nice initiatives, which includes the promotion of renewable energy, but it also has some left leaning tendencies, such as support for gay marriages.  Lastly, the good are the bullet proof companies, where their business is beneficial to society, and it is not plagued by moral issues.  I have yet to find such a company.  Why not?  It's simply because I'm just a regular joe.  I don't even know half of what's going on in the company at which I work, how is it possible to verify that all of activities of any one company are ethical?

That is not to be a cause for concern, however.  As ethical investors, we are not required to find the perfect company.  As I said, that is simply not possible.  What we are to do is to do the best that we can, within reason, to conduct research on a company to see if they are good corporate citizens.  What does that entail?  An hour or two of Google searches will likely suffice.  If there are some glaring misconduct, chances are people will know about it and it will be on the Internet.  If there are minor issues, you may not be able to find out about it, but then again, they likely don't warrant boycotting of their stock.  In the end, what matters is really up to you.  No one is pointing a gun at your head to make you screen stocks for ethical misbehaviour.  God will likely not damn you to the Inferno for not spending more than a couple of hours researching either.  The fact that you're looking into the corporate citizenship of a company already puts you ahead of 99% of all other investors.  Give yourself a pat on the back!

Now that we've gone through the USCCB investment guidelines, I think we can safely say that we can do our due diligence when investing.  Our research may not be perfect, but it's miles ahead of not doing any at all!

USCCB Socially Responsible Investment Guidelines - Part 6: Protecting the Environment

The fifth area covered by the investment policies of the USCCB is "Protecting the Environment".

This is one of my favourite categories.  I moved to Canada from Hong Kong when I was 8 years old in 1987.  Just shortly after I had arrived, Toronto started the curb side recycling program.  Initially, it was only a small "blue box" program where you had about 3 cubic feet of space to place your recyclables each week.  The idea that your garbage was really not garbage was really revolutionary.  There was also a big push in education in the schools.  Over the years, the recycling program had really expanded.  Currently, in Toronto, there are now 3 types of boxes for recycling.  The blue box still exists, but is now a big wheel barrel.  Items such as aluminum cans, glass, and Tetrapaks go here.  There is also a grey box which take paper products.  Similarly, it is a big wheel barrel.  Most recently, a green bin program was started.  Compostable material such as food scraps go here.  These items are all picked up weekly by the curb.  The goal of the city is to divert 70% of garbage from landfills.  A large majority of Canadian cities run similar programs and I would say they have been largely successful.

The same cannot be said for our friends in the US.  I work with many customers from the US and from the anecdotal evidence I have gathered, curb side recycling is still an exception rather than the norm.  I'm not here trying to trash my American friends, but the point I want to make is that the protection of the environment cannot be achieved, at least efficiently, unless there is governmental and corporate support.  This is where our investment comes into play.  We should be using our investment as our voice.

The USCCB's policy for their own investment is to actively promote and support shareholder resolutions that encourage corporations to act responsibly.  Just recently, I had exercised my shareholder right and obligation and voted, by proxy, on the various matters to be discussed at the annual shareholders meetings.  However, what I found was that most of the questions on which I voted were very broad.  They usually revolved around executive pay, use of certain accounting firms, and other shareholder resolutions.  Therefore, I have concluded that it would be difficult as an individual investor to voice peripheral concerns such as the protection of the environment, unless the company's business was directly linked to it.

How to Invest to Protect the Environment

As a result, our obligation is really to select companies that are already environmentally conscious, or better yet, have products or promote technologies that protect the environment.  We should also avoid in investing in companies that harm the environment, whether through their manufacturing processes and business practices or by the use of their products.

I will use my own portfolio as an example.  First and most obvious is my investment in First Solar (Ticker: FSLR).  It makes solar panels which produce electrical energy with no byproducts.  The only impact to the environment would be the manufacturing process and also the panels' disposal at the end of life.  One solar panel produces in the vicinity of 4000 kWh in its lifetime, which is equivalent to 14400 MJ, or 413 L worth of gasoline.  I hardly think one would need to burn a fifth of 413 L of gasoline to produce 1 solar panel!  Solar energy, is without a doubt, green energy.  First Solar is not without some problems.  It uses cadmium telluride in its panels.  Elemental cadmium and cadmium telluride in its own form are toxic to humans.  It is important that First Solar is able to recycle these panels at the end of their lives.

The second and less obvious green investment I have is Google (Ticker: GOOG).  To many people's surprise, Google is actually a very green company.  It invests heavily in solar and wind energy, for example.  It also uses goats to "mow" their lawn, instead of traditional lawn mowers.  There are many good things that Google is doing with regards to helping the environment.

On the flip side, we want to avoid investing in companies that do the environment harm in one way or another.  One obvious example is oil companies like Exxon Mobil (Ticker: XOM) and British Petroleum (Ticker: BP).  BP has become the poster child for companies to hate, with its recent oil spill in the Gulf of Mexico.  Aside from oil spills, the burning of fossil fuels derived from crude oil releases huge amounts of carbon dioxide and other pollutants.  Fossil fuels, in and of themselves, are not evil, but in today's world, humans rely so heavily on them that there may be irreparable damage done to the environment if we continue to consume them at the current rate.  Our insatiable thirst for crude oil is simply not sustainable.  We should direct our investment elsewhere.

