How Can You Invest in Artificial Intelligence?
Back in the day when Jobs and Wozniak invented the Apple computer they simply used existing technology to provide folks with their own personal computer. As computer technology has advanced over the last forty years it has been incorporated into PCs, laptops, tablets, and smart phones. Investors who profited were the ones who put their money in companies that made the best use of better and better technology. Today the “new wave” of technology is artificial intelligence. How can you invest in artificial intelligence? There are not very many companies that are pure AI investments. But, many of the tech giants and others are using AI for advanced products and services. The key to profits in this arena will be in the use to which AI is put and the profit potential of that application.
Artificial Intelligence
Computers can process information much faster than humans but can they think? The concept of artificial intelligence goes back to the 1950s and Alan Turing (inventor of the computer system that cracked the German Enigma Code). Turing wondered if we would ever create machine that could “reason at the level of a human being.” The “Turing test” is that “computers need to complete reasoning puzzles as well as humans in order to be considered thinking in an autonomous manner.”
A more current view is that in order to have artificial intelligence at computer system must display intentionality, intelligence, and adaptability.
Intentionality
A key feature of the algorithms that make up artificial intelligence is that they allow computers to make decisions. They do this by having access to vast amount of digital information, having remote sensors, and having incredibly fast processing power. Thus such a computer system can process huge amounts of information almost instantaneously to make real world decisions. The use of artificial intelligence in self-driving cars is a prime example.
Self-Learning (Intelligence)
Artificial intelligence systems learn from their mistakes and can correct their programming to avoid making the same errors again. Such systems can keep learning and improving their performance. They can spot relevant information within huge amounts of data and make predictions that even intelligent humans would find hard to make. Such systems require intelligent programming as well because the system needs useful input to make useful predictions.
Adaptability
A key feature of artificial intelligence is that the smart, decision-making, and self-learning system can adapt. They learn from their own experience and this takes them beyond what the programmer or database might have predicted.
(Brookings Institute, What Is Artificial Intelligence?)
Alan Turing
Self-Driving Vehicles
The reason why artificial intelligence can be applied to self-driving vehicles to day is because of the speed of data processing, size of databases, improved remote sensors, and programming that ties all of this together. The programming sets the parameters for the autonomous vehicle and then it learns “on the road.”
The Data Driven Investor writes about artificial intelligence and autonomous vehicles.
The automotive AI market reported that it is expected to be valued at $783 million in 2017 and expected to reach close to $11k million by 2025, at a CAGR of about 38.5%. IHS Markit predicted that the installation rate of AI-based systems of new vehicles would rise by 109% in 2025, compared to the adoption rate of 8% in 2015. AI-based systems will become a standard in new vehicles especially in these two categories:
- Infotainment human-machine interface, including speech recognition and gesture recognition, eye tracking and driver monitoring, virtual assistance and natural language interfaces.
- Advanced Driver Assistance Systems (ADAS) and autonomous vehicles, including camera-based machine vision systems, radar-based detection units, driver condition evaluation and sensor fusion engine control units (ECUs).
Deep learning technology, which is a technique for implementing machine learning (an approach to achieve AI), is expected to be the largest and the fastest-growing technology in the automotive AI market. It is currently being used in voice recognition, voice search, recommendation engines, sentiment analysis, image recognition and motion detection in autonomous vehicles.
So, how can you invest in artificial intelligence? We recently asked if it is time to buy GM based on their moving into electric and autonomous vehicles. We noted in that article that the self-driving car market could be worth as much as $7 Trillion by the middle of the century!
The Many Applications of Artificial Intelligence
Investor’s Business Daily writes about artificial intelligence stocks and notes, as we did, that although there are few companies that are strictly AI investments there are lots of companies applying the technology to their products and services.
It’s no secret that Alphabet (GOOGL), Microsoft (MSFT), Facebook (FB) and Amazon.com (AMZN) are all spending big bucks on AI technology. The tech giants are putting AI in consumer products and services, such as voice-activated smart home devices. Amazon, Google and Microsoft also are pushing AI technology into cloud computing.
Other companies highlighted in the article are IBM, Accenture, Epam Systems, Adobe Systems, Salesforce.com, Trade Desk, MTCH, IAC, Five9, Nvidia, Fortinet, Palo Alto Networks, VISA, and MasterCard.
The point is that artificial intelligence will have many possible applications. And, it will be how effectively a company applies the technology that will make the difference for the investor.
Selling Picks and Shovels Instead of Digging for Gold
A famous observation from the days of the 19th century California Gold Rush was that you were more likely to prosper selling picks and shovels to eager miners than by digging for gold yourself.
This thought may apply to the field of artificial intelligence as well. Applications of this advanced technology require lots and lots of advanced chips. The leader in this area so far is Nvidia but companies like Tesla are now starting to design and manufacture their own chips.
Forbes reported on why Tesla dropped Nvidia’s AI platform last year and replaced it with its own.
According to Musk, the Nvidia Drive PX2 computing platform – with one Pascal GPU and 2 Parker processors or CPUs – currently used in Tesla’s custom autonomous computerAutopilot Hardware 2.5 can process 200 frames a second, compared to “over 2,000 frames a second” with full redundancy and fail-over with Tesla’s designed computer.
Nvidia supplies chips for the likes of Mercedes and Honda. To the extent that a maker of self-driving cars wants to buy their chips instead of building that technology from the ground up, they will use someone like Nvidia, a leader in the field.
Waymo Self-driving Car
What Was Wrong at Kraft Heinz?
Last week the stock of the packaged food giant, Kraft Heinz, took a nosedive. The stock fell by 28% on news of a SEC investigation of the company’s accounting practices but more so the nosedive was due to gigantic losses in the last year. The package food business is very competitive and companies need to balance quality, price, advertising, and new product lines in order to stay competitive as much so as to gain an advantage. What was wrong at Kraft Heinz was that they seem to have lost their way. Cost cutting became the order of the day in order to maintain healthy profit margins. But, consumer tastes are always evolving and old, tried and true products can easily lose ground, especially in an era when everyone wants “organic.”
Kraft Heinz
Kraft Heinz was formed just a few years ago in a merger of two companies with hundred-year histories, Kraft Foods and Heinz, the famous ketchup maker. The deal was pushed by none other than Warren Buffett and is a classic Buffett investment. The so-called “Oracle of Omaha” only invests in companies when he fully understands how they make money and how they will continue to do so for years on end. The company formed by two packaged food stalwarts was a typical Buffett investment and is company, Berkshire Hathaway, owns slightly more than a quarter of Kraft Heinz stock shares.
