This Week In Barron's

The March 26, 2007 edition of Barron's has something important to say about Motorola (NYSE: MOT) in a piece on page 20 entitled, "Don't Ring Up Motorola Just Yet." If you are already invested in Motorola shares or are considering such an investment, then you should read this article!

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Automate Your Investment Tracking

Keeping track of your stocks, mutual fund shares and ETFs can be both cumbersome and very time-consuming. But you can automatically update your portfolio using online data sources, and you can do this for FREE by using QuoteTracker which you'll find in our "Links" list. And QuoteTracker also allows you to import data into spreadsheet programs such as Microsoft's Excel.

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The Way to Wealth

Ben Franklin is famous for giving advice to aspiring entrepreneurs on ways to create and maintain a profitable business.

What most people forget is that Franklin was also a successful investor after he retired from his printing business at the young age of 42. And despite war and numerous financial setbacks, he died a very wealthy man.

Franklin's way to wealth included building his investment retirement portfolio through saving, avoiding debt, placing well-collateralized loans (bonds) and investing in rental properties.

So how did Franklin manage his money?

The Way to Wealth Rule #1: Be an Optimistic Investor

Franklin ignored the doomsayers and profited from his prediction that America was destined to be a great, prosperous nation. An incurable optimist, Franklin was always bullish on America, and life in general. "The United States," he said, "is an immense territory, favored by nature with all the advantages of climate, soil, great navigable rivers and lakes... destined to become a great country, populous and mighty."


The Way to Wealth Rule #2: Beware of "Sure Deals"

Limit your speculative opportunities, so as not to jeopardize your entire portfolio with speculations that promise "guaranteed" profits. You are bound to be misled and overly optimistic about the risk involved.


The Way to Wealth Rule #3: How to Handle Financial Setbacks

Diversify your holdings and limit your risks. Franklin made it a point of having a wide variety of income sources so that a loss in one would not destroy his entire portfolio. In addition to earning income from his roles as minister and postmaster, he also maintained seven or eight rental properties; earned interest-bearing bank accounts in Philadelphia, New York, London and Paris; invested in common stocks such as the Bank of North America, which paid a sizeable dividend; and occasionally loaned funds at interest to individuals and institutions.

Ben Franklin's life is worth studying as a resource for building your own wealth. And of all the Founding Fathers, Ben Franklin can teach us the most in terms of practical advice in business and investing.

You would do well to pick up a copy of The Compleated Autobiography, by Benjamin Franklin, which is a memoir covering the final 33 years of his amazing career - as a revolutionary, diplomat and financial guru - and it's all in his own words.

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The Wisdom of Brackets

This is the title of a fascinating article beginning on page 128 of the March 26, 2007 edition of BusinessWeek magazine.

The article goes on to say that the use of bracket structure forces you to organize and focus your thoughts. "The smartest executives and the most successful investors have a unique ability to process an enormous amount of information and boil it down into binaries - "yes or no" is a binary - that simplify decision making."

What I find most interesting is the fact that there is a book: The Enlightened Bracketologist: The Final Four of Everything from which they used a particular bracket in making a decision about which will be the better performing asset class, given a cautious view of the global investment scene at this point in time.

And guess which one came out as the winner?... Something I have mentioned from time to time at our meetings - most recently our meeting last Thursday... GLOBAL REITs! And the particular Global REIT I mentioned has been generating an average return of 7%+ each year, and its 52-week total return (interest + appreciation) is 34.3%. Now I will not mention it here on the Blog, however, I will talk about it again at our next meeting in April for anyone who is interested.

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An Overview of Portfolio Management

Managing a portfolio is all about diversifying your risks without hurting your returns. By putting your money into several different investment vehicles, the risk from individual securities can be dispersed in such a way that your exposure to risk declines. This assumes, of course, that the securities you're buying are sufficiently different in return character- istics . If that's the case, then a security's risk will always be less when held in a portfolio than in isolation. Put another way, while the contribution of a given security to the risk of a portfolio depends on its return behavior traits, it can never be greater than its risk when held in isolation. Thus, from a risk perspective, you can 't go wrong by diversifying your holdings, for it can never increase your exposure to risk. On the other hand, while risk is reduced through portfolio diversification, return is unaffected by this process. The return you earn on a given security is the same whether it's held in isolation or in a portfolio.

To build a portfolio, start with an assessment of your own personal and financial characteristics:

• Your age and experience as an investor

• The size of your family and ages of your children

• The level and stability of your income

• Your net worth

• Your need for income

• Your tolerance for risk

These are the variables that set the tone for your investments. They determine the kinds of investments you should consider and how long you can tie up your money. In order for your portfolio to work, it must be tailored to meet your personal financial needs. Therefore, you must start the portfolio process by taking a thorough inventory of these needs, and repeat this type of inventory every three to five years to make sure your portfolio is staying on the right course.

