Inflation, Commodity Futures, Speculating, Hedging... And Coffee.

Few days ago, I read the news uttering about the Americans' reactions on the inflation- especially on higher food prices. And I immediately tweeted that the Americans should not outcry for higher prices when they have no idea about the painful inflation in the emerging markets. I spent 22 years in India and I can understand how cheaper the daily necessities in the US are.

Commodity futures are positively correlated with the inflation and that is the reason why investors choose them as an inflation-hedge in the long-run. Commodity prices are speculator's & hedger's game besides the global demand-supply. If perceived price risk in the future is higher for consumers of commodities, they buy the futures and the net long position sends market towards the contango. And if perceived price risk in the future is higher for producers of commodities, they sell the futures and the net short position pushes market towards the backwardation. Generally, perceived price risk in the future is higher for producers and because of this, commodity markets are in normal backwardation most of the time. But consistent upward pressure in the global inflation in the recent years has pushed the global commodity market in normal contango.

If we talk about the whopping prices of coffee, Starbucks is being considered as one of the culprits who pushed coffee futures in the contagion world. Based on their recent quarterly reports, they have shown noticeable hedging activities especially in coffee futures. Their speculation of higher coffee prices in the future made them take net long positions in the coffee futures. Per recent Financial Times news story, they are fully hedged against their needs until the end of this calendar year in April. And that tells the whole story about the speculation. I do not find any fundamentals.


It is a simple phenomenon. If bigger players like Starbucks keep on buying futures, then demand for futures increases regardless of other fundamental or economic factors. And contango stands out as a bull market with a possible commodity bubble. It is not illegal for corporations to perform hedging activities, but there should be some difference between speculating and hedging. Per my knowledge, whatever Starbucks is doing is speculation and whatever all airlines are doing is hedging.

Stepping Stone for Social Media IPOs...

One of the interviewers asked "If you have money to invest in, which stocks you buy?" And I responded "I would have said Netflix if you had asked me the same question few months ago, but now I like LinkedIn. I am waiting for their IPO." Yes, LinkedIn it is. Investors are waiting for Thursday, May 19, 2011 when LinkedIn is likely to hit NYSE.

When you have faith in a company's operations, culture, financials, policies and strategies; you will see your money being secured while investing in it. It is all about confidence factor, but not about following the herd. One of my friends said that this stock is going to make you wealthy and all variations thereof, never work in long-run. Such sort of investor confidence is provided to LinkedIn. And that is the reason why they have raised the size of their IPO twice after their announcement in January 2011. Per recent announcement of their IPO size, stock will likely to trade between $42-$45 and valuation will be around whopping $4 billions.

Why not? If company believes in their chores and realizes the lustrous confidence of investors, it should ride on it. Personally, I have faith in LinkedIn and that is why I gave that response to an interviewer. LinkedIn is a part of  bullish social media industry, but it may be the only company who is providing the professional networking. Their business model seems clearly different than what Facebook, Twitter and others have. They connect recruiters, companies and job seekers in the unique ways.

Stepping stone. LinkedIn being the first social media company in the US who is going public this week, provides some efficacious groundwork for potential future IPOs of Facebook & Groupon. LinkedIn's valuation is certainly way lower than what Facebook and Groupon are valued at. But their post-IPO stage may deliver few twists in this household industry.

... "what is LinkedIn and why is it so hyped?" I hear such questions from professionals of the industries where vacant jobs are more than number of job seekers. The only key limitation I consider in the business model.

Where's the dinner tonight?

Well, being a connoisseur of food, I love to visit world cuisines and new restaurants in the proximity. And that includes few restaurant chains as well. I am a global individual, ain't I? Restaurant/dining sector was punished hard during the recession of 2007. Few chains were not able to produce profits for consecutive 2 years. And few bounced back like a marathon spring. But as they are saying, gone are the days! Restaurant Performance Index (RPI) is up again and back at 2005-2007 levels. Consumers have started to hate cooking food at home and so the sector components have started to cook some profits after years.

Here are some of the characteristics of this rebounding and bullying sector:

• Industry leaders: Chipotle Mexican Grill, Inc (CMG), Panera Bread Company (PNRA), BJ's Restaurant Inc (BJRI) and Domino's Pizza, Inc (DPZ) are leading the sector with handsome growth and stock appreciation. 
• Other growth proponents: Few restaurants chains have not been able to beat the market, but they have succeeded to help sector to boost its performance. They are Yum! Brand, Inc (YUM), Darden Restaurants, Inc (DRI), Red Robin Gourmet Burgers, Inc (RRGB), The Cheesecake Factory Incorporated (CAKE), California Pizza Kitchen, Inc (CPKI), Papa John's International, Inc (PZZA) and many others.
• Turnarounds: A rise in consumer confidence, fall in unemployment rate, introduction of breakfast menus like Subway did, diversification in the traditional core menu like Domino's did by introducing all those gourmet pastas and subs and expansion of operations in emerging markets where consumers have newly found wealth to spend. 
• Optimism: Rise in IPOs is a good indication of industry optimism. Recently, Arcos Dorados Holdings, Inc (ARCO), Bravo Brio Restaurant Group, Inc (BBRG) and Country Style Cooking Restaurant Chain Co. Ltd (CCSC) went public. Leading coffee giant Dunkin Donuts Inc has just filed for an IPO under the ticker of DNKN.
• Pessimism: This sector is not an exception and that is the reason why it has also been affected by rising oil prices and skyrocketing inflation. These macroeconomic factors have caused restaurant chains to increase the noticeable prices in their menus.