Management sought to make the company more profitable by cutting $1.7 Billion in “excess costs.” And, prior to the recent debacle, Kraft Heinz as returning more per shareholder dollar than competitors like General Mills. That is no longer the case!
The company traded for $80 a share after the merger and from early 2016 to the middle of 2017 rose to the $90 range. Since that time the cost cutting at Kraft Heinz was not working so well as the share price gradually fell to the upper $40 range. Then the bombshell exploded.
Kraft Heinz Stock Price
CNN reported that Kraft Heinz posted a huge loss and revealed an SEC investigation.
Kraft Heinz wrote down the value of its Kraft and Oscar Mayer brands by $15 billion, posted a $12.6 billion loss, cut its dividend by 36% and announced its accounting practices are under investigation by the Securities and Exchange Commission.
Some pundits have referred to an “existential crisis” for Kraft Heinz. On the other hand, Warren Buffett who holds a fourth of the stock and suffered a loss of more then $4 Billion, says he expects to be holding the stock five years from now. His comment was that management seems to have gotten confused about cost cutting and consumer tastes.
Millennials, Organic Foods, and Amazon.com
A strong “selling point” for Kraft Heinz, General Mills, Unilever, Mondelez International, Nestle, and the like is that they have products with strong brand name recognition. Kraft macaroni and cheese, Heinz ketchup, and Oscar Meyer processed meats have been around for a long, long time. But, does the generation of millennials want these products or something with the label “organic?” Now that Amazon.com is running Whole Foods, there is a huge marketing machine pushing organic foods and the convenience that Amazon.com has created with home delivery.
The take home point from what went wrong at Kraft Heinz was probably that they quit thinking about what the consumer wants and thought their product line was golden and would sell forever. So, they focused on cutting costs. It is amazing really how such a large company with so many bright people could have missed this at their stock faltered over the last couple of years.
Kraft Heinz Products
Beware of a Visit by the SEC
CNBC reported the SEC subpoena.
Kraft also disclosed the SEC subpoena is part of an investigation into its procurement and accounting policies. The company said it launched an internal investigation into the matter after receiving the subpoena. Following its investigation, Kraft Heinz said it posted a $25 million increase to the cost of products sold after determining it was “immaterial to the fourth quarter of 2018 and its previously reported 2018 and 2017 interim and year to date periods.”
This may be a minor issue, blown out of proportion due to the huge stock loss and inventory write down. Or it might not be. Kraft Heinz has enough problems right now and does not need to have the SEC on their doorstep. But, that is how it is.
Is Kraft Heinz a Stock to Buy Right Now?
We write frequently about intrinsic stock value and long term investing. When a stock takes a hit but the company still has the ability to generate good profits over the long term, it is a good buy for a long term investor who is willing to wait and whose preferred length of holding a stock is forever. The issue with Kraft Heinz is if they can revitalize their old product line, add new items, spiff up the old ones and do so in such a manner as to bring back sales, profits, and their stock price.
It is of interest that Warren Buffett says that he believes he will holding that stock in five years. That is a good vote of confidence. On the other hand, he might be expected to say that in order to stock the decline of the Kraft Heinz stock price. In the case of Berkshire Hathaway’s investment in Kraft Heinz it will be instructive to see if they buy more of the stock, sell the stock, or simply hold their ground in the coming months.
The concern for long term value investors is that Buffett got it wrong this time around and that Kraft Heinz is now selling at its appropriate price considering the changes in the packed food industry and its aging product line. If that is the case, this is not a stock to buy and wait for bounce or recovery and not a stock to hold for the long term!
Panic Buying of Investments Is a Bad Sign
A friend of ours commented recently that panic buying of investments is a bad sign. He is old enough to remember when the three Hunt brothers tried to corner the silver market and failed.
Panic Buying of Silver in 1979 to 1980
The boom and bust of silver prices is remembered as Silver Thursday, March 27, 1980. Silver was trading at around $6 an ounce in early 1979 and as the brothers purchased increasingly larger amounts of silver on margin, the price rose to $49.45 by January 18, 1980. By that time the three Hunt brothers controlled a third of all silver on earth that was not in government hands!
Our friend commented on how people were taking money out of their bank accounts to buy silver as the price went up. Specifically, when the plumber came out to fix a leaky pipe at our friend’s home, the plumber confessed that he had “invested” his life savings of $30,000 in silver bullion so that he could retire soon.
The sad fact of the matter for our friend’s plumber is that the COMEX tightened margin requirements with Silver Rule 7 and when the price of silver fell ever so slightly, the Hunts did not have the cash to meet their margin call of $100,000,000. They had to sell at huge losses and the price of silver fell by half in just four days. Silver traded at $15 an ounce by June of 1982 and at $6.46 in January of 1993.
Needless to say the plumber lost a large portion of his life savings.
Hunt Brothers Testifying before Congressional Committee
Panic Buying of Bitcoin
Our friend is now well into retirement and living in Latin America. He met a realtor in the coffee growing and mountainous region of Colombia when looking at property there. This was in December of 2017. While Bitcoin had started the year at $900, it was approaching $20,000 and everyone wanted to know how to join in the profits. The realtor admitted that she had emptied her bank account and bought Bitcoin at $15,000. She was so pleased that her investment had gone up right away and that her Bitcoins (3 of them) were worth $19,000 each! She, like the plumber two generations before, envisioned an early and comfortable retirement.
Our friend used his best Spanish in trying to relate the story of the plumber, the Hunt Brothers, and the boom and bust of silver. The lady kept talking about how anyone with any sense should be buying Bitcoin right now (¡Ahora Mismo!).
Bitcoin peaked on December 17, 2017 at $19,783.06 and by December 22 was selling for $13,800. By February 5, 2018 you could buy a Bitcoin for $6,300 and by Halloween the cryptocurrency had stabilized at $6,300.
Our friend has not had any further contact with the realtor but suspects that any plans for an early retirement have been put aside indefinitely.