Conclusion

It is really not that difficult to evaluate whether a company is environmentally friendly or not.  Just look at its products and how it is made and used.  If you find that it's not that easy to evaluate, try multiplying its current volumes by 10 or 100.  That may make things more obvious.  Or, you can try googling the company name with "environment" and see what results come up.  The internet is really a great place to do research in this area.  In the end, using common sense is likely all you need to do.

USCCB Socially Responsible Investment Guidelines - Part 5: Pursuing Economic Justice

The fourth area covered by the investment policies of the USCCB is "Pursuing Economic Justice".

Economic injustices are plentiful in the business world where increasing profits is sometimes the only goal for companies.  With public companies, management is often evaluated based on the earnings per share metric. If a company makes a lot of money, the share price would naturally be higher.  Therefore, the incentives for management would often be just to maximize the profits.  That is not to say that all companies increase their profits and neglect any moral duty.  However, many a times, companies have to make an extra effort in ensuring that their operations promote economic justice.

The 2 sub-categories under this area are:

1. Labour Standards/Sweatshops
2. Affordable Housing/Banking

Labour Standards/Sweatshops

The use of sweatshops are especially prevalent in clothing manufacturers' operations in developing countries.  Sweatshops typically have harsh and dangerous working conditions.  Some force workers to work long hours with very poor wages.  Some exploit child labour.  Laborrights.org is an active voice on this issue and lists a number of companies that allegedly operate sweatshops.  They include Walmart (Ticker: WMT), Kohls (Ticker: KSS), and Abercrombie & Fitch (Ticker: ANF).

When I became interested in True Religion (Ticker: TRLG), one of the first things I wanted to find out was whether they operated any sweatshops.  It turns out that they do not manufacture their own products, but hire contract manufacturers in the United States to make their jeans and clothing.  So, I breathed a sigh of relief, knowing that labour regulations in the US are strictly enforced and as a result, no "sweat" would be involved in the making of their products.

There is, however, the other side to this argument.  Some argue that while it is true that conditions are harsh in these supposed "sweatshops", the working conditions of other work in those developing countries are often even worse.  For example, one could choose to work at a Nike factory for 12 hours a day or work on a farm under the burning sun for 14 hours.  Of course, the local farms don't nearly get as much attention as the Nike factory does.  Some also claim workers wished Nike would expand even more in their area so that their relatives would also get to work at Nike.

In the end, it all comes down to your own evaluation of the situation.  I always think that "where there's smoke, there's fire".  You will not get a real idea of the working conditions of a factory unless you're really there to investigate.  I would say it's best to avoid companies which have a long history of complaints (e.g. Walmart and Nike).

Aside from investing in these companies, perhaps it's also not a bad idea to boycott these companies yourself to send them a message that you don't agree with their business practices.

Affordable Housing/Banking

This category applies mainly in the US.  In the past (and even presently in a few cases), financial institutions engaged in a practice called "redlining".  This term was coined from the banks drawing lines on a map to highlight communities where they would use discriminatory lending practices.  The banks would either refuse to lend to certain people from an area or increase the borrowing costs for them.  Typically, the discriminated areas would be areas with a high concentration of non-white population.


This practice is essentially racial discrimination.  The Community Reinvestment Act was passed in 1977 to discourage this type of behaviour.  One interesting fact: apparently, President Obama, as a lawyer in 1994, represented a man who sued Citibank (Ticker: C) for redlining.  Some have attributed the curbing of redlining to the subprime mortgage financial crisis in 2008.  I don't believe that is the case.  The Act's intent was to help discriminated communities get fair treatment from the banks.  Nowhere in the Act did it tell the banks to lend money to borrowers who could not pay the loans they borrowed to buy seven houses that cost way more than what they would make in an entire lifetime.

Conclusion

The category of Economic Justice is an extension of the Human Rights category.  Every human person should be treated with dignity and not be discriminated based on their gender, race, etc.  Even with some cursory research, you should be able to dig up some dirt.  Good luck!

Update of Portfolio: Google (GOOG)

Next up on my portfolio update is Google (Ticker: GOOG).  Click on the link in the previous sentence to see all of my posts on the company.  I've written not little about this company.  Reading the older posts will give you a flavour of my thoughts.

Where to begin?  How about an amazing 2010 for Google?  If you look at the Rule #1 spreadsheet below, and click on "Big 5" and scroll down to "EPS", you will see the historical earnings for the past 10 years.  The growth is phenomenal!  Aside from year when the world was coming to an end (2008 if you weren't paying attention), the minimum year-over-year EPS growth was 28.9%, which was last year.  Yes, the growth of the company is slowing, but at 28.9%, it's still pretty red hot!

Figure 1: Rule #1 Analysis of Google (GOOG)

Red Hot Growth
Is the growth going to continue?  My answer is: YES!  There are several factors that we can look at.  First, and foremost, the internet has not stopped growing.  How do I know?  Well, let's take a look at a somewhat related technology, the cell phone.  It's been around for about 20-25 years now (at least commercially) and you would think that the technology has pretty much plateaued.  Are you kidding?  Just look at the new smartphones that are coming out every week, and you know there is still tremendous growth.  Now, going back to the internet...it's just about the most revolutionizing technology of the 20th and 21st century.  It has changed the way humans do things.  Just think about it: when was the last time you wrote a letter?  When was the last time you opened a phone book to find a phone number?  When was the last time you looked for a job in a newspaper?  And the list goes on.  Is the internet mature now, after being widely available for about 15-20 years?  I hardly think so.  Facebook, the newest internet darling is barely 7 years old!  Who knows what's going to happen in the next 20 years.  But you can bet Google will be part of it.

