What springs to mind when you think of legendary investor Warren Buffett?

For some, it’s his humble Omaha origins or his long-lasting obsession with Coca-Cola. For other people, it’s Buffett’s impeccable investing track record and extraordinary wealth that make a lasting impression.

While these are all legitimate connections to make with the Buffett name, perhaps he is most synonymous with the discipline of value investing – the style and mindset Buffett has made famous over the decades.

Today’s infographic provides a deep dive into Warren Buffett’s brain, and it explains everything about his investing philosophy, along with the framework he uses to evaluate potential opportunities.

It’s the second part of the Warren Buffett Series, which we’ve done in partnership with finder.com, a personal finance site that helps people make better decisions – whether they want to jump on the cryptocurrency craze or follow Buffett’s more traditional path to financial success.

….also from visualcapitalist.com:

The 10 Companies That Dominate the Global Arms Trade

At the end of last year, the Federal Reserve Bank of San Francisco published a paper* on historical rates of return of major assets. The particularly interesting aspect of this paper was the exhaustive lengths that team went through to assemble a truly impressive database of returns across developed nations stretching back almost 150 years. After the extraordinary returns seen last year from US equities, we think it is worthwhile to take a moment and recalibrate expectations around what might be considered “more normal” in a long-run historical context.

It turns out that the long-run average equity return has been just over 10% since 1870 across developed nations (Figure 1), and it is something closer to that which we should be expecting this year, rather than a repeat of the 22% returns seen last year.

More than that, however, the report shows that the proportion of investible assets across developed countries is roughly 25% in equities (Figure 3). In the US, however, that proportion is much higher at roughly 40%. The equity gains seen last year will therefore likely fuel consumption going forward disproportionately in the US rather than other developed nations.

Perhaps the other notable deviation from the normal is the UK, where the proportion of investible assets held in real estate is 27% compared to the average which is just 20%. The UK real estate market has been held back significantly since BREXIT, and that will no doubt be yet another factor holding back the UK consumer as wealth effects remain muted.

The report also shows that average returns from real estate and equities have been roughly similar, but equity volatility has been twice that of real estate (Figure 1). Part of the difference can be explained by the way in which the data has been collected – a more comparable method (year average returns for equities rather than year-end returns) would lower equity volatility by roughly one fifth. We suspect that real estate markets by their very nature also hide true price discovery on a real-time basis because transactions are so infrequent, and that is one reason why REITS are so much more volatile than real estate price indices.

Nevertheless, real estate investing seems to make sense for many households over and above equity investing for other practical reasons too. It is much easier to lever investment into real estate than equities, and there are obvious non-price utility gains from owning real estate, often combined with favourable tax treatments to gains from real estate (particularly if a primary residence).

In addition, the study by the San Francisco Federal Reserve noted another interesting comparison between equities and real estate, which has been the low level of co-variance or correlation between real estate investments across different countries as opposed to equities. For investors looking to reduce the correlation of returns within their portfolios, international real estate compares well in this report, and is something to which we plan to examine more closely in the future.

For now, we can’t help but recognize how this year has started in much the same way as the last one ended. US equities are up more than 5% in the first few weeks of the year. As bullish as we are on the coordinated global growth outlook, we suggest that this pace of return can’t last forever, and that investors should be recalibrating expectations back down towards longer-term averages.

Brent Woyat, CIM, CMT
Investment Advisor, Portfolio Manager
Canaccord Genuity Wealth Management
T: 604.699.0869 | F: 604.643.1802
www.brentwoyat.com

All information is given as of the date appearing in this document and Canaccord Genuity Wealth Management (CGWM) does not assume any obligation to update it or to advise on further developments related. All this information has been compiled from sources believed to be reliable, but the accuracy and completeness of the information is not guaranteed, nor in providing it do CGWM assume any liability.
All views expressed in this document are provided for informational purposes only and does not constitute an offer or solicitation to buy or sell any securities. The statements expressed herein are not intended to provide tax, legal or financial advice, and under no circumstances should be construed as a solicitation to act as a securities broker or dealer in any jurisdiction. All views are intended for general circulation to clients and do not have any regard to the specific investment objectives, financial situation or general needs of any particular person.
Forward-looking statements and past performance are not guarantees of future results. To the fullest extent permitted by law, neither CGWM nor its affiliates or any other person accepts any liability whatsoever for any direct or consequential loss arising from any use of the information contained in this document. Canaccord Genuity Wealth Management in Canada is a division of Canaccord Genuity Corp. Member – Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada.