Bitcoin Debacle
Panic Buying of Investments Is a Bad Sign
The twin demons of investing are fear and greed. Warren Buffett has often been quoted to the effect that the time to buy is when everyone is afraid and selling their investments and the time to sell is when everyone is buying in a panic. The point is that stocks, real estate, commodities, Bitcoin, and the rest all overshoot their fundamental or intrinsic value when investors imitate lemmings and march in large herds to their doom. This works both in bull and bear markets. And, because the memories of some investors are as short as those of the lemmings, it happens again and again and again.
Panic Buying of Investments Today
CNBC writes that panic buying is likely to drive up stock prices in the near term.
Stocks could get a short-term boost as fear of missing out on gains leads more investors to plow more money into the U.S. equity market, analysts said.
The S&P 500 rose more than 2 percent last week, posting its seventh weekly gain in the last eight. The surge in stocks comes as investors increasingly bet China and the U.S. will strike a trade deal in the near future. It also follows the Federal Reserve signaling it will be patient in tightening monetary policy.
The rationale of smart investors who are buying stocks today is probably that the trade war will averted at the last minute and that the stock market will resume its upward climb as the Fed backs off from its interest rate increases. Unfortunately, as we wrote recently, we could win the trade war and lose on investments.
What is important to note in the CNBC article is that they project a “short-term boost” and not necessarily a resumption of a strong and sustained bull market. In this regard panic buying of investments is a bad sign. Buying shares of companies like Apple, Amazon, or Microsoft today should not be compared to buying silver when the Hunts were cornering the market or when everyone went crazy about Bitcoin. Nevertheless, there are real concerns about the economy, both local and global, and particularly in over-grown and debt-heavy areas like China.
The Trump tax cut was, in the end, a bust for hiring and investment and will have added another trillion dollars to an already-huge US national debt. There may be hope for investment offshore in places like Brazil simply because they were hit so badly when commodity prices collapsed that they have room to recover and because they are still a developing nation with lots of infrastructure needs.
Take-Home Lesson about Panic Buying of Investments
The bottom line of this trip down memory lane is that panic is not a viable investment strategy. Whether you are scared that your investments will lose value or that you are missing out on an opportunity, jumping the gun and selling or buying in response to a moment of panic is a bad idea. Panic buying of investments is a bad sign for the markets because this usually leads to an overshoot in prices which will then correct, sometimes greatly. Then the latecomers to an investment will suffer all of the damage.
As we repeatedly advise our readers, doing routine fundamental analysis of your investments or investment opportunities is where to start. There are certainly times when investment opportunities arise and moving quickly is the only way to make a profit. But, smart investors limit their scope of investing to what they know and pass on getting into investments that they do not understand and where they cannot adequately assess the likelihood of future profits from increasing cash flow.
Time to Invest in GM?
General Motors was once the largest corporation in the world and the king of U.S. auto makers. Foreign competition ate away at its customer base and profits and the financial crisis dealt the final blow. In 2009 the once-king of U.S. automakers filed for Chapter 11 bankruptcy protection with US$172.81 billion in debts and US$82.29 billion in assets. The company divested itself of numerous assets keeping the Chevrolet, Cadillac, GMC, and Buick brands as well as controlling interests in numerous foreign automobile operations. After reorganization, the new GM emerged in a $20.6 Billion IPO in November of 2010. Any money invested in the new GM at the time of its IPO has doubled, counting dividends and stock appreciation. All of this having been said, is it time to invest in GM for the long term?
Is It Time to Invest in GM?
Simply based on its dividend of 3.9% and a share price that is just 6.1 times its projected earnings, GM looks attractive. This may well be why Warren Buffett increased the Berkshire Hathaway stake in GM to 37% and now holds 5.1% of GM shares. However, projected earnings that are the big question for all automakers these days. The industry is undergoing fundamental changes and only those automakers that adapt, innovate, and work with maximum efficiency will survive and prosper. If you believe that GM will lead the group of survivors, then you believe that it is time to invest in GM.
The factors that we see affecting the auto industry all derive from new technologies and the effects of these technologies on how we live, communicate, work, buy services, own cars (or not), and drive (or not).
Electric Cars
The leader in the field of commercially producing and selling electric cars has been Tesla. Tesla was founded in 2003 and after ten years of making electric cars was the best-selling manufacturer of plug-in electric passenger cars by 2018. They have delivered almost a quarter of a million electric vehicles and have a market share of 12%. Many in the auto industry see the electric car or electric-gasoline hybrids as the future of the auto industry.
And GM has been selling electric cars as well and is catching up to Tesla. According to Investor’s Business Daily, as if January of 2019 GM joins Tesla in the top tier of electric car sales, having sold more than 200,000 electric vehicles at which level the Federal Electric Vehicle Tax Credit starts to reduce. (Tesla passed this milestone in July of 2018.)
Tesla Electric Car
The issue with Tesla for years has been a huge amount of debt and not enough sales to show a profit. One of the factors that have supported Tesla has been the $7,500 tax credit for those who purchase electric cars. As the tax credit goes down, Tesla is having to sell their cars for less to make them competitive and this cuts into their attempts to make a profit.
In the electric car arena, GM needs to produce good cars to compete with and beat the likes of Tesla and do so at a profit. Those who believe that it is time to invest in GM also believe that GM can do this.
Chevy Cruze Electric Car
Self-Driving Cars
This may be a much smaller niche in the near term, but as computer technology and artificial intelligence advance, we may come to a point where all cars offer the option of letting the car drive itself. Seeking Alpha looks at the self-driving unit at GM and says it could be valued at more than the rest of the company combined. The writer predicts a world-wide autonomous car market of $7 Trillion by the middle of the century!
More information and detail about the autonomous vehicle market can be found at Allied Market Research.
Autonomous Vehicle Market by Level of Automation (Level 3, Level 4, and Level 5) and Component (Hardware, Software, and Service) and Application (Civil, Robo Taxi, Self-driving Bus, Ride Share, Self-driving Truck, and Ride Hail) – Global Opportunity Analysis and Industry Forecast, 2019-2026
As the complicated introduction indicates, there are a lot of players involved and a lot of pieces to this puzzle from the level of automation of the vehicle to the type of vehicle and how it will be used.
An autonomous vehicle also known as a self-driving vehicle uses artificial intelligence (AI) software, light detection & ranging (LiDAR), and RADAR sensing technology, which is further used to monitor a 60-meter range around the car and to form an active 3D map of the current environment. The vehicle is designed to travel between destinations without a human operator.
