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A framework for making good investment decisions

Warren Buffet has famously advised that “To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights or inside…

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Warren Buffet has famously advised that “To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights or inside information. What’s needed is a sound framework for making decisions and the ability to keep emotions from corroding that framework.” Below, I’ve provided a basic framework to help you make sound investment decisions.

Let’s start with another Buffett aphorism:

“Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten, and twenty years from now.”

Let’s break that quote down to highlight two of the quote’s four key offerings.

The first is a ‘rational price’, and the second is a business whose earnings will be ‘materially higher in five, ten, twenty years from now’.

Today’s market lows reflect great fears. As one finance reporter noted, ‘We now face serious global headwinds and challenges with elevated inflation. Growth is slowing globally. And energy and food prices have risen, driven partly by Putin’s terrible war in Ukraine and the pandemic’s lingering effects abroad. Climate change continues to devastate communities, exacerbating energy and food shortages in Europe and across the world.’

There are many concerns and influences for investors to fear.

The result is investors aren’t willing to pay as much for a dollar of a company’s earnings as they were when they were optimistic and could only see bright prospects and feared missing out on them.

Sentiment towards the stock market is forever changing. When investors are optimistic they’re willing to pay a very high price and when investors are depressed or despondent they’re only willing to pay a very low price. Even though the underlying business is stable and may have changed nothing, the price investors are willing to buy and sell it can change dramatically.

One measure of this sentiment – we can also call it popularity – is the price to earnings multiple, also known as the P/E ratio or, simply, the P/E.

If a company is earning $1.5 million of profit after tax and it has 300,000 shares on issue and held by various shareholders, the company is said to be earning $0.50 per share.

Now, these 300,000 shares trade on the stock market and every day they rise and fall.  Interestingly, the business doesn’t change very much day-to-day. In fact, it just keeps making the same widgets and selling them to the same customers. But despite this stability and reliability, the share price is never stable.

On days when a country’s central bank decides to raise interest rates, or a country invades another, the shares could fall dramatically. The next day, a central bank may simply raise rates by less than was expected, and the same shares could surge. Even though these exogenous events have nothing to do with the company, and even though they may have no impact on the company, its revenues, its customers or its profits, the shares will ride around like crazy reflecting the greed and fear of the investors who are buying and selling them.

So, on a day investors are happy and excited, the shares in our hypothetical company might trade at 30 times the earnings. Thirty times 50 cents equals $15.00, so on an exuberant day, the shares might trade at $15.00 and be on a ‘P/E’ of 30 times.

Conversely, if bad news about the world, inflation, or the economy is released, investors might only be willing to pay a multiple of eight times the earnings and the shares would be trading at $4.00.

Wild swings can occur in the multiple investors are willing to pay for a company’s dollar of earnings, even though the underlying business might be very stable.

Figure 1. illustrates the change in the P/E ratio of the S&P600 small cap index, and reveals just how much the P/E ratio can swing around, and how frequently.

Figure 1. P/E Ratio S&P600 Small Cap Index to 21 October 2022

You might be drawn to several observations about PE ratios but the two I want to bring to your attention are first, how frequently the P/E soars and plumbs the depths and second, where sentiment, as measured by the P/E ratio, is today.

As I noted earlier, investors currently believe they have a great deal to fear and hence they simply aren’t willing to pay a very high multiple of earnings.  Even though the concerns will pass – to be replaced by new concerns – investors aren’t willing to think too far into the future, instead, they’re stuck in the current rut.

What Figure 1. reveals is that these periods of despondency have occurred before and each time sentiment has recovered.  That will probably be what occurs this time.

Of course, the P/E ratio is made up of the price and the earnings.  When prices change and the earnings remain the same, the P/E ratio will change.  But it is also the case that if prices don’t change but the earnings change, the P/E ratio will also change.

A couple of quick examples will serve to demonstrate. If a company’s earnings are $10 per share and the price is $135, the P/E ratio is 13.5 times. If the earnings remain at $10 but the price halves to $67.50 the P/E ratio will be 6.75 times earnings. 

What if the price doesn’t change but the earnings per share does? If the price remains at $135.00 per share and the earnings halve from $10 per share to $5 per share, the P/E ratio will rise to 27 times earnings.

