Gold versus Apple

Recently, CNBC ran a short interview segment entitled "Battle of the Bugs," comparing the fanaticism of some Apple investors and some gold investors (or "gold bugs").*

While the network and interviewer chose to focus on the similar intensity of both camps, and jokingly tried to portray each group as a sort of "cult," we feel that the interview completely overlooked the real story.

The real story, in our opinion, is the amazing outperformance that investors who committed capital to an innovative company adding value would have experienced versus investors who put their money into a commodity such as gold, even during a time period in which egregious Fed oversteering has boosted the price of gold to record levels.

The chart below, frequently flashed on the screen during the CNBC segment, is worth a thousand words:

The chart shows that over the past twenty years, the price of gold has risen 229.66%, while the price of Apple stock has risen 3,866.97%. There truly is no comparison, no matter how hard CNBC tries!

The arguments for investing in gold found in the clip above are no doubt familiar to anyone who has seen or heard the numerous gold commercials on television and radio over the past year: namely, that the failure of the government to prevent inflation and dollar devaluation has led to the current stratospheric gold price, and all indications point to continued government mismanagement of the same sort in the future.

We ourselves have written many posts about the historic trend of dollar devaluation, and the fact that its cost is far more damaging than many people realize -- see for example "Stand still, little lambs, to be shorn!" and "Avatar and long-term inflation."

However, we have always argued that investing in innovative companies is a far better defense against such devaluation than investing in gold and other commodities. We made this point as far back as this post from February 2008 (which featured two San Francisco Giants tickets as an illustration of long-term dollar devaluation). That post included a link to a discussion by Professor Jeremy Siegel on the reasons that innovative companies adding value have historically been able to stay ahead of inflation better than either gold or real estate.

On a deeper level, we would point to the philosophical aspect of this "debate." Innovative companies such as Apple grow by adding real value to those who buy their goods or services. Commodities, by their very definition, are materials to which no value has yet been added -- they go up or down in value only by the changing value of currencies and markets. "Playing" the change in market valuation is very different from identifying a company that is adding value and participating in that growth by the investment of capital in that company. We discuss this distinction in "Growth is the answer: the primacy of human creativity" and in "Gambling, speculation, and investment."

While we have always agreed that gold (apart from its use as a commodity) has historically been a store of value, and that hasn't changed, lately it is being touted as an "investment alternative," and we would caution investors that playing its changing market price is speculation and should not be put into the same category as participation in the growth of a well-managed and innovative company.

The graph above from the more recent CNBC segment tells the story as powerfully as anything else we've seen. That was the real story that investors should take away from CNBC's "Battle of the Bugs."

* At the time of publication, the principals of Taylor Frigon Capital Management owned securities issued by Apple (AAPL).

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Why all investors should be Giants fans!

The Major League Baseball League Championship Series are going on this week in both the National League and the American League, and it occurs to us that there is an investment lesson (probably several investment lessons) in the various matchups taking place.

One of the most striking contrasts to us as portfolio managers is the difference between the San Francisco Giants, playing the Philadelphia Phillies for the National League Championship, and the New York Yankees, playing the Texas Rangers for the American League Championship.*

The Yankees are well-known as a team which habitually acquires big-name players from other teams, while this-year's San Francisco Giants team -- and especially their well-respected pitching staff -- is very much a product of players the Giants developed themselves within their own farm system.

Many of the Yankees stars were bought with the offer of a huge salary rather than brought up inside the Yankee system, including Alex Rodriguez, CC Sabathia, Mark Teixeira, AJ Burnett, and Lance Burkman (Derek Jeter being a notable exception, as is young pitcher Phil Hughes). This situation is no surprise for followers of baseball, as the Yankees have been known for this strategy for years.

In contrast, the Giants team largely grew up within the Giants system. Starting pitchers Tim Lincecum, Jonathan Sanchez, Matt Cain, and Madison Bumgarner all came up through the Giants farm system and played AAA ball with the Giants organization in Fresno, as did stellar rookie catcher Buster Posey.