To accomplish this goal, the auto used LiDAR, RADAR sensors, and sophisticated computer software. Developing each subsystem and integrating all of it is a complicated task and must be carried out with maximum efficiency in order for a company to make a profit!
A lot of major automakers are working on this technology as are auto suppliers, technology providers and even service providers.
Automakers include General Motors, Daimler AG, Ford Motor Company., Volkswagen Group, BMW AG, Renault-Nissan-Mitsubishi alliance, Volvo-Autoliv-Ericsson-Zenuity alliance, Groupe SA, AB Volvo, Toyota Motor Corporation, and Tesla Inc.
Technology companies include Waymo, NVDIA Corporation, Intel Corporation, Baidu, and Samsung.
Additional companies are Robert Bosch GMBH, Aptiv, Continental AG, Denso Corporation, Uber, Lyft and Didi Chuxing.
That is a lot of folks to keep track of. The consensus of experts is that Waymo is the technology leader in this field followed by GM. Waymo, by the way, is a subsidiary of Alphabet (Google)!
The short version is that GM is one of the two leaders in work to developing, market and sell self-driving autonomous vehicles.
If you see GM as successful in this quest, it is time to invest in GM!
Waymo Self-driving Car
Who Is Going to Own Cars in the Future?
A factor to consider when investing in any automaker is that more and more people cannot afford to buy or least a car. And many of these folks live in large cities where public transportation is an option. These folks can rent a car by the day or even by the hour when they really want or need an automobile.
This may well reduce the overall demand for vehicles and put more cars into the hands of rental agencies and the likes of Uber. The ability of downsize as needed and the ability to sell to a global sales network will be important for future auto industry success.
Who Will Sell Cars in Asia?
Access for foreign markets will also be important to the success of automakers of the future. Despite the threat of a trade war and bullying from the current U.S. president, GM is likely to stay in China where its profit margins are better than in North America and where it and its partner have a decent market share. If you believe that GM is wisely staying where the business is, then it is tie to invest in GM. The concern about GM in China is not GM but China. The Land of Managed Capitalism has a bunch of problems, not the least of which is the trade war with the USA. Nevertheless, Asia is a grown area while North America and Europe are mature markets. A company that is smart enough to reduce production capacity where it is selling fewer cars and beefing it up where sales are still healthy is a good bet. Maybe it is time to invest in GM.
Win the Trade War and Lose on Your Investments
The trade negotiations between the USA and China are coming to a head. Will there be genuine gains for the USA? We have written how both the USA and China have issues that they see as crucial to their national prosperity and security in our article about if the trade war becomes permanent. However, neither side wants to suffer the economic pain that could come out of a protracted trade war. China, especially, is seeing economic difficulties on the horizon and needs to do something sooner rather than later. So, there may well be a deal forthcoming. However, from the USA point of view, it is probably possible to win the trade war and lose on your investments. How is that possible?
Win the Trade War and Lose on Your Investments
An article in Market Watch caught our eye. They note that a trade-war win might not be a victory for the stock market!
Sometimes losing can pay dividends in unexpected ways, and that seems particularly true in the case of stocks and trade.
For the past five decades, the U.S. stock market has comparatively outperformed when the trade deficit widened and vice versa, suggesting that even if the U.S. emerges victorious from its trade war with China, investors may have few reasons to rejoice.
At face value, it may seem counterintuitive, but for the U.S., which relies on trade to fuel its economic juggernaut, a deficit can actually be a sign that all is well.
They provide a graph that demonstrates how this has worked since 1970.
Trade Deficit versus U.S. Stock Price Index
How Will a Trade War Win Relate to the Stock Market?
We have no reason to dispute the figures provided by Market Watch. It would indeed appear that when the trade deficit goes up that the stock market rises too. And the opposite seems also to be true, at least for the last half of a century. But, a relationship does not prove cause and effect.
In the Market Watch article they note that when the rest of the world is doing well economically and the U.S.A. is not doing so well, US exports may rise but US imports will fall off because people have less money and buy less. So, the balance of trade is better but the stock market suffers. And, when the USA is doing well economically, people buy more foreign products and the balance of trade worsens. Thus the balance of trade worsens but the stock market goes up.
The point is that in the past both the stock market and the U.S.A. balance of payments have been driven by consumer spending in the U.S.A. albeit in different directions. Will this be the case with a new trade deal?
What Kind of Trade Deal Can We Expect?
Many believe that as pressure mounts on both sides to make a deal, that a deal will happen, but it will not be as comprehensive as the U.S.A. wants or needs. Both China and the U.S.A. see trade, intellectual property, and control of whole economic sectors as existential issues. Thus both sides want more than the other can give. This especially applies to the Chinese Communist Party which fears for its survival if it gives up its heavy-handed control of the Chinese economy and Chinese society. Thus, there will likely be a deal and continued wrangling over issues into the distant future. And, to the extent that a trade deal results in a better balance of payments for the U.S.A. that may not be a good thing for your investments. But, the reasons might be different than what Market Watch describes.
A bone of contention on the US side is that China makes promises regarding access to its markets and protection of intellectual property and does not follow through. The US negotiators want to build in automatic increases in tariffs that will kick in when the Chinese continue with their old tricks of promising and not delivering.
It could be that higher tariffs on Chinese goods may become a permanent part of the equation. Either Trump will raise tariffs because there is no deal or tariffs will be triggered by non-compliance on the Chinese side.
Tariffs and the Balance of Trade
Tariffs by themselves do not affect the balance of trade. Rather, the consumer’s choice to pick another product due to the high tariff-added cost of a foreign product my result in purchasing from a domestic producer. That is the ideal solution for the U.S.A. if it wants to bring more manufacturing back into the USA. However, the Chinese have taken over whole sections of industry. For example, 70% of electronic production capacity is now in China. The bad end result of high tariffs for US consumers is that they simply pay more for imports from China because nobody else is producing what the consumer wants! When that happens, it raises prices for consumers in the USA but does not help the balance of payments. And, because consumer dollars are now going to pay for tariffs, it hurts the economy as well. If that turns out to be the case, there will no longer be a better stock market when people are buying more foreign products.
What Can You Do?
One can always hope for the best, but smart investors will look for better opportunities. Those opportunities may lie offshore from the USA. Then the issue is how to find value investments offshore. We recently wrote about investing offshore in Brazil and in our most recent article about job cutbacks in China we mentioned using foreign direct investment data from the World Bank as a guide to where offshore to invest.
