An informed investor’s reading list

After I got asked last week what in my opinion are good books for aspiring investors I gladly share my thoughts about it with my readers. As you’ll see I am a student so there are some standard college textbook in this list but I consider reading and more importantly understanding them essential to be a successful investor

1) General Investing

Benjamin Graham – Intelligent Investor
Widely considered to be the bible of value investing it gives the readers a good insight into why one should invest in which stocks. Even though it was written in the 30s and reviewed until the 70s, its conclusions are still valid today. Absolutely essential for every aspiring investor. In my opinion also the only book you HAVE to read to be informed about general investing.

2) Scientific Background

Zvi Bodie, Alex Kane, Alan J. Marcus – Investments
I guess the standard college textbook about investments. What I like about it is that it provides the reader with a good overview about many different aspects of investing. I in particular liked reading the descriptive section about investing and various securities that span for about the first 200 pages of the book. It is usually the part you never read when you are in college but in my opinion gives a good feeling and qualitative understanding of different investing possibilities.

Tom Copeland, Tim Koller, Jack Murrin – Valuation
The more hands on approach to valuation and the first book I read about valuation. Written by Tom Copeland, a former McKinsey partner and founder of the Monitor Group it has a particular focus on real life valuations and discusses several problems usually coming along when valuing companies. If you want to buy the book, watch out because it is no longer officially authored by Copeland, Koller, Murrin but instead is published by McKinsey on Finance.

John Hull – Options, Futures, and Other Derivatives
Standard literature about derivatives. Warning: The book is highly mathematical. If you – like me- like such books it is a brilliant book giving in depth insight into this interesting area of the financial markets. If you don’t like math you’ll probably hate this book. But: Never trade derivatives without understanding them and this books is in my opinion the best to help you understanding them.

3) Technical Analysis

John Murphy – Technical Analysis of the Financial Markets
I’m no fan of technical analysis and I’m especially no fan of books about technical analysis. Most of them present some kind of a proprietary system that promises a quick fortune. Murphy’s book is different. It just presents all the concepts technical analysts use, but he always points out that these concepts are not perfect. A great intellectual discussion of the advantages and disadvantage of this kind of analysis and the only book I would suggest anyone to read in this area. It also gives you some topics for small talk. You learn how to talk about support, resistance and all the other fancy stuff techies love talking about.

4) Understanding the World

Before I start with recommendation some words why I included a section titled “Understanding the World”. In my opinion the most important attribute of a good investor is the ability to understand the company and the broad macroeconomic context the economy is in. This section therefore includes several books about economics (however general macroeconomics is another section), politics, leadership and so on.

Thomas L. Friedman – The Lexus and the Olive Tree
Globalization is the broad economic maxim the world operates in so it is essential to understand it. Friedman provides the best description of it. Understanding it helps you to understand why globalization is good not only for a particular company or country but for society in large and the world.

James Surowiecki – The Wisdom of the Crowds
Deals with cooperation and the advantages cooperating provides for everyone. Brilliantly written scientific literature that can help you understand why you read my blog and several others.

Louis V. Gerstner – Who Says Elephants Can’t Dance?
Have you ever asked yourself why it is so hard to manage a company and why so many CEO’s fail? I guess for investing in companies it is essential to understand the challenges and issues a corporate CEO faces every single day. The book, written by the former chairman and CEO of IBM, Inc. when it was on the brick of bankruptcy in the mid 90s gives a brilliant insight into the life of a CEO.

5) Macroeconomics

N. Gregory Mankiw - Principles of Economics
Brilliant book. Period. – There is no better book giving an overview about contemporary macroeconomics. Lacks some detail but for readers interested in the broad picture best suited.

Oliver Blanchard – Macroeconomics
Has more depth compared to the Mankiw. I wouldn’t advise anyone to read both books, one is sufficient. The Mankiw covers more topics; the Blanchard has some more depth in selected topics.

6) Readings about Investing and Wall Street

Alexander Elder - Entries and Exits
The book portraits the strategies and lives of 16 trades. All share a passion for trading and for the market but are different in their style, the markets they cover and their investment approach.

Roger Lowenstein – When Genius Failed
Whenever you think that everyone else in the market is smarter than you just remember that the company of two Nobel Price laureates and some of the most brilliant minds on Wall Street produced the by far large default of a hedge funds ever. The book describes their story, their success and their failure. Just remember not to make the same mistakes.

ADM’s disappointing quarterly results

Shares of ADM got hammered yesterday as a result of worse than expected quarterly results. They finished yesterday losing 5.4%. However, even after this loss, ADM still outperforms the S&P 500 YTD by a large margin. While ADM gained 14.91% since the beginning of the year (15.33% w/ dividend payment), the S&P only gained 4.79%. Investing in ADM still turned out to be profitable, even despite yesterday’s disappointment.

