-- Posted Monday, 7 January 2008 | Digg This Article
| Source: GoldSeek.com
I have just finished my year end evaluation and the old portfolio looks pretty good. A 21% return over the last two years and a 15% return over the last 6 years. But then I had to ask myself, “What is a fair rate of return in this market”? You see the problem is I am measuring performance with a shrinking yardstick (the US dollar). If I rated my return in ounces of gold or ounces of silver it would be far less impressive than rating it in dollars.
For instance since 2000 the Dow has made slight gains in DOLLARS but has lost over half (almost 2/3rds) its value when priced in GOLD. While it may seem that the Dow is going sideways it is actually headed down hard but the measuring stick is faulty so it is hard to tell exactly what is going on.
John Williams’ web site, www.shadowstats.com, has many interesting charts and comments concerning inflation. The current CPI (consumer price index) is 4% calculated by the new formula. The current CPI would be 7.6% if it were still calculated by the old pre 1990 formula. The alternate CPI that Mr. Williams calculates on his web site is 12%. Anyone who goes to the grocery store, buys a new car, pays the electric bill, goes to the hospital or fills up his gasoline tank suspects that just maybe the 4% figure is too low?
We leased a building last week to a tenant for 10 years. We struggled to come up with a fair escalation clause to cover the yearly cost of living increase. I refused to use the CPI as I felt it woefully under reported inflation. We finally settled on 80% of the prime rate (about 6% currently). I wanted to use 100% of the prime rate but could not sell the idea. At any rate it was difficult to quantify the true inflation index in legal terms for a lease. I also wanted to make sure that it was something that would go up with strong inflation possibly to come in the next decade. I figured the prime rate would rise quicker than the CPI.
But exactly what is a fair rate of return if Mr. Williams’ 12% inflation number is correct? What is fair if we simply use the 7.6% old government CPI rate? Let’s just use 8% inflation (still probably low) for simplicity’s sake.
If we invested $1,000 we would want to get our principal back and make a fair rate of return. If we invested in a stock (risky) we would want a higher rate of return than if we purchased a CD (safe). Therefore at the end of the year we would have to get our principal back with inflation ($1,080) + our return. With a stock we should expect about a 10% return and with a CD about 2%. That would be $1,080 + 100 = $1,180 for the stock (18%) and $1,080 + 20 = $1,100 or 10% for the CD. If anyone is seeing these rates or these dividends please let me know.
Many people may say that they are indeed getting 18%+ on many of their stocks but that includes the capital appreciation. Due to way the tax code treats capital gains differently than dividends few companies are paying out big dividends. In a world where the tax rate was the same the capital appreciation should go up with the inflation rate plus the growth of the company. Dividends should also be paid based on earnings (hopefully around 10%). This would mean share prices should correspond with a rough P/E value of 7 (some earnings would be reinvested to pay for growth). This is the traditional stock valuation going back in time.
The trouble with profits through capital appreciation is you have to SELL the stock to realize any profit. Right now the largest demographic trend in the US (boomers) is moving into retirement age. If they all have to sell to realize profits, who will buy? If they were receiving their income through dividends they would have no reason to sell, however with our present system they have to sell for an income stream during retirement.
Another problem with capital appreciation and the tax code is CEO compensation. With stock options and stock grants to CEOs diluting shareholder value (sort of like printing more money dilutes cash holder’s value) it is hard to tell exactly how much a CEO is paid these days. As examples I list the following:
Bear Stearns (BSC) CEO, Mr. James Cayne receives a base pay of $250,000. He has been CEO since 1993. This year BSC suffered a loss and lost over half its stock value. The dividend payout is 1.6% and the P/E ratio is 52. Due to the poor performance of BSC Mr. Cayne has refused a year end bonus. Last year his bonus was $33,600,000. He now owns almost 6% of the entire company and was recently listed as one of the top 400 richest men in the country. He personally lost $571,000,000 this year with his BSC stock. How much of that was granted to him in options for compensation over the years?
At Goldman’s the CEO, Mr. Lloyd Blankfein gets $600,000 in salary. He received an additional 26.8 million in cash and 41 million in stock and options this year or $68,000,000+.
At my little bank there have been 3 CEOs in the last 7 or so years. The last one who was responsible for walking across the street and merging with another bank headquartered in the same town received quite a little package. In addition to his salary he received 50 million dollars. In addition, his contract called for the company to pay the taxes on the bonus of another 18 million. I assume the other CEO he merged with received a similar deal. The stock went up less than 10% after the merger and is now selling for half. It is hard to convince myself that these men were looking out for the best interest of their shareholders.
During the worst year in a decade on Wall Street year end bonuses are up 14% - shareholders be darned. As long as capital appreciation goes up not too many people are concerned about high P/E ratios and unrealistic price/book ratios. They are only concerned about the share price going higher without concern for the underlying fundamentals. No one seems too concerned about boardroom looting of the corporate treasury. No one seems concerned about directors who do not have substantial ownership in the company but receive large director’s fees. No one seems concerned about back scratching between compensation committees and CEOs. BUT, when the share prices start to drop and those unrealistic capital gains start to vanish, you can bet those small shareholders will howl. At this point they just may start to see that they have been had.
Whenever too many come to the same realization at the same time the exit doors just are never big enough. A friend once told me that if you are playing poker and can not spot the sucker at the table – it’s probably you.
Gold and silver should not create more wealth – they are wealth. They normally just allow you to safely carry wealth forward through time (unlike dollars that are melting daily). Going back to our discussion on rate of return, gold and silver should return the 8% per year inflation portion only. However, since they have been out of favor for so long they have a little long term catching up to do. Hang onto your hat because 2008 just might be quite a ride. Hang onto your wealth. There may be bargains ahead for those who still have some left.
Will Rogers told his buddy Wiley Post one day over breakfast, “These days I am more concerned about the return OF my money than the return ON my money”.
Larry LaBorde,
Silver Trading Company
Larry lives in the South with his wife Puddy of 30 years and sells precious metals at the Silver Trading Company. Larry can be contacted at llabord@aol.com. You can view his web site at www.silvertrading.net.
-- Posted Monday, 7 January 2008 | Digg This Article | Source: GoldSeek.com