... Mind well! Subway Restaurants have the honor of being considered as the world's largest restaurant chain after their locations figure surpassed McDonald's Corp (MCD) in the beginning of this year. And and and... The world's largest restaurant chain is still not publicly traded.

Tumbling WMT is healthy sign for the economy, isn't it?

We were given fictitious $250,000 to invest in 5 securities by our professor during one of the electives of the grad school. Investment Analysis it was. The objective of our portfolio was to preserve our capital. Those few lucky securities chosen by us were WMT, FDO and healthy weight on treasury bills. Based on our security selection and objective, I wonder any one cannot assume what period it was. Right? Yes, it was the midst of catastrophic recession which started in the 2007.

The best performance of WMT and the worst performance of NASDAQ Composite Index relative to each other during last 5 years, took place during the recessionary period. And that is the reason why we love to consider WMT as a recession-proof stock. But if we observe the charts now, NASDAQ composite and other market indices are quickly approaching to the higher returns. These are the signs of early expansion which are not preferred by discount stores like Wal-Mart who have been reporting consecutive decline in sales. Their stock is pretty much down from where it was during the great recession. If that is not enough, recent hike in gas prices and inflation have worsened  the outlook for the discount stores.

Wal-Mart has been trying various strategies to regain their momentum despite of negative correlation with the markets:

• Recently, they have announced to acquire Kosmix which discovers social content by topic. This acquisition may bring Wal-Mart to the new age of social media influence on electronic and mobile commerce. When a retail mammoth taps the Silicon Valley, it has to be something strategic. And these are the impediments behind the expansion of WalmartLabs. 
• Few days ago, they tested their online grocery store. This may have been game changing event if consumers easily adapt to this service. It can definitely give Wal-Mart some edge over its peers.
• After successful entry in the Chicago market in the 2006, Wal-Mart began to think over the New York City market which has high barriers for entry. And based on poll results in the early 2011, New Yorkers showed positive response to embrace Wal-Mart.

... and if these help them perform well and beat the market, do we have to remove WMT from the list of those recession-proof stocks?

Head to China and Enhance the Ubiquity

Rumors. Rumors. And more rumors. Once you are on the top of the tree, you will likely to hear all sort of rumors surrounding you. Social media is the new, intangible household material and the most bullish industry sector. Rumors follow it. Facebook rules that industry. More rumors follow it. News feed is considering Facebook deal with Baidu to reenter China as blockbuster rumor. Facebook may have dealt with some local social network to enter China again after it was banned in the July 2008. No news has been confirmed by either Facebook or Baidu. But I can see handsome & strategic implications behind this.

As of June 30, 2010

Facebook undoubtedly reigns the social networking. It has becoming more ubiquitous with every sunrise. But because of China's ban on Facebook, it is still unexposed to the biggest Internet usage market in the world. If Facebook collaborate with some local social network there as stated in the news, it may have been turnaround for them. Facebook may be household name in the market of nearly 1.5 billion people. And this Chinese Presence may help Facebook to flourish revenues and amplify its already whopping valuation. If such thing happens before Facebook's possible IPO, I   can imagine some record setting numbers for IPOs.


After these rumors, we should not be surprised to see manifold bankers to visit Mark Zuckerberg and other considerable heads of Facebook every now and then. The Chase is going to be earnest and pungent...

"Let's assemble new Netflix." says Dish TV?

OK. I had knocked the right door when I heard about the bankruptcy filing of Blockbuster back in the last year.   Looking at the swaggering stock performance of Netflix over the last two years, I thought of a potential deal of buying Blockbuster. And Dish TV has finally done it. With that, an array of acquisitions in media & cable industry continues.

I believe the impetus behind this $320mm deal is:

• Blockbuster has phenomenal collection in their library and it used to reign the movie rental market cleanly just before Netflix started to expand exceptionally.
• Looking at such potent parameters, distressed value of $320mm seems like a handsome investment.
• Subscribers do not need broadband connection to play content offered by Dish TV. This factor may become critical after AT&T and other broadband providers start putting "already announced" cap on internet usage.

If you cannot compete with expeditious NFLX, you have to build new NFLX. I will not be surprised if Dish TV has this gimmick behind the scenes.

"Trust Me" Factor & Portfolio Management

I was working and listening to the news yesterday evening and suddenly a tag line popped up saying Breaking News. It was about David Sokol's resignation from Berkshire Hathaway Inc. Why was it breaking? Because this is the man who was considered as successor of Warren Buffet at the company. This is the man who made the Netjets story. Since yesterday, I have been hammered by these news "Sokol's shocking exit", "Buffet's surprised by David's resignation" and so on. Among all, a news about Berkshire Hathaway's stock valuation appeared and that caught my attention.

It is about "Trust Me" factor.

• Inherent in the stock value of companies like Berkshire Hathaway Inc.
• Such investment vehicles do not have manufacturing or retail operations and this is why they are able to deliver much needed transparency in their financial disclosures to the investors.
• Because of such business nature, they have minimal accruals and accrual based earnings. As we know, the lesser the accrual based earnings and the higher the cash earnings are, the greater the quality of earnings is. In other language, when the accrual component contributes the least in total earnings, we get the earnings of the greatest quality.
• Forecast of greater quality of company's earnings will always have positive correlation with stock price or its valuation and this is the reason why we cannot consider this factor as trivial.

Should some PhD in multi-factor analysis or in quantitative methods can substantiate a theory on this factor, then is it likely to be employed by portfolio managers in their multi-factor models? In such models, sensitivity to this theoretical factor should be higher for portfolio composed of securities from companies like Berkshire Hathaway like the same way in macroeconomic model where sensitivity to recession factor is higher for Ford Motors and lower for Walmart.