On the other hand, if the China give ground and really let US and other foreign companies into the Chinese market and if they really turn around and protect intellectual property, and if they finally loosen controls on private industry, there could be an economic boom in China that would benefit any number of US multinationals. But, while you are waiting for an outcome of trade talks, a little re-balancing of your portfolio to include a few offshore stocks might well be in order.
Foreign Direct Investment in Brazil
How Do Job Cutbacks in China Relate to Your Investments?
China has been the economic miracle of the world for decades. From Nixon’s visit in 1972 to its entry into the World Trade Organization to the current day, China has not had a negative growth year since 1978 and has average a 10% GDP growth rate. At the same time North American and Europe are ecstatic with an occasional 5% growth rate and typically languish in the 2% to 3% range. But, things are not all well in the Land of Managed Capitalism (by the Communist Party). Debt is rising and there is a potential for a long term trade war with the USA. Meanwhile, small and medium-sized businesses are laying off workers in China. For many of us, China seems to be a long way away. So, how do job cutbacks in China relate to your investments?
Small and Medium-sized Business Downsizing in China
The South China Morning Post is beginning a series about the China economy.
Chinese President Xi Jinping warned on January 21 that the Communist Party needed to pay particular attention to the risks to social stability from rising economic problems, as evidence increasingly suggests that the nation’s employment situation is deteriorating rapidly, particularly among small and medium-sized businesses.
An important aspect of this situation in China is that the prospect of a significant economic downturn is not just that there could be a recession or even an “economic hard landing” but that it could lead to significant social unrest. The article goes on to give examples of companies that have reduced their labor forces by more than 75%! The end result is survival, not repayment of debts or prosperity.
Closed Factory in China
Chinese economic statistics have always been suspect, so anecdotal evidence is often relied upon to get an accurate picture of what is going on. What is known is that China has taken over a lion’s share of production in many industries from the rest of the world. Seventy percent of world electronic production capacity now is in China and the risk of a permanent trade war is taken very seriously, especially considering the amount of debt that companies and whole industries have taken on. As noted in the South China Morning Post article, many smaller Chinese businesses got into the habit of simply borrowing, expanding, and having enough money to service their debts. Now the world is changing and companies are downsizing very rapidly.
How Do Job Cutbacks in China Relate to Your Investments?
China ADRs
The first point of concern would be investments that you might have in Chinese companies. Investing.com lists 403 Chinese companies with ADRs available in the USA. If you are invested in any of these, you need to do your fundamental analysis and make sure if you want retain the investments in your portfolio or not. If you do not believe that you can do an accurate job at this because of sparse data, it might be better to sell.
Offshore Investing
The next issue is any other investment you might have offshore from the USA. We recently wrote about how offshore investment in Brazil was starting to look promising with the new government. But, Brazil and other exporters of raw materials will all have the same problem if China experiences a significant economic slowdown and quits importing at its current rate. The resource curse of boom and bust cycles is inherent in commodity exporters. There are relatively secure value investments offshore but you need to do your homework to find them and to assess their intrinsic value.
Direct Foreign Investment as a Guide
To know where to put your money offshore, a useful resource is the World Bank’s Foreign Direct Investment page of statistics. The most recent figures show that worldwide foreign direct investment was $2 Trillion in 2017, down from $2.5 Trillion in 2016. China received $168,223.58 million ($168 Billion) in 2017 versus $354,828.00 ($355 Billion) for the USA.
Meanwhile the European Union as a whole received $604,920.21! And Brazil came in at $70,685.05. It would appear that as the world economic situation worsens that money is flowing into developed economies more so than developing economies. Since this is where the smart money is going, smart investors will probably follow suit.
The World Bank updates these figures every year so it is always a useful resource for those wanting to invest offshore.
How Investments in the USA Will Be Affected
An old friend of ours recalled when the stock market crashed in 1929 and all of the businessmen in his small Midwestern town were not worried. New York was a long ways away and what happened there would never affect the prices of corn, soybeans, beef, pork, or eggs. Three years later our friend was burning corn cobs in his stove to keep the office warm because corn was cheaper than coal. The US Congress has picked a trade war with the Smoot Hawley Act and the US economy entered the Great Depression.
Great Depression Lineup for Free Food
If you think that what happens in the country that consumes more natural resources than anyone else does not matter in the rest of the world you are dead wrong. Companies like Boeing, 3M, Procter & Gamble, Deere, Caterpillar, Apple, and many many others derive a substantial portion of their incomes from trade with the rest of the world and with China in particular. When a company in China lays off 700 of its 1,000 workers, those workers have no jobs or take lower-paying temp jobs. The effects ripple through the economy and more companies lay off more workers and the downward cycle continues. The growing Chinese economy has been a consumer of many Western products. We in the West would like to have more access their economy and that is a lot of what the looming trade war is all about. The risk is that China will not open up to the West but will look inward instead. Apple already downgraded its projections for China for the coming year. This is how job cutbacks in China relate to your investments if you have multinationals in your stock portfolio. Trouble in China will spread to many developing nations and sales of goods by the USA will suffer.
The one bright spot for the USA and other developed economies is that foreign direct investment and cash via the Forex market will seek safe havens in these economies.
What Can You Do?
Some time back we wrote about how to invest without losing any money. As economic risks increase a wise investor will rotate part of his or her holding into AAA bonds (Microsoft and Johnson & Johnson, US Treasuries, and even CDs at the local bank. Any stock investments should be value investments until the economic situation in China and elsewhere improves. If the economy and market worsen, there will likely be quite a number of deep value investments for those willing to do their homework.
How Do Job Cutbacks in China Relate to Your Investments? PPT
Choosing Deep Value Investments
Many investors are pessimistic about the prospects of their investments in the coming year. In this regard we are looking at the process of choosing deep value investments. We see the pessimism in that stocks are rising on tepid earnings reports as The New York Times reports.
Late last month, chip giant Advanced Micro Devices reported disappointing financial results for the fourth quarter and warned that its first quarter performance would be weaker than expected. The stock surged 20 percent. A couple of days later, General Electric reported one of its skimpiest quarterly profits of the century, badly missing analysts’ forecasts. The company’s stock posted its biggest jump in nearly a decade.
In recent weeks, numerous companies including Wynn Resorts, Ford and JPMorgan Chase have missed Wall Street forecasts, only to see their stock prices rise.