I have seen the second scenario play out, particularly during recessions. What typically happens is share prices fall dramatically ahead of a recession, such as we saw in 1999/2000 and perhaps even today. The P/E ratio falls, but earnings don’t change much. Share prices then stabilise, but as the recession takes hold, company earnings are impacted and the ‘E’ in the P/E ratio falls. The result is that P/E ratios rise but the share prices don’t change dramatically.

Of course, the outcome of this latter development is that shares look expensive again because the P/E has risen, sometimes dramatically. Amid a recession, it is difficult to imagine coming out the other side of it. But this is how investors must think. The share price falls have already largely accounted for the recession, so even as the earnings decline, investors aren’t willing to sell their shares at any lower prices.

Once again, there is every possibility we have reached this point. Note in Figure 1., today’s P/E ratio is almost as low as it was during the Global Financial Crisis and lower than during the COVID-inspired sell off.

Growth

One thing we haven’t touched on is how an investor can mitigate some of the risks associated with investing today amid fear of recession and earning declines. By focusing their attention on those companies Warren Buffett referred to in the earlier quote – companies whose earnings will be materially higher in five, ten and twenty years from now –  investors can reduce the risk of further share price falls.

Here’s the result of some simple arithmetic. If you buy a company whose earnings grow by 15 per cent per year over the next five years, and you buy and sell the shares of that company on the same P/E ratio, your return will equal the earnings growth rate of that company. In other words, if, for example, you buy the company’s shares on a P/E of 10 and you sell them on a P/E of ten, and the earnings per share grow by 15 per cent, per year, your returns will also be 15 per cent.

And here’s the evidence of some more simple arithmetic. If the P/E ratio of that company falls by 25 per cent at the time you sell the shares in five years, your return will still equal nine per cent per year.

In other words, you will still generate a respectable return from owning the shares for five years, provided the earnings grow by 15 per cent per year and even if the P/E drops from say, 20 times when you purchased the shares to 15 times when you sell.

And that’s the second part of Warren Buffett’s quote covered. 

Right now, we have the opportunity to pay historically low P/E ratios even for high-quality companies that are growing fast. When companies can grow by taking market share, by expanding into new geographies, by raising prices, or because the industry they operate in is enjoying structural tailwinds, they don’t need the warmth of a growing economy to help them along.

There are many companies here and globally that are growing and aren’t sensitive to the vicissitudes of the economy. Of course, their share prices are sensitive and that is what provides the opportunity.  Share prices have fallen because P/Es have contracted, reflecting sentiment. The underlying businesses however are stable. And one day P/Es will expand again. Investors will then receive the return from the growth of the earnings and the return from the expanding P/E.

Today it’s time to sharpen your pencils.  Oh, and any further share price falls from here just strengthen the argument and boost future returns.

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Spread & Containment

Chinese migration to US is nothing new – but the reasons for recent surge at Southern border are

A gloomier economic outlook in China and tightening state control have combined with the influence of social media in encouraging migration.

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Chinese migrants wait for a boat after having walked across the Darien Gap from Colombia to Panama. AP Photo/Natacha Pisarenko

The brief closure of the Darien Gap – a perilous 66-mile jungle journey linking South American and Central America – in February 2024 temporarily halted one of the Western Hemisphere’s busiest migration routes. It also highlighted its importance to a small but growing group of people that depend on that pass to make it to the U.S.: Chinese migrants.

While a record 2.5 million migrants were detained at the United States’ southwestern land border in 2023, only about 37,000 were from China.

I’m a scholar of migration and China. What I find most remarkable in these figures is the speed with which the number of Chinese migrants is growing. Nearly 10 times as many Chinese migrants crossed the southern border in 2023 as in 2022. In December 2023 alone, U.S. Border Patrol officials reported encounters with about 6,000 Chinese migrants, in contrast to the 900 they reported a year earlier in December 2022.

The dramatic uptick is the result of a confluence of factors that range from a slowing Chinese economy and tightening political control by President Xi Jinping to the easy access to online information on Chinese social media about how to make the trip.

Middle-class migrants

Journalists reporting from the border have generalized that Chinese migrants come largely from the self-employed middle class. They are not rich enough to use education or work opportunities as a means of entry, but they can afford to fly across the world.

According to a report from Reuters, in many cases those attempting to make the crossing are small-business owners who saw irreparable damage to their primary or sole source of income due to China’s “zero COVID” policies. The migrants are women, men and, in some cases, children accompanying parents from all over China.