Second, Google is still supreme in the internet space.  One piece of anedoctal data: Google makes up about 94% of the search engine traffic to this site.  Facebook, while exhibiting tremendous growth, made about $2 billion in revenue last year, while Google made about $8.5 billion in net income, and about $29.3 billion in revenue.  Facebook still has a ways to go to catch up from a business standpoint.  Many speculate that Facebook will dethrone Google, but the two companies don't really even directly compete against each other (save Google's Orkut).  In fact, I believe they complement each other pretty well.

Third, Google has good products and services.  Unlike Microsoft (Ticker: MSFT) but like Apple (Ticker: AAPL), people enjoy using Google's offerings.  Gmail is quick, Google Maps is indispensable, Android is a very compelling alternative to the iPhone, Youtube is synonymous with online videos, and last, but definitely not the very least, the Google search engine is still the very best.

Lastly, Google has vision.  The co-founders Sergei Brin and Larry Page are two of the brightest computer scientists around.  They have the technical know-how to steer the company in the right direction.  The foresaw the emergence of mobile internet a few years ago, bought a small company called Android, and developed it into the smartphone platform that now has the greatest market share in the US.  It could very well have developed a "gPhone", but instead, it made a platform that was free to phone manufacturers.  Consumers like choice.  Some people, like myself, just don't want to own something that everyone already has.  I like to be relatively unique, but don't want to sacrifice on performance either.  Android fills that gap nicely.

Cloud computing is undoubtedly the next progression in computer technology.  Google understands that and is already committed with their Google Docs and upcoming Chrome OS.  If you have not used Google Docs before, it's a cloud-based replacement for Microsoft Office.  Granted, it's nowhere near what MS-Office could do, but for everyday, simple tasks, it fills its shoes quite nicely.  Lately, my wife and I have been contemplating moving to a larger house and we use Google Docs to collaborate and save listings that appeal to us, whether we're looking at the listings from our computers at home, or browsing during our lunch hours (I swear, I never surf the web during work hours!! [just in case my boss reads this] LOL!).

Some Numbers
Looking at the Rule #1 spreadsheet above, the fundamentals look good.  The only thing is that Google is approaching its intrinsic value or sticker price of $673.  However, it has seen a slow, but sure drop to the $550 250-day EMA support lately.  Couple this with a forward P/E of around 14, I thought this was the biggest discount the stock was going to see.  So, I did what felt right: I added to my position.  We'll see what happens next.

My current average cost is $494.  So, I'm making a bit of money.  Analysts have Google making around $34.59 in 2011.  If the P/E ratio is maintained at around 20, the stock price could go up to $700 by the end of the year.

Some Caveats
There are some caveats for sure.  They include i) China and ii) ethics.

As we all know, the Great Firewall of China is even more formidable than the physical wall itself.  China is very paranoid about free speech and the free flow of information.  It requires that search engines present censored search results.  If you don't believe it, go to www.baidu.com and search for "tiananmen square massacre".  I got a total of 8 results...8!!!  Google.com gave me 477,000 results!  Just early last year, Google decided it wasn't going to censor its results anymore.  The Chinese government quickly blocked the site.  Google now runs google.com.hk as its Chinese version of the search engine, because the Hong Kong Special Administrative Area has different laws than the mainland.  However, the government can still block that site from its mainland users at any time.  When everyone is trying to get into China, Google has opted for higher moral ground and has gotten out.  This may not be an permanent situation, but for now, it definitely has not helped its business in China.  Investors have punished Google for this move in 2010.

Google also has some fairly left-wing leanings.  It fully supports the homosexual movement and advocates for them.  I've discussed this issue before.  So, please check it out.  In any case, this is one thing that holds me back from 100% endorsing in the company.  I have weighed the pros and cons in my reflections and have determined that this does not warrant me to pull my investment from Google, but I do keep an eye on any new developments and may change my position to reflect them.  If you do decide to invest in Google, I advise that you do the same.

Conclusion
From the business side of things, there really are no concerns.  Google is in a good position to capitalize on the continued growth of the internet.  It is fully aware of its competition and I'm sure they've got some bright brains behind the curtains working on something.  Unless the business fundamentals show significant deterioration, or the ethical side of things take a really horrible term, my money is still with this company.

USCCB Socially Responsible Investment Guidelines - Part 4: Reducing Arms Production

The third area covered by the investment policies of the USCCB is "Reducing Arms Production".

Every country has a right and obligation to defend itself.  This right inevitably leads to the purchase of weapons.  Are weapons in themselves evil?  No.  They are merely tools.  So, why does the Church have this category altogether?  It is not so much concerned about the Church's stance on the morality of weapons, than its stance on the disproportionate amount of money spent on the military.  In 2010, the budget of the US Department of Defense was upwards of $500 billion dollars!  That is larger than the market capitalization of any company in the world!  Imagine dissolving a bit less than 2 Apples (the company) tomorrow, and taking all the shareholder value and putting it into military spending.  That would only last 1 year in the US.  What would happen if only 10% of that budget ($50 billion) was put to improving the lives of the poor?