Is it possible to put a value on Bitcoin? The geeky economist in us is inclined to say that we can, but the real world is often more complicated than models allow. Nonetheless, we set about the valuation challenge by asking a relatively simple question: “what if Bitcoin were to replace the US dollar (USD) as the world’s reserve currency?” We ask that question because on one simplistic level Bitcoin is a fledgling currency, so perhaps we should aim to value it as such. Fledgling is the key word here though, there are many impediments to Bitcoin growing up and successfully becoming the world’s reserve currency, so we must probability adjust the price accordingly. When we do that, we conclude that Bitcoin is already overvalued. To buy from here, you need to forget about the price tag, because it is not about the value.

Our simple question assumes that Bitcoin is a currency, but it does not yet have all attributes required to be a cash alternative, and it is also competing with equally compelling solutions to grow into that space, so we should probably value it at a discount to cash. Just as was the case during the “dot com” mania of the late 1990s, Bitcoin is an exciting investment opportunity for speculative investors. It may or may not survive, but just as we would struggle to imagine a world without the internet today, we suspect that in ten years’ time a world without the blockchain will be equally unimaginable. In many ways, it is the blockchain which is the more interesting story.

Let’s begin by recognizing that not every investment conforms to the standard model. Take equities for example, the most common method of valuation is to discount the expected future dividend payments from a company to arrive at a theoretical valuation based on the net present value of all future cash flows that return to the investor. That view came under significant pressure through the “dot.com” era, where many internet companies achieved large stock market valuations without making any profits, let alone returning dividends to shareholders.

Today, we no longer flinch when considering a company with a market capitalization of $560bn that has never paid a dividend, and reports earnings that are so low it has a Price to Earnings (PE) ratio at around 300x (wider US market at 22x). All that said, this company (Amazon) has enjoyed almost exponential price growth. Some assets are simply worth what someone else is willing to pay for them. A fiat currency is similar, but without a balance sheet of tangible assets behind it.

If we were to compare the market capitalization (shares outstanding times share price) of Amazon to Bitcoin market capitalization (number of coins times price) then Bitcoin has roughly half the market capitalization of Amazon (Figure 1). The most shocking element of that chart, however, is the speed at which Bitcoin has achieved this. No wonder the speculative interest in Bitcoin. Amazon is one of the successful survivors of the “dot.com” boom, there are plenty of companies that just didn’t make it – remember using Netscape?

The point is this, Bitcoin may have had an impressive start, so did many of the dot.com companies, but in this fast-moving world of cryptocurrencies, there are many other candidates that could dominate over Bitcoin. Ethereum, Ripple, Litecoin, and Bitcoin Cash are all existing contenders for cryptocurrency supremacy, and there are almost certainly other candidates waiting in the wings, perhaps even a few state sponsored alternatives. Would a cryptocurrency backed by a sovereign nation be more or less attractive than Bitcoin? Whatever the answer, each of the competing currencies should have a discount applied to the true value of a successful solution.

To value Bitcoin, we really want to compare Bitcoin to money. To do that, we should first define what we mean by the term money. That might seem like a silly endeavour given that we all use money every day – we are all intimately familiar with it. Nonetheless, we think it is helpful to define money as a medium of exchange, which is also a store of value and a unit of account – the traditional economist definition. The medium of exchange is straightforward, something that can be exchanged for goods and services. In some way the next two attributes follow from the first in so far as money also must be recognizable with an agreed value, hence the “store of value,” which is also likely to mean it should have a relatively stable value over time.

That last point is important because money, as a store of value, can be used to separate transactions in time. If that were not the case, money would just be an intermediate step in a barter system where all transactions occur simultaneously – not that helpful. Finally, the unit of account simply allows us to express the value of something using money. In a barter system, one haircut might be worth a dozen apples, but in a money system, it can simply be priced as $10. When money functions as a unit of account, it also facilitates credit – much easier to borrow $10 than it is to borrow a haircut. So money has a number of attributes that make it useful, perhaps not all of those attributes are obvious at first glance.

Unlike money, which has a physical form, Bitcoin is held by the user in an electronic wallet that has a Bitcoin address (actually many of them), much like an email address, each of which are unique, and then shared with other parties to send or receive Bitcoin (to make transactions). Unlike traditional money where transactions are checked by banks, Bitcoin transactions are checked and verified on what is called the blockchain. This is a distributed public ledger upon which the complete Bitcoin network relies and its integrity is protected with cryptography. A transaction is therefore a successful transfer of Bitcoin between two Bitcoin wallets that has been verified by the blockchain using a process called mining – a competitive lottery that prevents individuals being fraudulent. In many ways, it is the blockchain technology that is more interesting than Bitcoin, as it has a massive disruptive potential to any industry that relies on record keeping, but that is a note for another time.