Chinese nationals have long made the journey to the United States seeking economic opportunity or political freedom. Based on recent media interviews with migrants coming by way of South America and the U.S.’s southern border, the increase in numbers seems driven by two factors.

First, the most common path for immigration for Chinese nationals is through a student visa or H1-B visa for skilled workers. But travel restrictions during the early months of the pandemic temporarily stalled migration from China. Immigrant visas are out of reach for many Chinese nationals without family or vocation-based preferences, and tourist visas require a personal interview with a U.S. consulate to gauge the likelihood of the traveler returning to China.

Social media tutorials

Second, with the legal routes for immigration difficult to follow, social media accounts have outlined alternatives for Chinese who feel an urgent need to emigrate. Accounts on Douyin, the TikTok clone available in mainland China, document locations open for visa-free travel by Chinese passport holders. On TikTok itself, migrants could find information on where to cross the border, as well as information about transportation and smugglers, commonly known as “snakeheads,” who are experienced with bringing migrants on the journey north.

With virtual private networks, immigrants can also gather information from U.S. apps such as X, YouTube, Facebook and other sites that are otherwise blocked by Chinese censors.

Inspired by social media posts that both offer practical guides and celebrate the journey, thousands of Chinese migrants have been flying to Ecuador, which allows visa-free travel for Chinese citizens, and then making their way over land to the U.S.-Mexican border.

This journey involves trekking through the Darien Gap, which despite its notoriety as a dangerous crossing has become an increasingly common route for migrants from Venezuela, Colombia and all over the world.

In addition to information about crossing the Darien Gap, these social media posts highlight the best places to cross the border. This has led to a large share of Chinese asylum seekers following the same path to Mexico’s Baja California to cross the border near San Diego.

Chinese migration to US is nothing new

The rapid increase in numbers and the ease of accessing information via social media on their smartphones are new innovations. But there is a longer history of Chinese migration to the U.S. over the southern border – and at the hands of smugglers.

From 1882 to 1943, the United States banned all immigration by male Chinese laborers and most Chinese women. A combination of economic competition and racist concerns about Chinese culture and assimilability ensured that the Chinese would be the first ethnic group to enter the United States illegally.

With legal options for arrival eliminated, some Chinese migrants took advantage of the relative ease of movement between the U.S. and Mexico during those years. While some migrants adopted Mexican names and spoke enough Spanish to pass as migrant workers, others used borrowed identities or paperwork from Chinese people with a right of entry, like U.S.-born citizens. Similarly to what we are seeing today, it was middle- and working-class Chinese who more frequently turned to illegal means. Those with money and education were able to circumvent the law by arriving as students or members of the merchant class, both exceptions to the exclusion law.

Though these Chinese exclusion laws officially ended in 1943, restrictions on migration from Asia continued until Congress revised U.S. immigration law in the Hart-Celler Act in 1965. New priorities for immigrant visas that stressed vocational skills as well as family reunification, alongside then Chinese leader Deng Xiaoping’s policies of “reform and opening,” helped many Chinese migrants make their way legally to the U.S. in the 1980s and 1990s.

Even after the restrictive immigration laws ended, Chinese migrants without the education or family connections often needed for U.S. visas continued to take dangerous routes with the help of “snakeheads.”

One notorious incident occurred in 1993, when a ship called the Golden Venture ran aground near New York, resulting in the drowning deaths of 10 Chinese migrants and the arrest and conviction of the snakeheads attempting to smuggle hundreds of Chinese migrants into the United States.

Existing tensions

Though there is plenty of precedent for Chinese migrants arriving without documentation, Chinese asylum seekers have better odds of success than many of the other migrants making the dangerous journey north.

An estimated 55% of Chinese asylum seekers are successful in making their claims, often citing political oppression and lack of religious freedom in China as motivations. By contrast, only 29% of Venezuelans seeking asylum in the U.S. have their claim granted, and the number is even lower for Colombians, at 19%.

The new halt on the migratory highway from the south has affected thousands of new migrants seeking refuge in the U.S. But the mix of push factors from their home country and encouragement on social media means that Chinese migrants will continue to seek routes to America.

And with both migration and the perceived threat from China likely to be features of the upcoming U.S. election, there is a risk that increased Chinese migration could become politicized, leaning further into existing tensions between Washington and Beijing.

Meredith Oyen does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.