We've made the point before that there are interesting portfolio management lessons to be learned from sports, particularly from baseball (see for example this previous post). We believe it is not a stretch to apply this contrast between the Yankees approach and the approach of the Giants to the difference between companies that grow by acquisition (similar to the Yankees spending a lot on players whose developmental years were on other programs) and companies that grow organically (similar to the Giants, many of whose stars came up through their own system).

Examples of companies that have grown by acquisition might include serial acquirers General Electric and Oracle, while examples of successful companies that have grown primarily by pursuing their own organic business ideas with few acquisitions include cloud computing star and even consumer powerhouse Apple.**

In general, we believe investors are generally better served by allocating capital to companies that resemble the Giants (organically grown) than to companies that resemble the Yankees (big-dollar serial acquirers), if for no other reason than the fact that "Giants-type" companies are typically smaller and may be focusing more exclusively on their core competency. A danger with serial acquisitions in the business world is the tendency for a company to end up focusing on too many possible avenues for future growth, rather than the one or two that they have been involved in from the start.

Some readers (particularly if they are Yankees fans) might counter with the argument that the Yankees have long been the winningest team in baseball, perennial contenders for the American League pennant and even the World Series.

We would answer this with the observation that for an investor, by the time a company is big enough to throw around the kind of money that the Yankees do, it may be past its growth phase (there are notable exceptions). We have written about the difference from a portfolio management perspective between trying to build a portfolio of well-run up-and-coming businesses (like the Giants) and trying to build a portfolio of larger, more mature companies in previous posts (see especially the discussion in the second half of this previous post).

These are important issues for investors to consider as they enjoy this year's exciting post-season play in the great American pastime of baseball.

* Full disclosure: Blog authors Dave Mathisen and Gerry Frigon have been long-time fans of the San Francisco Giants and may be somewhat biased in their comparison of the Giants and the Yankees.

** At the time of publication, the principals of Taylor Frigon Capital Management owned securities issued by (CRM) and Apple (AAPL). At the time of publication, the principals of Taylor Frigon Capital Management did not own securities issued by General Electric (GE) or Oracle (ORCL).
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Freedom and the rescue of the Chilean miners

The ongoing rescue of the miners in Chile may well go down in history as one of the most amazing events of our time.

Here in a short video clip (above), two members of the Wall Street Journal's Editorial Page, Deputy Editor Daniel Heninnger and "The Americas" columnist Mary Anastasia O'Grady, explain some very important lessons from this moving rescue.

They make the point that the technology that made the rescue possible came from far-flung businesses specializing in very niche equipment, and that only capitalism enables such innovation and only capitalism can effectively bring such diverse resources to bear on solving difficult problems.

The great advocate of capitalism and freedom, Milt Friedman, explained this lesson in his famous lecture on the pencil (see here for a short 2-minute video of Milt Friedman explaining it as only he can; note also that he thinks the graphite probably came "from some mines in South America").

The Journal writers also point out the difference in the Chilean response, welcoming the technology from firms based in other countries, to the rebuff the US gave after the gulf oil spill to ships from other countries, based on anti-market laws on the books for decades (as we discussed here).

We would also draw a parallel between the role of capitalism in the ability to rescue miners lost for weeks, half a mile below the surface of the earth, and the role of capitalism in the ability to put a man on the moon back in 1969. As we discussed on the fortieth anniversary of that momentous event, "during the 1960s, the space program was very much seen by the entire world as a contest between two nations with very different views about the best way to allocate limited resources."

It is valuable to think about the contrast between free-market capitalism and anti-market protectionism, because that battle is still going on today. The dramatic rescue of the Chilean miners underscores the fact that capitalism really promotes life and freedom, or, as Milt Friedman said so long ago: "That is why the operation of the free market is so essential -- not only to promote productive efficiency, but also to foster harmony and peace among the peoples of the world."