Canadians are in a better position.  Our military spending is dwarfed by the US military spending, at roughly $20 billion per year.  Still, that is not a small number.  Imagine dissolving Rogers Communications...Let's look a little more closely.

The 2 sub-categories under this area are:

1. Production and Sale of Weapons
2. Antipersonnel Landmines

Production and Sale of Weapons

The USCCB's stance on the production or sale of weapons is twofold.  First, it will not invest in any company that derives its revenue primarily from the production of weapons.  Second, it will not invest in any company that develops weapons that is contrary to the Church's teaching on war, that is, weapons of indiscriminate, mass destruction.

A few of the larger defense contractors in the US include Lockheed Martin (Ticker: LMT), Northrop Grumman (Ticker: NOC) and Raytheon (Ticker: RTN).  Government expenditure in each of these companies are in the magnitude of billions of dollars.  Even without doing much research, it is not far fetched to think that these companies are major supplies of weapons or weapons related products.  Typically, you can find out a lot about a company's products in its Yahoo Finance profile page.  That would be a place with which I would start my research.  Just reading the Lockheed Martin profile page was enough to turn me away from that company.

The first was easy to detect; the second, not so much.  Companies that develop weapons of mass destruction would likely not advertise that they're doing such work.  It's best to avoid all companies that develop or manufacture arms.

Antipersonnel Landmines

The use of landmines is similar to weapons of mass destruction.  The device will not care whether a soldier or a 4-year old boy steps on it, it will activate when anyone steps on it.  Indiscriminate landmines have since been banned by the Ottawa Treaty.  They're really just a specialized form of weapons.  So, if you already avoided arms manufacturers, you'd be pretty safe.

Conclusion

Conclusion is simple: avoid defense contractors and avoid weapons manufacturers.  If you do get into aerospace companies, be very vigilant as some are also involved with building fighter jets or components for them.  I'm not saying these are necessarily bad, but you would need to investigate and make a judgment call.  Better to stay away than to be ignorant.

USCCB Socially Responsible Investment Guidelines - Part 3: Promoting Human Dignity

The second area covered by the investment policies of the USCCB is "Promoting Human Dignity".  This follows the first category of "Protecting Human Life".  It is not sufficient for us to protect human life, we must recognize that humanity is made in the image of God, and that we have a special dignity above all other creatures.

The 5 sub-categories under this area are:

1. Human Rights
2. Racial Discrimination
3. Gender Discrimination
4. Access to Pharmaceuticals
5. Curbing Pornography

Human Rights

Human rights sounds almost like a no-brainer.  Of course, we need to promote adoption of human rights, correct?  Absolutely!  Everyone has the right to life, religion, freedom of speech, etc.  We should not, for example, invest in a company that uses sweatshops, which denies its employees of their most basic needs.  Most operations in the developed world will be very respectful of human rights.  However, we need to cautious of American companies with operations in developing countries, to ensure that they operate under the same standards as they would in the West.  Examples of these companies that have bad international practices include Walmart (Ticker: WMT) and The Gap (Ticker: GPS).

On the other hand, the issue in the developed world is not so much the violation of human rights, but the protection of "rights" that should not be treated as human rights.  In the past decade or so, the homosexual agenda has made headway in most western countries.  Same-sex marriage is now a reality in Canada and a number of US states.  In Canada, there is now a bill (Bill C-389) going to the Senate right now to add "gender identity" to the Canada Human Rights Act.  Essentially, if this bill is passed, it means that, for example, employers cannot discriminate based on gender identity.  So, if a transvestite comes for an interview for a teacher position at an elementary school, the school board cannot discriminate based on his "gender identity".  These progressions are a deconstruction of the society that Christianity had built in the past 2 millennia.  We should avoid investing in companies that promote this deconstruction.  In my post on Apple (Ticker: AAPL), I talked about how it was rated highly by the Human Right's Campaign, a pro-homosexual group.  This would be a good place to start your research.  Remember, if this group rates a company highly, that's a BAD thing!

Racial Discrimination, Gender Discrimination, and Access to Pharmaceuticals

I am putting racial discrimination, gender discrimination, and access to pharmaceuticals into one group.  Chances are if you dig up some dirt in the human rights category, you will also see issues in these categories as well.  If a company treats that workers like trash and provide horrible and dangerous working conditions, I don't think they would, for example, provide them with excellent access to pharmaceuticals.  These go hand-in-hand.  There's not much else to say, except: don't invest in companies that adopts these reproachable behaviour.

A good way to start your research is googling, "[company name] ethical issues".

Curbing Pornography
Here, I quote the USCCB investment policy regarding pornography, "The USCCB will not invest in a company that derives a significant portion of its revenues from products or services intended exclusively to appeal to a prurient interest in sex or to incite sexual excitement. These would include, but not be limited to, sexually explicit (X-rated) films, videos, publications, and software; topless bars and strip clubs; and sexually oriented telephone and Internet services."

The obvious companies in violation include Playboy (Ticker: PLA).  A less evident company is American Apparel (Ticker: APP).  If you haven't seen their ads before, just google, "American Apparel ads" and select images; you'll understand what I'm saying very quickly.  Although it sells very normal clothing, the advertisements are close to soft-core pornography, and the sad part is they are targeted towards the younger segments of the population.  Although the company probably passes the USCCB test, because it sells morally neutral clothing.  Yet, there is something wrong with investing in a company like such, because it essentially does what all pornography do.  That is, it reduces the subject (the female models in this case) into an object.