So, does Bitcoin meet this definition of money? Perhaps the fairest answer is to say that it has the potential to do so, but not just yet. Bitcoin can in some circumstances be used to purchase goods and services, although it is still a long way from being ubiquitously accepted as a means of payment. The city of Arnhem in Holland has a particularly dense population of vendors (including Burger King and Spar) that will accept Bitcoin, but this has been driven by a small group of enthusiasts that have promoted it tirelessly within their community since 2014. There are not many other similar examples. One obvious problem for Bitcoin in becoming more widely used as a medium of exchange is price stability, and that is clear from Figure 1, the value of Bitcoin is far from stable. Given the exponential rate at which the value of Bitcoin has grown over the past few years, consumers now have expectations that it will continue in the same way, they are therefore unlikely to want to part with Bitcoin in exchange for goods and services – a classic deflation problem. The price of almost any good or service in Bitcoin today is almost 2000 times cheaper than it was a year ago. Why buy today when tomorrow it will be cheaper? It is this very same problem, however, that attracts the speculative investors, but can they justify the potential value of Bitcoin rising still further?

Bitcoin is not quite a money alternative insofar as it is not ubiquitously accepted as a means of transaction, and it is not yet an effective store of value. Anything that can appreciate by 2000% over a year must have the potential to fall by the same, so it cannot really be relied upon as an intertemporal separation between purchase and sale. Once the price of Bitcoin settles down, and the mania subsides, then maybe it will move further into the realm of money, but until then, it should be priced at a further discount to that of cash. Perhaps it is fairer to compare Bitcoin to gold, so we make both comparisons below, starting with the assumption that Bitcoin can completely replace US dollars and then gold.

In figure 2, we chart the market capitalization of Bitcoin, all cryptocurrencies, USD M1, and financial gold. The US money supply, defined as notes and coins plus cash money balances at banks (M1) is worth just less than half of the total value of all gold above ground, but slightly more than what we have called financial gold. Financial gold is the gold held for investment purposes in bars, coins, ETF’s and by central banks as currency reserves. We ignore the rest because Bitcoin could never be a gold substitute in jewellery and other industrial applications because it has no physical form. Comparing Bitcoin to the US money supply is therefore the most favourable comparison for Bitcoin given that it is just over 12 times smaller than the US money supply. If Bitcoin were to replace US dollars in M1, then it could be worth 173,000 dollars a coin at the theoretical maximum supply of Bitcoin. That’s quite some headroom for further gains in Bitcoin, but then we have not yet considered how to discount Bitcoin appropriately relative to USD to take account of the hurdles ahead of it in replacing USD as the world’s reserve currency.

Before we consider the discounting of Bitcoin against the potential value in replacing USD in M1, we should first recognize that it is quite unlikely that the US dollar will disappear entirely any time soon. Central banks earn a fee from printing coins and cash, and are unlikely to give that up (seigniorage). There is also a libertarian argument to say that individuals should be free to conduct their business without anyone else interfering or even knowing about it. Bitcoin addresses the privacy part of that to some extent, but then it was only recently that many US citizens thought they had asset privacy via offshore Swiss bank accounts. So perhaps a tighter assumption about replacing USD is that Bitcoin could possibly replace half of the money stock in M1. On that assumption, Bitcoin could be worth $86k per coin in the future – a five times uplift in valuation from here.

As already discussed, however, Bitcoin is not the only cryptocurrency solution out there, and there will surely be more to come. We should apply a discount to the theoretical dollar replacement value, but what should that be? Well we have listed four alternatives to Bitcoin above, but there are 100 alternatives listed on coinmarket.com. Let’s keep things simple and say that Bitcoin has a 1 in 2 chance being the eventual winner based on the market capitalization of Bitcoin, relative to the total market capitalization of cryptocurrencies that exist today. That would take our hypothetical value down from $86k to $43k, still more than 2.5 times the present value of Bitcoin.

There are of course other risks to Bitcoin. What about other solutions that have yet to present themselves, perhaps even a state sponsored solution? If there were a 20% chance of a state sponsored cryptocurrencies surpassing Bitcoin, then the hypothetical value falls to just twice the current traded value of Bitcoin. That is all before we consider that Bitcoin is far from universally accepted. To gain more mainstream acceptance as a medium of exchange it is needs a much higher level of vendor engagement, and that will be difficult to achieve because no vendor wants to accept a currency mismatch – dollar costs and Bitcoin revenues – without hedging which is not free. Then we have the problem that Bitcoin does not quite function as a store of value. What about the possibility of other countries (not just China) outlawing Bitcoin exchanges? Applying a further discount to these issues, most likely more than 50%, takes us below the market price for Bitcoin.