Once you've done a thorough inventory of your financial needs and have set your sights on one or more investment goals, your portfolio can start taking shape. But before you buy any stocks, bonds, or mutual funds, you must take the time to develop an asset allocation scheme that's right for you. In asset allocation, the idea is to position your assets in such a way that you can protect your portfolio from potentially negative develop -ments in the market, while still taking advantage of potentially positive developments. This is one of the most overlooked yet most important aspects of investing. Indeed, there's overwhelming evidence that, over the long run, the total return on a portfolio is influenced more by its asset allocation plan than by specific security selections.

Generally speaking, most professional money managers view portfolio construction (and/or revision) as taking place in stages:

Asset Allocation

• It all starts with asset allocation!

• Divide the portfolio into major asset classes--how much in stocks, bonds, etc.

• Select groups/types of securities to hold within each major class -- e.g., the mix of corporates and Treasuries within the bond class.

Security Selection

• Last stage/step deals with selection of actual securities to include in each asset class/sub-group--i.e., what specific stocks/bonds you are actually going to invest in.

Basically, all that asset allocation involves is a decision on how to divide your portfolio among different types of securities. What portion of your portfolio is going to be devoted to short-term securities, longer bonds and/or bond funds, and common stocks and/or equity funds? In asset allocation, emphasis is placed on preservation of capital. The idea is to position your assets in such a way that you can protect your portfolio from potentially negative developments in the market, while still taking advantage of potentially positive developments. Asset allocation is one of the most overlooked, yet most important aspects of investing. Indeed, there's overwhelming evidence that, over the long run, the total return on a portfolio is influenced more by its asset allocation plan than by specific security selections.

Asset allocation deals in broad categories and does not tell you which individual securities to buy or sell. So all you're really doing is deciding how to cut up the pie, and then, which particular securities to invest in.

Security selection and portfolio management are recurring activities that become an almost routine part of your investment program. You receive an interest or dividend check, and you have to find a place to put it; you add new capital to your investment program, or one of the Treasury notes you're holding matures, and you have to decide what to do with the money. These events occur with considerable regularity, so you're likely to be faced with a series of little (and sometimes not so little) investment decisions over time.

This, in short, is portfolio management: the initial construction and ongoing administration of a collection of securities and investments.

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What Are REITs All About?

Congress created Real Estate Investment Trusts (REITs) in 1960 in order to provide the investing public with a way to invest in large-scale commercial properties. A REIT is a tax-advantaged operating company that specializes in owning and managing commercial property. REITs avoid taxation at the corporate level if they distribute 90 percent of their net income to shareholders annually. REITs thus typically provide a much higher dividend yield relative to most common stocks.

REIT dividends received by individuals are taxed as ordinary income, where federal rates top out at 35 percent. The Jobs and Growth Tax Relief Reconciliation Act of 2003 cut the tax rate on dividends for most common stocks to 15 percent, but REIT dividends, because they avoid taxes at the corporate level, were excluded from this break. For this reason investors should consider holding REITs in tax-deferred accounts if possible, while holding more tax-efficient assets (e.g. common stocks, which provide returns largely through capital appreciation) in taxable accounts.

Many investors have bitter recollections of the commercial real estate market. The REIT market of the 1970s, for example, was dominated by "mortgage REITs." These REITs, which originated, held and marketed mortgage loans, were crushed by skyrocketing interest rates and left investors with significant losses. Real estate limited partnerships bring even darker memories; these structures were touted more for their tax advantages than their economic advantages. When the tax laws changed, these highly illiquid instruments crashed and burned.

Equity REITs, however, are distinct from both of these ill-fated predecessors. Unlike mortgage REITs, equity REITs directly own and manage commercial properties. They also bear very little resemblance to limited-partnerships, which were frequently assembled by brokerage firms and promoters who claimed exaggerated appreciation potential. Those entities charged high fees, typically held only few properties, and were highly illiquid. Raising new capital proved very difficult. Equity REITs, by contrast, trade in a highly liquid market where they are valued based on their ability to grow their earnings and dividends. Capital can be quickly and efficiently accessed by issuing new debt or shares, by reinvesting undistributed dividends, or by selling appreciated properties. Finally, unlike limited partnerships whose general partners frequently had conflicts of interest with the limited partners, the managers of most successful equity REITs hold a significant stake in the business themselves.

The FTSE All REIT Index currently includes 178 REITs. Of these, 134 are equity REITs (the remainder are either mortgage or "hybrid" REITs). Equity REITs invest in shopping centers, malls, apartments, hospitals, nursing homes, office buildings, manufactured home developments, industrial properties, and hotels. Some specialize within these areas, or within a geographic region, while others are diversified. According to the National Association of Real Estate Investment Trusts (NAREIT), the market capitalization of all equity REITs stood at $401 billion at the end of 2006, up from only $118 billion seven years earlier.

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And Now...Futures on Your Home!

No need to worry about a decline in the value of your home because financial instruments are now available that can alleviate your fears, at least according to those who are offering these products. The indexing mania that now reaches virtually every corner of the capital markets recently extended into residential real estate, through the S&P/Case-Shiller Home Price Indices, which cover 20 metropolitan areas, and include a nation-wide gauge as well. These market barometers have given rise to investment vehicles that have the potential to provide a hedge against declining home prices, or, alternatively, to allow speculators to bet on rising prices.