Other companies to avoid would be media companies that produce distasteful films, magazines, services, etc. A majority of these companies are smaller-sized, privately owned companies.  So, you may not need to worry so much.  Do keep an eye open though.

Conclusion

In the category of promoting human dignity, there is one question that you need to ask, "Does the company treat human beings as though they were human beings?"  The company should not exploit their employees to increase profits; they should not discriminate; they should not treat or portray people as though they were objects.  Even if their products or services were benign, but the image they portray does any of the above, I would still rather not invest in them.  Of course, it's all a balancing act.  A lot of great companies will indeed violate some of the principles discussed above.  You would need to make a judgment call on your investment decisions.

Rule #1 Analysis Blitz #10: Coca-Cola (KO)

This is the concluding post of the Rule #1 Analysis Blitz Series.  I had intended to write 10 posts in 10 weeks, but due to sickness and various other reasons, I was unable to stick to that goal.  Luckily, I was only behind a week or two.  So, I'll give myself 8 out of 10 for punctuality! :)

This week, I'll end with the company with which everyone is familiar: Coca-Cola (Ticker: KO).  Coca-Cola happens to be one of Warren Buffet's favourite companies and we will explore why that is the case.  Let's see if it meets Rule #1 standards!

Moat

You can download the completed Rule #1 spreadsheet here.

Coca-Cola is the ultimate example of a company with a brand moat.  Time after time, Pepsi has shown through blind taste tests that people generally prefer the taste of Pepsi.  However, most people I know, when ordering fast food, will order a "Coke" and not a "Pepsi".  When it happens that the fast food place only sells Pepsi, I get a little annoyed when I'm asked, "Is Pepsi ok?", when I asked for a Coke.  Heck, I don't even know if there's any difference in the taste, but just the thought that I'm not going to get a Coke frustrates me.  I won't go much further, but I think you understand well the power of Coca-Cola's brand.

Looking at the numbers, they look pretty darn good.  Considering Coca-Cola is a more than 100 years old, the growth is pretty spectacular.  ROIC is very high in the high teens to low 20s for the past 10 years.  EPS growth is at an impressive 14.3% over last 9 years.  BVPS and free cash flow growth are both excellent.  The only yellow flag I have is sales growth.  Sales dropped a bit last year and grew at single digits for the past decade.  As I said, this is a mature company, the sales growth numbers are not bad.  However, this is truly a yellow flag.  This trend cannot continue indefinitely.  If sales growth is slow, EPS growth will eventually slow because gross/operating margins cannot increase indefinitely towards 100%.  And of course, we all know that earnings is pretty key in the valuation of a stock.  So, it can be expected that, unless sales growth accelerates, EPS growth will likely decrease to the levels of sales growth.

Recently, Coca-Cola bought the North American operations of Coca-Cola Enterprises, which is the bottling company for Coca-Cola's products.  This is seen as a move to gain more control of how product move through the pipeline and also to enable better adoption of non-carbonated drinks as demand shift.  So, management sees this as a move to accelerate revenue growth.  At least, Coke knows what requires work in their numbers!

Coca-Cola gets a 10 for the qualitative portion of Moat, but overall, I'm going to give it an 8.

Moat Score: 8 / 10

Figure 1: Rule #1 Analysis of Coca-Cola (KO)

Margin of Safety

Unfortunately, Coca-Cola is overpriced right now.  At $63 right now, the stock has a P/E ratio of 19.4.  It's fairly high for a company whose EPS growth has been single digits.  For comparison, Apple (Ticker: AAPL) has a P/E of 22 right now and its year-over-year EPS growth was 78%!

Using somewhat conservative numbers of EPS growth of 9.0% and P/E ratio of 16.7, we come up with a sticker price of $33.03 and entry price of $16.52.  So, the share price is almost double that of its current value and almost 4 times that of its entry price!

Payback time is also at 10.9 years, which is way too long for stockpiling of the stock.

Coca-Cola gets a 2 out of 10 for Margin of Safety.

Margin of Safety Score: 2 / 10

Management

Muthar Kent is the CEO and Chairman of Coca-Cola.  He has a long track record with the company, starting his employment there as an entry level employee some 30 years ago.  He worked his way up the ranks, left the company for about 6 years in the late 90s to mid 2000s, and finally returned to Coca-Cola and assumed the CEO position in 2008.

Kent comes from an interesting and noble background.  His father, Necdet Kent, is nicknamed "Turkish Schindler" for helping saved many Jews during the second World War.  Kent was born in New York City, when his father was consul-general there.  He grew up in Turkey, was educated in the UK, and worked in the US (later back in Turkey).  He definitely has led a cosmopolitan career, which is almost a requirement for the CEO of such an international company.

Kent has ownership of about 68000 shares of KO, which is worth about $4.3 million.  If you compare this to ownership of, say, Google executives, this is peanuts.  Is this a cause for concern?  Maybe...But do keep this in mind: Kent only rejoined Coca-Cola a few years back and has been CEO for less than 3 years.  Also, he has not sold many KO shares recently.  So, my guess is that he has only started to accumulate his ownership of KO shares.  As much as most of us think executives of big companies are billionaires, they are probably far and few between.  These billionaires are likely produced "overnight", when their creation transformed from a startup to being an industry stalwart within a few years (read Microsoft, Google, Facebook, etc.).  Kent is not one of these billionaires! His net worth, I'm guessing, is probably around $20 to $50 million.  Having $4 million, or 8 to 20% of ones net worth in his own company stock is probably pretty significant.