Essentially, to see value in Bitcoin from here, you would need to see the probability of Bitcoin replacing 50% of the US dollar notes and coins as being greater than 1 in 5. That seems like a stretch to us. It really is all about the price tag, and this one is way too volatile to be anything other than a speculative play. Like all manias, there needs to be a good story, and Bitcoin is no different, the blockchain is here to stay, but to buy into Bitcoin at these levels you’d, “…need shades on your eyes and heels so high….”, and to, “…forget about the price tag.”

Brent Woyat, CIM, CMT

Investment Advisor, Portfolio Manager

Canaccord Genuity Wealth Management

T: 604.699.0869 | F: 604.643.1802

www.brentwoyat.com www.retiretoday.ca

All information is given as of the date appearing in this document and Canaccord Genuity Wealth Management (CGWM) does not assume any obligation to update it or to advise on further developments related. All this information has been compiled from sources believed to be reliable, but the accuracy and completeness of the information is not guaranteed, nor in providing it do CGWM assume any liability.

All views expressed in this document are provided for informational purposes only and does not constitute an offer or solicitation to buy or sell any securities. The statements expressed herein are not intended to provide tax, legal or financial advice, and under no circumstances should be construed as a solicitation to act as a securities broker or dealer in any jurisdiction. All views are intended for general circulation to clients and do not have any regard to the specific investment objectives, financial situation or general needs of any particular person.

Forward-looking statements and past performance are not guarantees of future results. To the fullest extent permitted by law, neither CGWM nor its affiliates or any other person accepts any liability whatsoever for any direct or consequential loss arising from any use of the information contained in this document. Canaccord Genuity Wealth Management in Canada is a division of Canaccord Genuity Corp. Member – Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. 

Have you ever played the game Monopoly? If so, you’re probably familiar with the image of “Rich Uncle Pennybags,” the game’s unofficial mascot. Sporting a bushy white mustache, a black top hat, and a cane, Mr. Monopoly (as he is sometimes known) has become a cliché. Created as a caricature of J.P. Morgan, the legendary financier, Pennybags serves as a kind of stock image for the ultra-wealthy investor. 

Thanks to this and other stereotypes, some people seem to think that investing is a game for only the super-rich to play. But you don’t have to own a huge pile of cash to invest. That’s because investing isn’t about “playing the stock market.” It’s not necessarily even about getting rich. No, investing is about building for the future. It’s about compounding the money you already have so that you can afford to reach your goals in life. 

No matter who you are or where you come from, everyone has financial goals. Your goal could be to save for retirement so that you don’t have to work forever. It could be to help your children attend college. It could be to build a new house, open a business, or travel the world. It could be all those things and more. But achieving those goals costs money, and that’s where investing comes in. 

Nowadays, most people—even those with high-paying jobs—simply don’t earn enough regular income to achieve all their goals. It’s not enough to store your money under the mattress. Nor is it enough to put your money in a bank and rely on interest. In the 21^st century, your money has to grow. It has to work for you. It has to outpace inflation. The good news? All of that can be accomplished through investing. 

People often ask me, “So how can I invest if I don’t have a huge pile of cash?” Fortunately, there are many ways. While I certainly wouldn’t recommend any one specific approach without understanding your personal financial situation, here are a few ways to get started:

Ÿ Set up a Tax-Free Savings Account (TFSA), which aside from allowing you to invest, also comes with specific tax benefits.

Ÿ Participate in your employers Defined Contribution Pension Plan or Employee Stock Purchase Plan.

Ÿ Invest in an index fund, which allows you to “match” the investments held in a market index, like the S&P/TSX 60 or S&P 500. Index funds are both simpler and less costly than most other types of funds, and can also help you diversify your portfolio. (See point #2 below.) 

Doing any of these things allows you to:

1. Start small. You don’t have to invest a lot of money all at once. Even a little bit is better than nothing, because once you’ve invested, your money can start growing and compounding in value. 

2. Invest in broad sections of the market. This is valuable because different industries or types of investments do better than others at different times. By participating in an index fund, you can effectively invest in several areas at once rather than relying on one specific investment to do all the work. This is known as “diversification.”

3. Save for the future. As you know, so many of the financial decisions we make are based on short-term needs. Meanwhile, our long-term plans are ignored. But by investing wisely, you are actively determining what tomorrow will be like…today! 