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Rip Van Winkle, 2010

A little over a year ago, we published a post entitled "If Rip Van Winkle took a one-year nap before September 15, 2008." The purpose of the post, as we explained at the end, was not to encourage the kind of negligent attitude that Washington Irving ascribed to the protagonist of his famous short story (a character of "insuperable aversion to all kinds of labor," who would rather "starve on a penny than work for a pound") but rather to point out the importance of investing in good companies of the type we discuss on this blog, a portfolio of which had returned to within 5% of its original value, one year after the collapse of Lehman Brothers and the most ferocious bear market in over seventy years.

At that time, the broader market was still down over 16%. We have previously written about our belief that "just owning the market" is not something we recommend in any economic environment, but that in periods such as the 1970s or the current environment, just owning the market can be far more problematic than in more friendly environments such as the 1960s or the 1990s.

Now, two years after the start of Rip Van Winkle's hypothetical September 2008 nap, it is the overall market that is almost back to the prices it hit in the week before September 15 (the Monday after Lehman Brothers declared bankruptcy the day before, and a day which saw the Dow Jones Industrial Average plunge over 500 points by the close).

On September 11, 2008 -- the Thursday before the "hurricane hit Wall Street" -- the Dow closed at 11,433.71 and the S&P 500 closed at 1,249.05. At the end of September of 2010, the Dow Jones Industrial Average closed at 10,788.05 (down about 5.6%) and the S&P 500 stood at 1,141.20 (down about 8.6%).

Over the same period, the Taylor Frigon Core Growth Strategy (an actively-managed portfolio of growth companies of the type we discuss on this blog, managed using a discipline based upon the principles we discuss on this blog) is above its September 11, 2008 mark by over 16%, and has grown at a compounded annual rate of over 13% per year, net of fees, between September 30, 2008 and September 30, 2010 (complete GIPS-compliant performance numbers, with important GIPS disclosures, are available here).

We hesitate to highlight market performance over a period of only two years, because we know that what really matters to real investors is performance over periods of thirty, forty or even fifty plus years. However, we believe that bringing Rip Van Winkle out into the sunlight again at the end of September, 2010 is helpful to our readers for a couple of reasons.

First, it is an important reminder to investors to "stay on the train," rather than trying to anticipate market plunges. One year later, investors who owned growing, well-run companies would not have noticed much difference in their portfolio prices if they had been asleep for a year. Investors who panicked at the bottom and bailed out, as evidence suggests many investors did, made a very grave mistake. Two years later, the results are even more conclusive.

Second, these numbers speak to the importance of selecting the right kinds of companies. We have discussed the importance of selecting companies involved in major "paradigm shifts" in many previous posts (see here for example), and have discussed the very important "exaflood" paradigm shift in many posts stretching back more than two years.

Finally, while Rip's nap illustrates the fact that investors can actually stay invested and come out ahead through even the most trying market gyrations, his laissez-faire attitude towards what we might call "due diligence" can also serve as a cautionary tale for investors.

We believe and have said before that investment is not rocket science, in spite of the air of mystery cultivated by many in the financial services industry and by those who write books about it. However, it is not something that simply "takes care of itself." Investors must follow a consistent discipline, and put in the required work on their portfolio every day (unlike the main character in Washington Irving's short story). We have discussed this topic both for those who wish to do it themselves and those who would prefer to hire someone to do that work in several previous posts, such as here and here.

While there is no way of telling what the upcoming year holds, we believe that these "Rip Van Winkle" lessons will continue to be important for investors to understand in the years ahead.

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Comparisons between cloud computing and the dot-com bubble

We have written previously about the continuity between the dot-com crash of 2000-2002 and the financial panic of 2008-2009, and the belief that "The new economy of the late 1990s was an invention of media and Wall Street [. . .]. By 2000, new economy rhetoric became a frenzy of half-truths, bad history, and wishful thinking" -- a belief that the dot-com crash seemed to vindicate (see this previous post).