Though it is possible for home owners to participate in this market, these instruments were intended to appeal to builders, lenders, and other industry participants who have a large stake in the residential real estate market. I'm only citing this development to highlight the remarkable innovative capacity of U.S. capital markets. Enormous advances in information technology and data transmission now allow market participants to instantly gather, combine or segment, and ultimately bet on the aggregate prices of virtually any widely owned asset -- the concept is not even restricted to assets; one can bet on or take refuge from the possibility of inclement weather through weather futures contracts.

One can participate in the residential real estate market through housing index futures contracts or through options on housing index futures. A futures contract is simply an agreement between a buyer and a seller to exchange an asset at a specified future date at a price set today. The seller is betting that the prices will decline during the interim, while the buyer hopes for a rising price. Futures options, unlike futures contracts, provide a limited downside. An option provides its buyer with the right to exercise an option to buy (or to sell) an asset at a predetermined "strike" price for a limited period of time. If the asset price moves in an unfavorable direction, the buyer simply does not exercise the option, and it expires worthless, but the investor's loss is limited to the price he/she paid for it.

Individual investors, however, need not be familiar with the intricacies of these instruments to benefit from them. Economic growth ultimately benefits all of us, but growth requires capital investment and risk-taking. The ever-improving ability of market participants to gauge and refine their risk exposure bodes well for the supply of investment capital and for our future.



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Buffett's Views About Diversification

"Diversification is a protection against ignorance. It makes very little sense for those who know what they're doing."


If you don't understand what you are doing, you should broadly diversify your investments, with the hope that not all your eggs will go bad. If your investment adviser recommends broad diversification, he is really telling you that he doesn't know what he is doing and he wants to protect you from his ignorance.

Warren knows what he is doing, so he prefers to concentrate his investments on a few well-chosen eggs, and then he watches them like a hawk.

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Calculating Cash Flow Ratios

One of the most frequently overlooked financial statements is the cash flow statement, which normally plays third fiddle to the income statement and the balance sheet.

Traditional financial statement liquidity ratios are based upon utilization of two balance sheet ratios: the current ratio (current assets/current liabilities) and the quick ratio [(cash + cash equivalents + accounts receivable)/current liabilities].

The problem with using just the balance sheet for liquidity analysis is that it presents data that measures only where a company stands at a particular point in time. And the income statement includes many non-cash allocations, accounting conventions, accruals, and reserves that don't reflect a company's true cash position.

The cash flow statement records changes in both the income statement and balance sheet while eliminating the impact of accounting conventions. What's left is what shareholders should care about most: cash available for operations and investments.

In addition, while the balance sheet ratios mentioned above measure how liquid a company was on a single date in the past, cash flow ratios can be used to evaluate how much cash a company generated over a period of time and compare that figure to its near-term obligations. The result is a more dynamic picture of what resources a company has available to meet its current financial commitments.

When computing any of the ratios discussed below, it is important to remember that the ratios are most meaningful when they are used to compare peer companies.

The operating cash flow ratio (OCF) measures a company's ability to generate the resources required to meet its current liabilities. The equation is:

Cash flow from operations/ Current liabilities.

The numerator of this fraction, which is found right on the cash flow statement, represents a company's accounting earnings adjusted for non-cash items and changes in working capital. The denominator takes into account all current liabilities found on the balance sheet.

The purpose of this ratio is to assess whether or not a company's operations are generating enough cash flow to cover its current liabilities. If the ratio falls below 1.00, then the company is not generating enough cash to meet its current commitments. In this case, the company is likely to have to find other sources to fund its operations or slow the rate at which it is spending its cash. Any existing cash balance can help the company meet these needs, but there has to be some concern about whether or not the company will be able to continue operating without raising additional funds, as the existing cash balance cannot last forever.

In some ways, it's even more important to assess whether or not a company is generating enough cash to repay its current debts. If the company defaults on these obligations, then the risk of bankruptcy increases, as does the company's risk of having its assets seized by creditors. If a company cannot meet its current debt obligations, then it's not going to be easy for it to borrow additional funds. And even in the event that it can borrow funds, the associated terms are not likely to be very favorable.

Cash current debt coverage (CCD) is a ratio that can be used to measure a company's ability to repay its current debt. CCD is calculated as follows:

(Cash flow from operations - cash dividends)/Current interest-bearing debt.

The numerator of this fraction represents a company's retained operating cash flow. (Note: cash dividends paid can be found in the "net cash used for financing" section of the cash flow statement.)

Like the OCF, if a company's CCD is less than 1.00, the company is not generating enough cash to repay its current debt obligations. The higher the multiple calculated by this ratio, the higher the comfort level you should feel when you see debt on a company's balance sheet. Of course, as long as the company is not insolvent, the appropriate level varies by the characterists of the industry.

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