More Tales From the Tech Bubble…

Posted by Preet on Dec 17, 2008 | 1 comment

Here’s another interesting tidbit: 3Com had spun off the division responsible for the once popular Palm Pilots during the tech bubble. The price of Palm was so high that for a short time it was actually worth more than General Motors (easy to believe now, but quite a feat back then). General Motor’s quarterly dividend was many times bigger than Palm’s annual sales.

Meanwhile, back on the farm… 3Com owned most of Palm’s shares, yet 3Com was trading below the value of its holdings in Palm – which means that the market essentially assigned a negative value to 3Com’s other operations.

Market Cap Per Employee

Posted by Preet on Dec 15, 2008 | 2 comments

Hindsight is 20/20 of course, but when looking back on the tech bubble you have to wonder just how far out of wack things got. Case in point: Cisco Systems. At its peak, Cisco was the largest company in the world by market cap with a value around $600 billion. There were fewer than 30,000 employees which means the stock market assigned an average of $20 million of value per employee.

When the bubble burst, Cisco proceeded to lose $500 billion in value over the following thirty months.

10% Interest on Bank Deposits in India

Posted by Preet on Dec 12, 2008 | 2 comments

I forgot to mention that I’ve already left for India! Posts will be sporadic, but I may decide to sit down later this weekend and write up some short posts to publish over the next couple of weeks. I spent the first week in Fort Ramathra which is about as far away as you can get from the city – there is actually no pollution there. My uncle owns the fort and they’ve been rebuilding it and it now operates as a resort/hotel. Further away from civilization is harder to imagine – and how welcomed it has been! Anyways…

While on our way into one of the main cities (Jaipur) I noticed plenty of signs advertizing 10% interest rates on bank deposits. Sounds pretty good compared to our paltry 2-4% rates on offer these days for similar short terms… until one looks at inflation – it just dropped to about 8% annualized. So after inflation and after taxes rates are comparable for the most part.

Please take a look at the website for the Ramathra Fort – it is breath-taking. If you are planning a trip to India, I highly recommend spending a few days here. One of my cousins will take you for a hike to see the rural (and I mean RURAL) villages of India – a side of the country not normally seen by tourists.

FTSE RAFI Methodology

Posted by Preet on Dec 3, 2008 | 5 comments

As discussed yesterday, there are actually many variants of fundamental indexation out there and most are based on single metrics. For example, Jeremy Siegel of “Stocks For The Long Run” fame has teamed with Wisdom Tree to produce ETFs that index on either a dividend weighted basis, or an earnings weighted basis. FTSE RAFI (to my knowledge) is the only one that uses multiple metrics – four to be exact: 1)Sales, 2) Cash-Flow, 3) Book Value and 4) Dividends.

Index Construction

It’s probably helpful to go over how a cap-weighted index (vernacular for Market Capitalization Weighted) is constructed. If we had 100 companies in a market, and the total sum market capitalization of all the companies put together was $100 Billion, then if Company 1 had a market cap of $4 Billion, it would have a 4% weighting in a cap weighted index. If Company 100 had a market cap of $50 million it would have a weighting of 0.05% in the cap weighted index.

To weight on fundamentals is very much the same process, you just use different numbers. So let’s say our 100 companies have combined sales of $100 Billion, and Company 1 had sales of $2 Billion. In the sales-weighted index it has a weighting of 2%.

With FTSE RAFI there’s a bit more to it. You do the same for Cash-Flow, Book Value and Dividends. You then take the average of the four weightings to create a composite weighting. (If a company does not pay dividends, then you take an average of the first three only.) There’s one more step: you then take the rolling 5 year average of this composite to create the final FTSE RAFI Weightings (the index is reconstituted once per year, based on receiving all the audited annual financial statements for the market constituents once per year).

So you can see, none of these metrics or calculations have anything to do with the stock market price – therefore the structural link between portfolio weight and pricing error is removed. Pricing errors still occur, but the point is that they are random and they cancel each other out – instead of having most of your over-pricing errors magnified and most of your under-pricing errors diminished.

FTSE RAFI

Posted by Preet on Dec 3, 2008 | 1 comment

FTSE RAFI: Pronounced “Footsie Raffy”.

FTSE

FTSE got its name because it was a collaboration between the Financial Times and the London Stock Exchange. It is best known for being an index data provider. You are probably most familiar with the FTSE 100 – which is the most widely followed UK stock market index. It is often mentioned in the same breath as the Dow or the S&P 500. FTSE currently provides index data for many thousands of indices globally.

RAFI

RAFI is an acronym for Research Affiliates Fundamental Index. It is a specific fundamental indexation methodology developed by Rob Arnott. Fundamental indexation can take on a variety of forms, mostly based on single metrics (i.e. just sales-weighting, or just dividend-weighting), but RAFI is a more well-thought out design which utilizes a composite of four separate fundamental metrics, and then further uses a five-year rolling average of those numbers. Research Affiliates is Arnott’s company and it gets its name because they are very “research” oriented and then license the use of research-driven products through various affiliates around the world. For example, the company I work for (Pro-Financial Asset Management) is an affiliate in that we provide the unit trust structure of index funds that track FTSE RAFI mandates around the world.

There is roughly US$35 billion in assets indexed according to Research Affiliates methodologies globally. I’ll flesh out the the nature of the methodology in the next post.