The bitterness investors felt towards technology stocks and Wall Street in general after the dot-com crash -- and the mistaken "lessons" of that event -- helped drive more capital into just about everything else, including real estate and securities composed of various flavors of home mortgage. The Fed's over-steering and artificially low borrowing rates added fuel to the fire.

Just as the Great Depression of the 1930s colored the investment perceptions of an entire generation (as well as the investment perceptions of the next generation, in many respects), there is evidence that the dot-com crash continues to color thinking about technology investment, often leading to mistaken conclusions.

For example, this recent article entitled "Storm is brewing for cloud computing stocks" is built around the argument that there is a new tech bubble brewing: "the cloud computing bubble." The article draws directly on the comparison to the dot-com bubble, saying: "the frothy environment is beginning to resemble the tech bubble of the late 1990s."

While it is true that investors must be careful of owning stocks with excessive valuations, we believe that the sell decision is extremely complex and that more weight should be given to business considerations than market action when replacing a core holding (a subject we discussed in greater depth here). As an aside, a distinction could be made here between trimming a position that has run up due to market action and selling a position altogether, but that is another matter.

While agreeing with the author of that article in that respect, we would argue that investors who fall for an easy comparison between today's "cloud computing" companies and the many dot-com companies of the late 1990s that enjoyed explosive IPOs and skyrocketing prices despite having no profits and not much in the way of a business model risk making a serious mistake.

Cloud computing is not primarily about providing free consumer services on the web supported by advertising, as the article implies. Cloud computing is a catch-all term to describe one of the obvious advantages made possible by the enormous increase in the speed at which data can be sent from one computer to another at very low cost, which we have been discussing on this publication for years and which we highlighted in our most recent post.

When ever-larger streams of data can be sent instantly and very inexpensively, individuals and businesses begin to ask themselves, "Why would I want to own software applications and storage on my machine?" Cloud computing companies run the software and the storage on their machines, which their clients can tap into remotely. Because of the massive increase in speed, storing a document or running a program on a remote computer feels the same as running it on your own machine, but with many real and tangible benefits.

For example, enterprises formerly had to buy costly software which had to be installed on possibly hundreds (or thousands) of employee computers, and then pay for costly maintenance and service contracts to keep that software running smoothly and address any glitches, as well as pay for costly upgrades every time the software authors decided to make improvements (or else do without those improvements), as well as paying for their own storage equipment, all the electricity to run all the servers and storage devices and backup power equipment in case of an emergency, and a massive in-house IT staff to keep it all running (as well as for a host of outside consultants and contractors who promised to help make it all run more efficiently).

The cloud computing model creates savings by eliminating much of the hardware, software, consulting, and services required by the traditional model. Instead, the customers can allocate their IT resources towards creating applications to make themselves more efficient using the cloud services, rather than worrying about crashes, upgrades, etc.

This phenomenon is no "dot-com" scheme to sell petfood over the internet: it is a real value-add that can save businesses literally millions of dollars.

We fully understand that the crash of 2000-2002 (to say nothing of the panic of 2008-2009) continues to loom in investors minds, and fill many of them with trepidation about investing in anything to do with technology. However, we would caution against making easy comparisons without fully understanding the actual situation. We have always said that owning well-run, innovative companies can actually be safer than investing in big, established companies such as the ones the author of the cloud computing article suggests to readers at the end of his dot-com analogy.*

We would argue that it is actually a very good thing that most pundits (and many Wall Street firms) still do not completely understand this important topic, and that ill-founded comparisons to 1999 continue to keep many investors out of the companies that are enabling this paradigm shift or positioning themselves to benefit from it.

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At the time of publication, of the stocks mentioned in the referenced article, the principals of Taylor Frigon Capital Management own securities issued by (CRM). At the time of publication, the principals of Taylor Frigon Capital Management did not own securities issued by Open Table (OPEN), Rackspace (RAX), Google (GOOG), Microsoft (MSFT), Yahoo! (YHOO), or the ETFs mentioned (XLK or IYW).
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