“We performed well in a challenging quarter,” Patricia A. Woertz, Chairman and CEO Archer Daniels Midland said yesterday commenting last quarter’s performance. While sales quarterly sales increased by 25%, operating profits only increased by 12.8% leading to a diminishing of ADM’s already small operating margin. The quarterly operating margin now is below 5%, after being 5.4% last year’s third quarter.

After accounting for non-recurring events of ADM’s divisions only corn processing, the division engaged among others in the production of ethanol, has been able to increase its operating profits. All other divisions, especially oil seed processing and agricultural services weren’t able to increase their operating income compared to last year’s quarter.

What are the implications of ADM’s quarterly results? First of all, even though ADM had disappointing results, it is still a solid company with huge growth potential in its ethanol operations. However, the company seems to have some margin problems most likely in the non-corn processing and agricultural services divisions. As we have seen investing in ethanol seems to be profitable.

Maybe investing in other ethanol producers is a possibility. However, Verasun (VSE) and Pacific Ethanol (PEIX) are very young and focussed companies. For someone like me who is more a value oriented investor investing in these companies is too risky. ADM in comparison to these companies is not strictly focussed on ethanol, has a good management and different brand recognition due to its other services. In my opinion ADM is still the best ethanol investing pick. However, for speculating on good earnings VSE and PEIX seem to be interesting as ADM’s profits in corn processing give an indication that both companies will perform well. Watch out especially for PEIX as their last quarters performance was adversely influenced by an extraordinary loss and their current estimates are conservative.

Report Date
PEIX: 5/15
VSE: 7/24

Disclosure: The author is a happy and satisfied investor in ADM

ADM to produce world's first bio plastic

Just a short update about the whole bioplastic story described here last week and of course an update on my favorite stock: Archer Daniels Midland today announced an Joint Venture with Metabolix (MBLX) to produce the world's first bio plastic under the brand Mirel Natural Plastic. Click here for the press release

Fast Food restaurants: Suffering from increased corn prices

Friday’s Wall Street Journal featured an article about the increased cost structure of McDonald’s (MCD) as a result of an increase in the corn price (For those following the link: It is the second article within the article. Somehow the WSJ combined two articles to one on its website). Corn is used to feed the chicken and cattle that eventually end up as parts of your Big Mac and Mc Chicken. It is also used for the salad dressing and various other ingredients of McDonald’s food. An increase in the price so would definitely have an adverse affect on McDonald’s profits.

McDonald’s doesn’t purchase the meat or the corn on the spot market but through procurement contracts. They function as a hedge against short term fluctuations in the purchasing price. I don’t know what the average duration of such contracts is but I would expect that they are renewed annually, resulting in an average duration of about six month. An increase in the corn price is therefore going to have an about six month lagged impact on McDonald’s costs. You better watch out if your Big Mac combo costs a dime more in a couple of months.

This kind of argument works similarly for every other restaurant chain. In particular fast food chains suffer as their cost structure mainly consists of costs for the ingredients. Burger King (BKC), Jack in the Box (JBX) and Wendy’s (WEN) face the same problem McDonald’s has. We therefore have to determine which company will suffer the most from an increase in the corn price.

Meat and other food ingredients are mostly purchased locally as transportation costs and freshness (time) are crucial. A McDonald’s restaurant in California isn’t going to purchase their meat from a farmer in Germany but from one in Northern California. Keeping the local procurement in mind we have to have a closer look at regional differences in corn prices. As pointed out in an earlier post, right now the corn price is driven by the demand for ethanol. Interestingly turning corn into ethanol is only an American phenomenon. In Europe and Asia ethanol is primarily produced from palm oil instead of corn. Deducting the effect from this lack of additional demand, corn prices outside of the US should be significantly lower.

Hence, the impact of rising corn prices on the average cost structure of a fast food chain depends on the ratio of domestic sales to international sales. As we can see (Table below) McDonald’s has the lowest ratio, meaning that the biggest proportion of sales is generated abroad. The impact of rising (US-) corn prices is modest. Compared to that Jack in the Box and Wendy’s generate virtually all of their sales in the US, so their profits are most likely going to suffer from an impact in corn prices.

This leaves us with a promising long-short bet: McDonald’s long, Wendy’s and Jack in the Box short.