It’s a classic relief rally.
In other words, investors expected further reports of bad earnings, were bracing for such reports, and were relieved that things were not as bad as anticipated! That is a heck of a way to start out the year! If you are good at choosing deep value investments, you will pick stocks that have been or will be beaten down and which will recover and provide you with great earnings and dividends for years to come. If you are not so good at choosing deep value investments, you will lose money time and time again.
Three Stock Market Perspectives
Deep Value Investing
What is deep value investing? Several years ago CNBC explained the concept.
PIMCO defines deep value investing as investing in stocks that are significantly undervalued based on their intrinsic worth (determined by asset-based or cash flow valuation).
When you find such an investment, it will typically have been unfairly punished by the market for any of a variety of reasons. Thus, its share price will have fallen and investors who see the falling share price may punish it further in the belief that the stock is ready to collapse. When this stock is a potential deep value investment, the market is not looking at its intrinsic stock value but rather at short term market price performance.
Deep value investing is a great concept and very profitable if you can do it right. Warren Buffett famously made a huge investment in Coca Cola at the end of the 1980s when the stock was languishing at 82 cents a share (factoring in stock splits since then) and today a share sells for $49 today. The Coca Cola dividend has a 3.16% yield based on the current price. That works out to be $1.55 a year. This is nearly double the share price when Buffett chose KO as a deep value investment! Choosing deep value investments and doing it correctly leads to great long term profits. The rub is how to do the job properly.
Choosing Deep Value Investments
One way to do this is to follow the advice of others. For example, Seeking Alpha recently touted 3 deep value dividend stocks that they believe will beat the market over the long term. The three picks are CVS Health, Qualcomm, and Vodafone. Here is the summary of the article.
Deep Value contrarian dividend stocks can be a powerful investing strategy that leads to both great income and market-crushing returns.
But investors have to be careful to weed out good opportunities from yield/value traps that could lead to permanent losses or chronic underperformance.
Qualcomm, CVS Health, and Vodafone are three deep value dividend stocks my new portfolio bought this week, because I’m confident the market is excessively bearish on these companies.
While each has very real risks investors need to be comfortable with, ultimately I’m confident that from today’s deeply discounted prices you’ll enjoy a safe dividend and great returns in the future.From current valuations (28% to 45% discount to fair value), I expect each of these companies to generate at least 18% long-term total returns.
So, how does this analyst go about choosing deep value investments? They stick to blue chip stocks that have recently lost ground in the market and which are strong on fundamental analysis.
It is a long article with a lot of detail but the bottom line is the need to distinguish between beaten down stocks with value and just plain value traps that will eat up you money time and time again. When we wrote about intrinsic stock value, we noted that this valuation is based upon projected future cash flow. Going back Buffett, he uses this approach continually and has been quoted as saying that he and his associates throw out 95% of the stocks they look at as too tough to call.The “Oracle of Omaha” insists on understanding how a company makes its money and how its business model will result in continued profits for years to come. He has tended to avoid tech stocks because he cannot predict the future of tech beyond a couple of years and his preferred holding period for a stock is forever!
So, if you want to walk in the steps of a master investor go ahead and see what folks like Seeking Alpha are suggesting. Then do your own analysis of a company’s fundamentals. Do not be afraid to throw out most of the investments you look at as “too tough to call.”
How Long Term Is Long Term Investing?
Choosing deep value investments fits in with a long term investment strategy. Your chosen company has been beaten down by the market but is still making plenty of money. Its management seems to understand what they need to do to keep the company moving ahead and are not resorting to tricks like buying back huge blocks of stock to support the share price or artificially inflating their dividend in order to attract unwary investors. How long will it take for this stock to regain share price? How long will it take to replicate Buffett’s experience with Coca Cola? We once asked how many years will it take to make an investment long term. The answer is that it takes at least 5 to 10 years for market fluctuations to average out and reveal the true long term value of an investment. This is the time horizon when choosing deep value investments.
Coca Cola
Trump Tax Cut a Bust for Investment and Hiring
When Congress passed the biggest change in the U.S. tax code in thirty years, taxes were cut by $1.5 Trillion. The promise was that U.S. industry would invest that money, hire more people, and raise yearly GDP growth to the 4% range for the indefinite future. That did not all seem to have happened according to recent information. Was the Trump tax cut a bust for investment and hiring? Here are some thoughts on the subject.
Trump Tax Cut a Bust for Investment and Hiring
Fortune explains why the tax cut has not sparked hiring or investment.
The Trump administration’s $1.5 trillion in tax cuts appears to have not made any major impact on businesses’ capital investment or hiring plans, according to a new survey.
A quarterly poll from the National Association for Business Economics published Monday found that some companies reported accelerating investments because of lower corporate taxes, but a whopping 84% of respondents said they had not changed their plans. That’s up slightly from 81% in the previous survey published in October, Reuters reports.
The one bright spot was in goods-producing companies where half reported increased investments and a fifth reported redirecting hiring and investments from offshore to the USA.
Of S&P 500 companies studied by the University of Michigan, only 4% planned to give back part of the tax cut to workers and a fifth anticipated increasing their business-related investments. Small business investment fared better according to the National Federation of Independent Business with 5% increasing their investments while a third increased employee pay.
Market Watch is bit more cynical, saying that Trump tax cuts were a bust!
President Trump proclaimed: “It’ll be fantastic for the middle-income people and for jobs, most of all. I think we could go to 4%, 5% or even 6% [GDP growth], ultimately. We are back. We are really going to start to rock.”
A year later, it’s very clear that the tax cuts boosted gross domestic product and jobs a bit – and just for one year. Its effects are fading as U.S. GDP growth appears likely to weaken in 2019. The only things that “rocked” were corporate profits and the stock market. And we’re facing trillion-dollar deficits as far as the eye can see.
They report that the increased investment that did occur went primarily to technology and intellectual capital and less to new structures and equipment. So, where did all of that money go?
Trump Tax Cuts and Share Buy-backs
Where the money seems to have gone is to buy back shares of stock! Market Watch goes on to say that the end result was to prop up the stock market.
Companies actually spent more on buybacks than on capital investments in 2018’s first half, and remember, capex weakened as the year went on. Buybacks shrink the number of shares, boosting earnings per share and eventually, the stock price. That helps all shareholders, of course, but especially corporate executives, more than half of whose total compensation is in stock.