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Government

Is the National Guard a solution to school violence?

School board members in one Massachusetts district have called for the National Guard to address student misbehavior. Does their request have merit? A…

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Every now and then, an elected official will suggest bringing in the National Guard to deal with violence that seems out of control.

A city council member in Washington suggested doing so in 2023 to combat the city’s rising violence. So did a Pennsylvania representative concerned about violence in Philadelphia in 2022.

In February 2024, officials in Massachusetts requested the National Guard be deployed to a more unexpected location – to a high school.

Brockton High School has been struggling with student fights, drug use and disrespect toward staff. One school staffer said she was trampled by a crowd rushing to see a fight. Many teachers call in sick to work each day, leaving the school understaffed.

As a researcher who studies school discipline, I know Brockton’s situation is part of a national trend of principals and teachers who have been struggling to deal with perceived increases in student misbehavior since the pandemic.

A review of how the National Guard has been deployed to schools in the past shows the guard can provide service to schools in cases of exceptional need. Yet, doing so does not always end well.

How have schools used the National Guard before?

In 1957, the National Guard blocked nine Black students’ attempts to desegregate Central High School in Little Rock, Arkansas. While the governor claimed this was for safety, the National Guard effectively delayed desegregation of the school – as did the mobs of white individuals outside. Ironically, weeks later, the National Guard and the U.S. Army would enforce integration and the safety of the “Little Rock Nine” on orders from President Dwight Eisenhower.

Three men from the mob around Little Rock’s Central High School are driven from the area at bayonet-point by soldiers of the 101st Airborne Division on Sept. 25, 1957. The presence of the troops permitted the nine Black students to enter the school with only minor background incidents. Bettmann via Getty Images

One of the most tragic cases of the National Guard in an educational setting came in 1970 at Kent State University. The National Guard was brought to campus to respond to protests over American involvement in the Vietnam War. The guardsmen fatally shot four students.

In 2012, then-Sen. Barbara Boxer, a Democrat from California, proposed funding to use the National Guard to provide school security in the wake of the Sandy Hook school shooting. The bill was not passed.

More recently, the National Guard filled teacher shortages in New Mexico’s K-12 schools during the quarantines and sickness of the pandemic. While the idea did not catch on nationally, teachers and school personnel in New Mexico generally reported positive experiences.

Can the National Guard address school discipline?

The National Guard’s mission includes responding to domestic emergencies. Members of the guard are part-time service members who maintain civilian lives. Some are students themselves in colleges and universities. Does this mission and training position the National Guard to respond to incidents of student misbehavior and school violence?

On the one hand, New Mexico’s pandemic experience shows the National Guard could be a stopgap to staffing shortages in unusual circumstances. Similarly, the guards’ eventual role in ensuring student safety during school desegregation in Arkansas demonstrates their potential to address exceptional cases in schools, such as racially motivated mob violence. And, of course, many schools have had military personnel teaching and mentoring through Junior ROTC programs for years.

Those seeking to bring the National Guard to Brockton High School have made similar arguments. They note that staffing shortages have contributed to behavior problems.

One school board member stated: “I know that the first thought that comes to mind when you hear ‘National Guard’ is uniform and arms, and that’s not the case. They’re people like us. They’re educated. They’re trained, and we just need their assistance right now. … We need more staff to support our staff and help the students learn (and) have a safe environment.”

Yet, there are reasons to question whether calls for the National Guard are the best way to address school misconduct and behavior. First, the National Guard is a temporary measure that does little to address the underlying causes of student misbehavior and school violence.

Research has shown that students benefit from effective teaching, meaningful and sustained relationships with school personnel and positive school environments. Such educative and supportive environments have been linked to safer schools. National Guard members are not trained as educators or counselors and, as a temporary measure, would not remain in the school to establish durable relationships with students.

What is more, a military presence – particularly if uniformed or armed – may make students feel less welcome at school or escalate situations.

Schools have already seen an increase in militarization. For example, school police departments have gone so far as to acquire grenade launchers and mine-resistant armored vehicles.

Research has found that school police make students more likely to be suspended and to be arrested. Similarly, while a National Guard presence may address misbehavior temporarily, their presence could similarly result in students experiencing punitive or exclusionary responses to behavior.

Students deserve a solution other than the guard

School violence and disruptions are serious problems that can harm students. Unfortunately, schools and educators have increasingly viewed student misbehavior as a problem to be dealt with through suspensions and police involvement.