Company	Sales	Domestic	International
MCD	21,586.00	34.6%	65.4%
BKC	1,936.00	67.1%	32.9%
WEN	2,439.00	94.9%	5.1%
JBX	2,100.00	100.0%	0.0%

Bio-Chemicals: Coffee out of Corn-Cups

Inspired by the article about ethanol of my colleague Alex, I started thinking about what else might be affected by using soft commodities instead of petroleum. As I’m sitting in the cafeteria of my University and enjoying my hazelnut coffee, a short spot at my cup gives me the answer. Plastic! All kinds of synthetics material are made of petroleum. Plastic bags for salad, plastic tables, plates and cutlery, even the foam in the seats might be replaced by ecological produced substitutes. At the moment about 10% of the petroleum consumption is related to plastics production.

By having a look at the soft commodities available to transfer into bio-plastics, it does not take much time to find out which are mainly used to produce bio-synthetics: Corn and Soybeans. While corn is more attractive for plastics, soybeans are especially used to produce soy-foams.

Now that we’ve seen that there are many more opportunities to use agricultural products as a substitute for petroleum, than only running cars by ethanol, the question arises if they also offer an opportunity to earn a profit

We can see in Alex’s article: Ethanol: Attack at the Gas Station, natural-gas producers can work profitable. But what about the natural-plastic producers?

Referring to a Wall Street Journal article, a today’s bushel of corn worth about $3.25 can be transformed into $15 worth of bio plastic, which offers a lot bigger profit opportunities than processing the commodities into food ingredients.

Rising petroleum prices make it even more attractive to diversify at the production of plastics between petroleum-based and bio-based plastics. Doing so, the companies are less vulnerable to changes in the oil price and have the Opportunity to market a green image.

But which kind of firms have the possibility to start up in producing bio-plastics? First of all chemical producers like Dow Chemical or Wilmington Chemicals might start producing bio-plastics as they are already in the plastic business, but also grain-processors like ADM or Cargill are investing into the growing market of bio-plastics.

Right at the moment it is not sure if the demand for bio-plastics will grow as fast as some analyst think, but as the oil price stays high and companies start investing in the development of producing cheaper bio-plastics combined with a growing demand to hedge against uncertainties in the oil market the bio-plastic sector will be worth to be observed.

As my coffee is finished now, so is the article, but on my way to the trash can another thought comes into my mind: What about the recycled synthetics market…?

What's up to come

Right now I have several interesting ideas for blog entries in my head. I already researched some of them, others are just ideas. However, to pressure myself a little bit and to save them in case I lose my memory here are some of the ideas left to turn into blog entries:

I'm still into renewable energy so I think about writing an article about prospect technologies and companies researching them. I recently read an interesting article about future wind energy concepts and I really like to research water energy a bit. Furthermore, nuclear power seems like a "clean" alternative to fossil energy. The price for uranium increased by 50% since the beginning of 2007, so I'll probably have a look into several companies of this sector.

I am going to intensify my analysis of the agricultural industry, either going into different crops or different countries.

My long time favorite sector has not received any attention in this blog so I guess I'll have to start giving it the attention it deserves. Steel is my all-time favorite sector. I don't really know why. Maybe its just the masculine image steel implies. Hard as steel. I have two favorite companies in this sector: Salzgitter (SZG.DE) and Tenaris (TEN.MI). Salzgitter has been one of Germany's best performing stock in 2005 and after that continued to perform well. The stock rose from about 15 EUR in Jan 2005 to above 115 EUR just recently. That's 660% in 2 years and a quarter.

Hopefully the success of the Net working Capital less Total Debt strategy continues. I'll continue report weekly success of the strategy and I am going to come up with a shorter and more elegant name for this strategy. Maybe I'll even explore some other quantitative strategies as researching them sparked my interest in this are.

Just for personal interest I'm going to publish an article about Goldman Sachs. This article is almost finished and only needs some last adjustments. Further continuing the pursue of personal interest maybe the video games series started with the Wii article will continue. A good friend of mine, Marius, is currently researching the Playstation 3 for an university project and is thinking about contributing a guest comment about the PS3.

So much to do, so little time. So I better get started...

Stock Market Extremes: High P/E Stocks

After I posted yesterday that Electronic Arts with a P/E ratio of about 180 was the highest I've ever seen I went ahead today and checked high P/E ratios for the US market. Obviously, Electronic Arts was only ranked 28th. The first place went to Guitar Center (GTRC) with a P/E ratio of 4546. Notable runner ups include Warner Music (7th), First Solar (10th) and Mastercard (16th).

Just as an investment idea: Wouldn't it make sense to short these companies, especially those that have other multiples also out of a reasonable range. I'm more and more drawn towards a quantitative investment approach and I wonder what would be the success of a soundly constructed.