What has happened is that company profits have done very well and by buying back their stock, companies have preserved and increased their share prices. Employment has increased but barely at all in the manufacturing sector when Trump promised. Most of the new jobs are in the professional and business services areas as well as in health care. Meanwhile the country has shouldered an additional $1.5 Trillion in debt and likely see the GDP fall back to 2% this year!
The repatriation of offshore corporate profits was strong at the beginning of 2018 and has fallen off ever since. Thus, the huge boom from offshore cash has not really happened.
US Debt and US GDP
Trump Tax Cut Sugar High
Bloomberg is also negative in regard about the Trump tax cuts.
They note that wage growth in 2018 was primarily a result of the temporary economic stimulus caused by the tax cuts and will level off or fall as the tax cut economic benefits fade!
In other words, the most desired effect of Trump’s corporate tax cuts is very hard to find in the available data. So far, what we’re seeing is probably a sugar high driven by deficit spending. That’s not terrible, and could even undo some of the damage done by the last recession. But it’s not what the tax cuts are really supposed to achieve.
What Is in Store for Investors in 2019?
Investors in the stock market were prime beneficiaries of the Trump tax cut because companies pumped their tax savings into share repurchases. It is of note that so many corporate executives have stock options as a large part of their payment packages. This, of course, makes suspect the practice of buying back shares to prop up stock prices instead of expanding their businesses and hiring more workers.
Unfortunately, the short term sugar high of the tax cuts will wear off. The trade war could become permanent with long term damage to sectors like agriculture. We wrote recently about investments to choose right now. There is less of a problem if you are using intrinsic stock value as a guide and investing for the long term. There is more of an issue if you are looking for short term gains at a time when the tech stocks that previously led the markets seem to be weakening.
Canary in the Coal Mine?
Industry Week writes that chipmakers may be harbingers of things to come in tech.
Investors in Intel Corp. were unpleasantly surprised by the computer-chip company’s forecast for relatively flat revenue and profit margins for 2019. Fellow chipmaker Nvidia added to the dour news on Jan. 28 by cutting its expected revenue.
Well before these disappointments, however, the U.S. internet superpowers had already hinted at the chipmakers’ meek results. The chipmakers may, in turn, be sending warning signs about slipping growth for the tech powers.
Intel said last week that the biggest customers for its computer server chips – titans such as Amazon, Google, Microsoft Corp. and Alibaba – were “absorbing capacity” from their stockpiles of previous orders and would, therefore, most likely hold off on buying more chips for a few months.
When these companies see leaner times ahead, they will start looking for ways to save money. In the case of tech firms, cutting back on chip orders is at the base of the economic pyramid. We agree that reduced orders for chips could be compared to the canary no longer singing down in the mine shaft. Investors will want to pay attention.
Interest Payments on US Debt
Why Would You Want to Invest Offshore in Brazil?
Not that long ago Brazil was touted as one of the BRICs nations. Along with Russia, India, and China and it seemed destined to join the ranks of the most developed and prosperous economies within just a decade or two. Brazil was considered a model for developing nations as employment soared, poverty was reduced, and safety net social programs helped stabilize their society. Then prices for oil and other commodities collapsed. Much of this had to do with China importing less as well. Nevertheless, Brazil was not equipped to moderate its social programs. And, on top of that, investigators uncovered corruption at the highest levels of the socialist government. And, Brazil entered an economic decline rivaling that of the Great Depression. So, why would you want to invest offshore in Brazil today?
70 Years of Crude Oil Prices
Source: Macro Trends
This graph of 70 years of oil prices shows the fall from $111 oil in June of 2014 to oil selling for less than $40 by the end of the year. As income from oil and other commodity exports fell, Brazil’s economy went into decline from which it is just now starting to recover. The reason to consider investment in Brazil today has to with the new conservative government. It will be friendlier to and more closely allied with the USA, and more open for foreign investment.
US Relations with Brazil
Senator Marco Rubio wrote a piece published on the CNN website. Rubio says the US should go big on Brazil.
On New Year’s Day, President Jair Bolsonaro was inaugurated in Brazil, ushering in a new era in Brazilian politics that marks a dramatic departure from the leftist, anti-American governments of Luiz Inácio Lula da Silva and Dilma Rousseff. The new Bolsonaro government has already indicated it seeks an even closer security and economic relationship with the United States.
The senator notes that closer cooperation in areas from space exploration to protection of intellectual property rights are already in the works. Foreign direct investment is likely to increase in Brazil as investors see a government friendlier to foreign investment.
Direct Foreign Investment in Brazil
The World Bank tracks direct foreign investment year by year and country by country. Brazil took a hit after commodities fell in 2014 and the situation there was compounded by social and political turmoil.
Foreign Direct Investment in Brazil
Source: Deloitte
So, why would you want to invest offshore in Brazil based on this data? We have often commented that a good investment strategy is to follow the smart money. Folks with billions of dollars to invest have the resources to spot and take advantage of emerging investment opportunities. Financial services and the food and beverage industry are favorites of many investors. As the graph shows, direct foreign investment bottomed out in 2018 and is expected to rise in the coming years.
How Could You Invest in Brazil?
We assume that you do not have a few billion dollars laying around for investment purposes and that you probably do not speak Portuguese or have an English speaking stock broker ready to pick up the phone in São Paulo and place your orders on the Bovespa stock exchange. But, in order to invest in companies in Brazil, you can buy American Depositary Receipts in the USA. These instruments trade in the USA and level 3 ADRs are subject to the same reporting requirement as US companies.
Investopedia discusses American Depositary Receipts.
American Depositary Receipts (ADRs) are stocks that trade in the U.S. but represent a specified number of shares in a foreign corporation. Like regular stocks, ADRs are bought and sold on U.S. markets. They also trade in U.S. dollars and clear through U.S. settlement systems allowing ADR investors to avoid transacting in a foreign currency.
The advantages of ADRs are twofold. For individuals, ADRs are an easy and cost-effective way to buy shares in a foreign company. They save money by reducing administrative costs and avoiding foreign taxes on each transaction. Foreign entities like ADRs because they allow non-U.S. companies to gain more U.S. exposure, allowing them to tap into the wealthy U.S. equities markets.