Looking from all angles, Kent seems to be a trustworthy, reliable, and ethical leader.  There is some degree of uncertainty due to his short tenure as CEO at Coca-Cola, but I believe in the years to come, he will demonstrate his leadership.

Management Score: 8 / 10

Meaning

Who doesn't like Coke in this room?  Didn't think there were many of you!  Unlike some people I know (my cousin), I don't live on Coke.  It takes a couple of parties at my house to clear out the 2 cases of Coke in my basement, but that is exactly the power of the brand.  I consume maybe 1 to 2 Cokes in a month, and yet, I still have 2 cases of it sitting in my basement.  It is the universal beverage!  When someone comes over to your house, what do you offer them as a drink?  It's either a coffee/tea (depending on your ethnic background) or a Coke.  Coca-Cola is universal.  Does it have meaning to me?  You bet!

On the ethical side of things, is the drink itself ethically positive, negative, or neutral?  No one has ever praised Coca-Cola for being a healthy drink.  It has plenty of calories, lots of sugar, some caffeine, etc.  Diet Coke or Coke Zero is no better.  Just the thought of drinking something tasty but has zero calories tells me something is wrong.  However, many products out in the world are not good for you.  You can argue that oysters are not good for health because they have high levels of cholesterol.  But as with all things, Coke needs to be taken in moderation.  Like myself, I can freely enjoy a Coke whenever I have it, because I don't drink it 3 times a day.  So, I don't necessarily buy the argument that because Coke does not contribute positively to your health, then it is an unethical product.  The product itself is neutral at worst.  Having said that, Coca-Cola also produces healthier products like Minute Maid, Dasani, Nestea, Powerade, etc.

Coca-Cola is a company that supports gay/homosexual rights.  I talked a bit about this issue in my Google post.  Although this is not something Catholics would like to see, it is not something that would cause the USCCB to withdraw its investment funds.

There has been some complaints in Coca-Cola's business practices.  One example involves a Coca-Cola bottling plant (which may not even have been owned by Coca-Cola, but rather, Coca-Cola Enterprises, which is a separate company...but, we'll assume Coca-Cola is the culprit) in India where the bottling plant has caused a decrease in groundwater, in an already poor area.  Another example is allegations that union activists were dealt with in a violent manner in Latin America.  Where there's smoke, there is fire...so, I'm sure that these allegations have some merit.  In a corporation as large as Coca-Cola, you can be sure to find some part of the company that has less than desirable business practices, especially in developing countries.  This is not to give Coca-Cola an excuse, but it does not appear that the problem is systemic.  In North America and Europe, Coca-Cola has had a good reputation in its business practices and all-in-all, I don't see too great of a concern over the company's ethics.

Meaning Score: 6 / 10

Summary

Moat Score: 8 / 10

Margin of Safety Score: 2 / 10

Management Score: 8 / 10

Meaning Score: 6 / 10

OVERALL (not an average): 4 / 10

If only the shares were not overpriced, I'd probably invest in Coca-Cola too.  Warren Buffet has about $11 billion in Coca-Cola.  So, there's probably some merit to owning KO.  I'd wait for a dip in price!

And so, this concludes my Rule #1 Analysis Blitz.  If you've enjoyed it and would like to see more, please leave me a comment and also the company you'd like to see.  I'm probably going to continue this kind of post, but it'd be done in a lesser frequency.  I'm also open to constructive criticism!  Thanks for reading!

Rule #1 Analysis Blitz #8: Google (GOOG)

For this post, I'm going back to a stock I own.  It's probably a stock you know too, especially since you're reading this on the internet.  From a brief look at the statistics of this blog, about 90% of traffic is directed here from this search engine.  Yep, you guessed it, it's Google (as if you didn't know from the title of this post)!

Relatively speaking, Google is a really young company.  It was founded only in 1998 and became a public company a little more than 6 years ago.  If you are over 30 years old, you probably remember there was a time before Google was around.  When you wanted to search for something on the web, you would open your Netscape browser and click on the "Search" button.  It then brings you to some search page, of which, frankly, I can't recall the contents.  Later on, I realized that there were actually websites that did these searches.  My early favourite was Alta Vista.  Then, some time during my university days, I switched to Google.  I can't remember exactly when that happened, but it did so very naturally and I never looked back.

The same thing happened with Mapquest.  From Mapquest, I went to Yahoo maps just because I had a Yahoo account.  But when Google maps came on the scene, it was a no-brainer.  I didn't have to click on the arrows on the map to move north/south/east/west.  Just click the mouse and drag the map around...it was so intuitive and convenient.

Moving my main email account to Gmail took a little longer.  As you may know, I have my own domain and have been using POP3 email through Outlook to access my email.  Then, the frequency at which I checked email became less and less, because it was a hassle to download email (along with all the spam) onto my computer.  As well, I couldn't access my email while on the go. I had (still have) a Yahoo email account, but it was just never quick enough.  Then, I took the leap and let Google host my email account.  I get to keep the felixwong.ca address and have the convenience of having my email in the cloud.  Gmail is also amazing fast and keeps your emails in its appropriate threads.  Spam hardly ever gets into my inbox either.