Of course, it’s not enough to simply invest. To reach your goals, it’s even more important to invest wisely. That’s why it’s sometimes a good idea to seek out the advice of a qualified financial advisor. With an experienced advisor, you can get unemotional, educated insight into how to invest properly. 

But the most important thing to remember, is that you don’t have to wear a top hat or own a hotel on Boardwalk to invest. And because you can invest, you don’t have to wait another day to begin working toward your goals in life. So go out and start determining what tomorrow will look like…today!

Brent Woyat, CIM, CMT

Portfolio Manager

www.retiretoday.ca

www.brentwoyat.com

The latest issue of Street Freak came out on Tuesday. Street Freak is a bit of an aggressive stock-picking newsletter, where we come up with a new idea every month. I try to keep the ideas a secret—if you want them, you have to subscribe! But I’m going to let you in on this month’s idea for free. Are you ready? Here it is:

Pay down your mortgage.

Yes, that’s a bit unorthodox for a financial newsletter. But people spend too much time thinking about the next get-rich-quick idea and not enough time thinking about their overall financial well-being. I’m willing to bet that in addition to having a successful portfolio, many investors reading this also have a lot of debt.

Going into what might be a downturn, I’m uncomfortable having a lot of financial leverage. If you think the market is going to go down, then you should stop thinking about buying inverse VIX ETNs and start thinking about how to deleverage in a smart fashion.

Better Risk-Reward

Paying down your mortgage is part of that. It is part of an overall exercise in balance sheet repair, which includes—

1. Building a cash position
    
2. Paying off debt:
   1. Margin debt
   2. Credit card debt
   3. Car loans
   4. Mortgage debt

Financial leverage cuts both ways. It can help you on the way up, and it can hurt you on the way down.

Funny thing about paying down debt—technically, you are “making” whatever the interest rate on your loan is. If you are paying down a 4% mortgage, you are actually earning a 4% return (on a pre-tax basis). Given that high-yield ETFs yield about 5% these days (and are circling the drain), it seems like a much better risk-reward.

Also, I would not get too caught up in thinking about your mortgage interest deduction. Chances are, it is going away anyway in the tax reform bill, and besides, that is a terrible reason to have debt. There is nothing quite like the peace of mind of having a house that is paid for, or nearly so. Trust me, I’ve been there.¹

As for credit card debt… there is no reason to have credit card debt unless you are experiencing temporary financial stress, in which case a stock pick from a newsletter is not going to help you.

And I would not worry too much about your credit score suffering because you do not have any debt. That’s the wrong reason to take out debt.

Freedom

Bernie Sanders likes to talk about how the US isn’t really a free country because people don’t have freedom from financial stress. Well, financial stress is just a part of life in a free market economy.

But take a page out of the Bernie Sanders playbook and… eliminate your financial stress! All this money going out the door in monthly payments—you can make it stop. There is no freedom in the world quite like freedom from debt.

If you don’t do this, and we get the downturn I think we are going to get, your balance sheet is going to deteriorate as the asset side of the ledger gets smaller. So the goal here is to deleverage when you can, not when you have to. Forced deleveraging (i.e., margin calls) is never any fun.

I am half-descended from flinty New Englanders. You have never met a cheap b****** like a Connecticutian, so part of this is in my DNA. New England is the land of the good credit scores.

Don’t worry, I’m taking my own advice. The goal is to get the house paid off in 2-3 years. When I look in the mortgage amortization spreadsheet I built and add up all the interest I’ve paid since I bought the house in 2015, it just makes me mad. I told the loan officer when I got the mortgage that I was going to prepay the hell out of it. He didn’t seem to mind. Not his problem.

The heuristic on paying down your mortgage is that you shouldn’t do it when interest rates rise. To use an extreme example, if interest rates rose to 10% and your mortgage was 4%, you would be better off keeping the money in a savings account than paying down your mortgage. But one thing that is not factored into that calculation: less debt is always better than more debt.

My guess is that when the market turns, we are going to be hearing about a lot of hidden leverage that we never even knew was there. It is like that old Warren Buffett quote: “You only find out who is swimming naked when the tide goes out.”

One final thing. Early bird registration for Mauldin Economics’ Strategic Investment Conference opens today. If you’re planning on going, now is the time to get your ticket—because you can get it at a discount of more than 20%. Last year was terrific (Matt Ridley was a personal favorite) and SIC 2018 will be too. Get your ticket here. 

Jared Dillian
Editor, The 10th Man