There are companies in Brazil that list as ADRs on US exchanges. You can find a complete list of Brazilian ADRs at TopForeignStocks.com. Twenty-eight of these are listed on the New York Stock Exchange and are subject to NYSE financial disclosure requirements. There are also 45 that trade over the counter and provide less financial information.
The stocks in the NYSE list include the aerospace and defense company, Embraer, several large banks, a number of electric companies in a country where hydroelectric power is dominant, and Petroleo Brasileiro-Petrobras, the Brazilian oil and gas giant.
The trick will be to determine which of these will be the most likely to prosper as Brazil’s economy improves. Using the financial information provided for level 3 ADRs, investors will be able to do their own fundamental analysis of these stocks.
Investment in Brazil and Monetary Exchange Rates
If you do not invest directly in Brazil you will not need to convert US dollars to the Brazilian real (currently = 27 cents). However, the valuation of ADRs will be affected by the exchange rate. As a point of reference, a real was worth 44 cents before oil took a nosedive in 2014 and has been as low as 24 cents. As such the currency seems to have bottomed out and will likely appreciate in value versus the dollar as US interest rates level off and the Brazilian economy surges.
Brazil Selling Off Assets of State Owned Companies
An interesting bit of news from NASDAQ is that in order to reduce their national debt, Brazil is looking at selling assets of several of its state-owned companies. These include subsidiaries of the state oil company, banks, and insurance companies. Those interested in investing in Brazil during its economic recovery may want to watch this story as they search for buying opportunities.
Why Does Dividend Growth Investing Work So Well?
Among the more successful approaches to long term investing, dividend stocks provide a steady income stream as well as the ability to reinvest without paying fees. When evaluating dividend stocks to add to their portfolios, wise investors look for a long history of continual dividend payments and a steady stream of dividend increases. When you use this approach as your guide, it is referred to as dividend growth investing. Why does dividend growth investing work so well? Here are some thoughts on the subject.
Why Does Dividend Growth Investing Work So Well?
We have three simple answers to this question. They have to do with intrinsic stock value, outperformance of the market as a whole, and income protection in times of overall market decline.
Intrinsic Stock Value of Dividend Growth Stocks
First of all, steady dividend growth over the years is a result of a company making more money each year. A steadily increasing income stream indicates a strong intrinsic stock value. And a company with an intrinsic stock value in excess of its market price is always a good investment.
The market has a recurring tendency to be overly greedy when times are good and excessively fearful when times are bad. This fact can make the current market price of a stock an inexact predictor of underlying value in the coming years. A company sells a product that everyone needs and uses and has been successfully making money with that approach for decades or even more than a century. We refer to the likes of Coca Cola, Exxon Mobile, Colgate Palmolive, Procter & Gamble, and Eli Lilly and Company. These are investments with strong intrinsic value as they will endure and prosper over time.
The ability to steadily increase dividends over the years and decades is a sign of the intrinsic value of an investment and a guide to successful long term investing.
Market Performance Characteristics of Dividend Growth Stocks
Strong companies with high intrinsic value not only may pay increasing dividends over time but they tend to increase their share prices as well. Intelligent Income has a useful chart, courtesy of Ned Davis Research, in their article, 5 Reasons to Be a Dividend Growth Investor.
While it may seem counterintuitive, companies that consistently pay and grow their dividends have historically outperformed non-dividend stocks, further increasing the appeal of being a dividend growth investor.
[From the end of 1972 to the end of 1973,] companies that consistently grew their dividends during this time performed the best of any group and delivered the lowest volatility (standard deviation).
And, here is the chart showing that over a longer time frame, dividend growth investing provides the best returns.
Performance of Dividend Growth Stocks
A 10% return on investment, with dividends reinvested, will result in a doubling of value every ten years. This is a big part of why dividend growth investing works so well.
Dividends as Asset Protection in Down Markets
While dividend growth stocks outperform other dividend stocks and stocks that do not pay dividends, they also provide protection when the entire market is down. Intelligent Income again provides us with a useful graph courtesy of Hartford Funds. This shows us how much dividend income has contributed to total stock market returns over the years.
Dividends As Part of Total Stock ROI
As we can see, steady and increasing income from dividends provides a significant return on investment over the years. When the stock market is languishing, dividends can provide a majority of returns, such as in the 1040s and 1970s. And, in the first decade of this century, when the market ended up lower than when it started, dividends provided the only income for someone who bought in 2000 and sold before the market recovered from the crash! And, we know that while the percent return of dividends is lower in years with a surging stock market, we also know that over time dividend growth stocks tend to outperform the rest of the market.
Criteria for Choosing Dividend Growth Stocks
We found an interesting article on Wallet Hacks about building a dividend growth investment portfolio. It is a first person account of how the author chose this approach and the criteria he uses to pick investments in this subset of stocks. He mentioned that Warren Buffett bought Coca Cola when it was low in 1988 and today gets a 45% dividend based on his original investment!
Buffett acquired shares of Coca-Cola in 1988. Back then he wrote “We expect to hold these securities for a long time. In fact, when we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever. We are just the opposite of those who hurry to sell and book profits when companies perform well but who tenaciously hang on to businesses that disappoint. Peter Lynch aptly likens such behavior to cutting the flowers and watering the weeds.” (1998 letter)
The point of investing in companies that steadily increase their dividends is that you too can replicate Buffett’s success.
An easy approach to investing in dividend growth stocks is to pick a fund that simply does the investing for you. The author mentions Vanguard Dividend Appreciation Index Fund Investor Shares (VDAIX) although Fidelity and others offer similar products. The advantage is that you only need to make one investment and not several. And, you are getting a decent mix of blue chip dividend stocks such as Coca-Cola, P&G, Pepsi, Microsoft, J&J, Wal-Mart, IBM, Medtronic, CVS, and 3M.
Alternatively, you can choose your own stocks. In this case, choosing companies that have paid dividends for decades and have been increasing them for a quarter of a century or more is a good place to start. Then, to make sure that a great company is not starting to fade from the scene, look for “dividend coverage.” This is earnings per share divided by dividends per share. A good coverage is 2 or more. In other words, the company is paying out less than half of its earnings in dividends and is not simply jacking up the dividend in order to disguise a failing business!
And, when should you buy these companies? Because you are not trying to time the market and are relying on long term appreciation of stock price and dividends, you can simply invest a set amount every month, quarter, or year as your cash flow allows, using intrinsic stock value as a guide.