I'm not going to go through all of my transitional stories to Google, but I think you get the point.  Its products and services are really top notch and I believe Google's management are real visionaries.  Let's see if the stock is "investable"!

Moat

You can download the completed Rule #1 spreadsheet here.

Before we begin, note that Google has only gone public for 6 years.  So, any data before that was from its private days.  I wouldn't pay attention to much to it's 9-year numbers, not that they're bad or even mediocre!  Everything looks astounding!  With the exception of sales growth, the lowest growth number in the summary table was last year's BVPS and it was at 26.4%!  Sales growth last year was relatively slower at 8.5%.  It raises a yellow flag, but with a 8.5%, it's close enough to our 10% threshold to give it a pass, especially since 2009 was just the beginning of the economic recovery.  We also see zero debt; in fact, Google has amassed $33 billion in cash.  There are only about 250 companies worldwide that have market caps as large as this amount!  Without a doubt, Google has one of the best balance sheets amongst the mega-cap companies.

Google makes a significant amount of its revenue from advertising.  They are the ads that appear at the top and right of the search results page that are under the "Ads" title.  The average advertiser pays about $0.50 - $2.00 every time a link is clicked.  When I was still in school, I never really understood why anyone would click on those ads and how Google could make any money.  However, when I started working and wanted to search for vendors, I found those ads to be very useful, sometimes more helpful than the search results themselves.  The reason is that I was trying to find somebody selling something, but the search results gave me everything from news on the topic, to a blog post, to a definition on wikipedia, etc.  The ads gave results only of people trying to sell stuff.  That's exactly what I was looking for, and because the ads are contextual (based on the keywords that I typed), they are usually pretty good.  The second major part of Google's revenue comes from their Adsense ads, which you can find on this blog after a post and on the right column.  Google scans the page for its content and matches advertisements that fit within that context.  As you can see on the ads on this blog, the advertisers are usually stock brokers or financial companies.

So, the moat of Google has to do largely with its search engine.  Why would you want to stay with Google?  Actually, let me ask myself why I would stay with Google and not go with Microsoft's (Ticker: MSFT) Bing? I did switch from Alta Vista to Google fairly painlessly.  If you have used Bing, there's definitely some appeal to the product.  It looks nice and the search results aren't bad either.  But why haven't I switched yet?  It's because Google offers a host of other products that have increasingly built up my loyalty for the company.  Many people criticize Google for offering products that don't generate cash, but I say those services are the essential ingredients to building an awesome brand moat.  When I switched from Alta Vista to Google, it was just a matter of changing my bookmark on my browser.  If I wanted to switch from Google to Bing, there would be this invisible mental blockade that prevents me from doing so.  I would unconsciously say to myself, "Ok, you use Gmail, Google Maps, Google Reader, Blogger, Android, why not just stick with the search engine?"  And that's exactly what has happened.  Although Google may not even give the most relevant results (I wouldn't know since I don't even use Bing or Yahoo), there's a preconception (perhaps even misconception) that Google is just better.  That is brand moat!  It's just like people choosing Coca Cola over Pepsi even though time after time, Pepsi does better in blind taste tests.

And Google was kind enough to give me a personalized "Happy Birthday" doodle for my 32nd birthday yesterday!  Why wouldn't I stick with Google?

As Google continues to branch out even more (just do a search on Chrome OS, Google TV, Google eBooks), it will get more and more intertwined with various aspects of your life.  If any company is going to produce a Skynet (from Terminator 2) or the Matrix, it's going to be Google!

Having said all this, it is not unimaginable that another company, Microsoft (although I doubt this would happen) or another startup, may displace Google in what it does.  The cost of switching over is not terribly great either.  You may need to fiddle with things for a couple of days, but after that, your internet presence can be switched over to any other provider.  So, Google does not get a perfect 10 for moat...it gets a 9!

Moat Score: 9 / 10

Figure 1: Rule #1 Analysis of Google (GOOG)

Margin of Safety

The sticker price on Google is $844.53 and entry price is correspondingly $422.26.  The stock is trading at $601.  So, the stock is still underpriced, but not enough to justify starting a new position right now.  This is using the assumption that future growth is at 20.4% and P/E ratio will be 21.6.  If we use a slightly higher growth rate of 23.5% and the current P/E ratio of 24, then the entry price would be $605.  I'm not going to use these assumptions, though, because I want to be more on the conservative side.  

Do keep in mind that it has about $104/share in cash.  If we could just "eliminate" that from the share price, it'd be at $601 - 104 = $497 and we can pretend that Google has no cash right now.  That's actually a pretty attractive price.  But there is some risk to this type of discounting method.  So, tread carefully.

Payback time is 8.8 years, which is pretty good, but this does hinge on a 20.4% EPS growth rate.

Google gets a 7 for Margin of Safety.  I would have given it a 6, but due to its strong cash holdings, I gave it a bonus point!