A number of people – from the NAACP to the local mayor and other members of the school board – have criticized Brockton’s request for the National Guard. Governor Maura Healey has said she will not deploy the guard to the school.

However, the case of Brockton High School points to real needs. Educators there, like in other schools nationally, are facing a tough situation and perceive a lack of support and resources.

Many schools need more teachers and staff. Students need access to mentors and counselors. With these resources, schools can better ensure educators are able to do their jobs without military intervention.

F. Chris Curran has received funding from the US Department of Justice, the Bureau of Justice Assistance, and the American Civil Liberties Union for work on school safety and discipline.

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International

Rand Paul Teases Senate GOP Leader Run – Musk Says “I Would Support”

Rand Paul Teases Senate GOP Leader Run – Musk Says "I Would Support"

Republican Kentucky Senator Rand Paul on Friday hinted that he may jump…

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Rand Paul Teases Senate GOP Leader Run - Musk Says "I Would Support"

Republican Kentucky Senator Rand Paul on Friday hinted that he may jump into the race to become the next Senate GOP leader, and Elon Musk was quick to support the idea. Republicans must find a successor for periodically malfunctioning Mitch McConnell, who recently announced he'll step down in November, though intending to keep his Senate seat until his term ends in January 2027, when he'd be within weeks of turning 86. 

So far, the announced field consists of two quintessential establishment types: John Cornyn of Texas and John Thune of South Dakota. While John Barrasso's name had been thrown around as one of "The Three Johns" considered top contenders, the Wyoming senator on Tuesday said he'll instead seek the number two slot as party whip. 

Paul used X to tease his potential bid for the position which -- if the GOP takes back the upper chamber in November -- could graduate from Minority Leader to Majority Leader. He started by telling his 5.1 million followers he'd had lots of people asking him about his interest in running...

...then followed up with a poll in which he predictably annihilated Cornyn and Thune, taking a 96% share as of Friday night, with the other two below 2% each. 

Elon Musk was quick to back the idea of Paul as GOP leader, while daring Cornyn and Thune to follow Paul's lead by throwing their names out for consideration by the Twitter-verse X-verse. 

Paul has been a stalwart opponent of security-state mass surveillance, foreign interventionism -- to include shoveling billions of dollars into the proxy war in Ukraine -- and out-of-control spending in general. He demonstrated the latter passion on the Senate floor this week as he ridiculed the latest kick-the-can spending package:   

In February, Paul used Senate rules to force his colleagues into a grueling Super Bowl weekend of votes, as he worked to derail a $95 billion foreign aid bill. "I think we should stay here as long as it takes,” said Paul. “If it takes a week or a month, I’ll force them to stay here to discuss why they think the border of Ukraine is more important than the US border.”

Don't expect a Majority Leader Paul to ditch the filibuster -- he's been a hardy user of the legislative delay tactic. In 2013, he spoke for 13 hours to fight the nomination of John Brennan as CIA director. In 2015, he orated for 10-and-a-half-hours to oppose extension of the Patriot Act

Rand Paul amid his 10 1/2 hour filibuster in 2015

Among the general public, Paul is probably best known as Capitol Hill's chief tormentor of Dr. Anthony Fauci, who was director of the National Institute of Allergy and Infectious Disease during the Covid-19 pandemic. Paul says the evidence indicates the virus emerged from China's Wuhan Institute of Virology. He's accused Fauci and other members of the US government public health apparatus of evading questions about their funding of the Chinese lab's "gain of function" research, which takes natural viruses and morphs them into something more dangerous. Paul has pointedly said that Fauci committed perjury in congressional hearings and that he belongs in jail "without question."   

Musk is neither the only nor the first noteworthy figure to back Paul for party leader. Just hours after McConnell announced his upcoming step-down from leadership, independent 2024 presidential candidate Robert F. Kennedy, Jr voiced his support: 

In a testament to the extent to which the establishment recoils at the libertarian-minded Paul, mainstream media outlets -- which have been quick to report on other developments in the majority leader race -- pretended not to notice that Paul had signaled his interest in the job. More than 24 hours after Paul's test-the-waters tweet-fest began, not a single major outlet had brought it to the attention of their audience. 

That may be his strongest endorsement yet. 

Tyler Durden Sun, 03/10/2024 - 20:25

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