Margin of Safety Score: 7 / 10

Management

Google management gets a fair bit of spotlight, partly because it's the biggest internet company, but also partly because it sometimes come up with the wildest ideas, and any one of them could be game changers (or busts).  Sergei Brin and Larry Page were the Stanford graduates who created Google.  Due to their inexperience in actually running a business, they hired Eric Schmidt, then CEO of Novell to be Google's CEO.  Schmidt had been the CTO at Sun Microsystems before that.  Some call them the Google Triumvirate.  While Schmidt generally runs the business, it's Brin and Page who mainly drive the company's innovations.

Without a doubt, Schmidt is a seasoned veteran in the tech space.  Brin and Page, together, essentially eliminated all other search engines at the time with their mispelled website, Google (was intended to be Googol or the number 10¹⁰⁰).  These 3 dudes added together bring the brightest minds of Silicon Valley into one place, and that's definitely nothing to scoff at.

Similary to Apple's (Ticker: AAPL) CEO Steve Jobs, the Triumvirate each get paid a total of $1 each year.  Wow, I feel like a millionaire when I compare my pay to theirs!  Of course you know that's not what their total compensation is!  We would be able to see in Google's annual report what kind of compensation they are getting, but I'm not going to dive into that detail.  They probably have stock options, etc.  However, I do like that their pay is a symbolic $1. It means that their interest is in line with shareholder interest.  Since their compensation is stock based, whatever happens to their stock happens to their fortune.  As of January 2010, Brin and Page together owned about 57.7 million Class B shares of the company, which would be worth about $34.7 billion dollars right now!  That's not even counting what Schmidt owns (I believe he owns about $4 billion worth of shares).  The duo planned to sell 10 million shares over 5 years to diversify their holdings, but I'm not really worried about that.  With more than $30 billion at stake, the Triumvirate has more interest in growing shareholder value over the long term than any other shareholder!

I don't know if any other company has a more talented management team.  Schmidt is the seasoned veteran (distinguished in his own right), flanked by two brilliant, young, enthusiastic founder.  If Google doesn't get a 10 for management, I don't know what company does!

Management Score: 10 / 10

Meaning

From my introductory paragraphs, you can likely tell I'm a huge Google fan.  I use its search engine, Blogger, Reader, Maps, Gmail, Android, Analytics, Youtube, Apps, etc.  I know more about this company than most other.  The only disadvantage is that I may be biased towards it in my analysis.  I hope this is not the case here.

Anyway, as I mentioned long ago, I had some concern over Google's political leanings, especially of its support for legalization of same-sex marriage and rights of same-sex couples.  However, I did find some consolation when I looked at the USCCB investing policies that support of same sex marriage was not listed explicitly as something that would turn away the USCCB's investment funds.  Having said that, the USCCB still advises against investing in companies that "protect human life" and "protect human dignity".  I believe the support of homosexuality falls somewhere in these 2 categories.  I won't go into it too much, but I'm sure somewhere somehow, supporting same-sex marriages runs counter to the Catholic faith, but luckily not to the extent that one cannot invest in such company in USCCB's opinion.

On the brighter side, because of its left leanings, Google is also a very good corporate citizen.  Google has a philanthropic arm, Google.org, which has a number of initiatives to improve the well being of humanity.  Google has also invested a large amount of money in renewable energy.  It probably has its hands in the following USCCB categories: Pursuing Economic Justice, Protecting the Environment, and Encouraging Corporate Responsibility.  As many know, Google has an unofficial motto, "Don't be evil", and I believe many of its initiatives do offset, if that could even be done, its support for same-sex unions.

Just this year, Google decided that it wasn't going to continue censoring its results on its Google.cn website.  This is a bold endorsement for a freer China, but the Chinese government was quick in its response and began to block Google's site.  Google now puts up a link on its Google.cn website to its Hong Kong website, Google.com.hk, where the Chinese government plays by different rules.  This is somewhat of a workaround, but it shows that Google is not afraid to stand up for what it thinks is the right cause.

Another piece of news that surfaced this year was that Google collected wifi information as it was collecting Streetview images for its maps.  I actually don't think that was unethical, because it was only collecting information that was freely accessible and not encrypted.  So, Google was able to see information that people were sending back and forth on unsecured networks.  In my opinion, if you're on an unsecured network, you have to assume that your data is going to be visible by others.  In any case, Google apologized for this action and promised not to use those data collected.  Be your own judge on this issue.

With a company having the size and success of Google, there's always fear of it monopolizing its markets.  As Google continues to grow, its competitors will allege that Google is violating anti-trust laws.  Whether they be true or not, you should keep your eyes open to discern whether Google is doing anything unethical.

I will give Google a 7 out of 10 for Meaning.

Meaning Score: 7 / 10

Summary

Moat Score: 9 / 10

Margin of Safety Score: 7 / 10

Management Score: 10 / 10

Meaning Score: 7 / 10

OVERALL (not an average): 8 / 10

Although a mega-cap in its own right, Google is still a growth stock.  The internet is still in its infancy stage.  50 years from now, we will look back at what we have today and think how far we have come.  It would be like looking at a Ferrari Enzo today and then comparing it to the original Ford Model T.  Google is in the best position to capitalize on this (r)evolution.  Cloud computing will be the next stage of the game and we will see how it eventually pans out, but I would put my money on Google.  The company is like an octopus with its tentacles reaching into different spaces.

You may want to wait for a pullback before buying your first shares, but as the stock is still undervalued (just not 50% off), it may not see too much of one, especially since the macroeconomic conditions have improved. Lucky for me, I got in early.  I'm going to enjoy this ride!