Thursday, February 24, 2005

Lowest common denominator

Microsoft recently released anti-spyware software which some people see as an anti-competitive move against several small companies that were selling spyware removal tools. I remember the Netscape saga as well as the next guy, but I think what Microsoft has done is (for once) good for the public at large.

Windows is lowest-common-denominator software. Everyone uses it including people who can't afford a system administrator. It is a waste of time and talent for these people to spend more than a few hours a year fixing their OS. For years I would have long phone conversations with my dad to solve his computer (read Windows) problems. And I could count on spending an afternoon trying to fix things every time I came home from college. Fortunately, a combination of his understanding and Windows usability has eliminated those duties. But I still have to help my grandparents set up their email. And help my in-laws get rid of viruses and spyware.

I have a dirty little secret. I don't know what I'm doing either. My entire professional life and much of my personal life has been spent working on computers and it took me a few weeks to upgrade to Windows XP. Moments after I installed it the first time, my computer was invaded by a virus (MyDoom I think) that caused it to reboot every time I connected to the Internet.

Things would be worse if Linux were the LCD OS. I'm glad that I don't have to remove spyware for Joy's sister anymore. She can just run Microsoft's anti-spyware software. It would be better if Windows security wasn't as loose as a prostitute, but failing that, at least Microsoft is starting to give out medicine and vacines.

Friday, February 11, 2005

Financial Red Flags

The guy I share an office with at work sells candy and Coke out of his desk and a little refrigerator. (My managers obviously don't read Joel on Software.) I know that he has a very loose accounting system, but I thought it would be amusing to imagine what sort of things he might be on the lookout for if he did keep track. Obviously revenue and earnings would be high on the list. If he found out he was losing money or fewer people were buying stuff, he might get concerned. These are basic, but how might he notice the trends earlier? What red flags would warn him of trouble?

My coworker buys his wares when they go on sale at the grocery store and sells everything for 50¢. His profit margin depends exclusively on how much he pays for the stuff he sells. If the grocery store raises prices or people buy more of the expensive items, his margin would go down. If he raised his prices, his margin would go up, but his sales might go down. So changes in margin over time are danger signs.

The office store's best selling item is Diet Coke. As it turns out, diet sodas go bad over time because the sugar substitute breaks down. Most of the time, this isn't a problem because people buy the stuff almost before it gets cold. But suppose there was a big sale at the grocery and some of the best customers went of vacation for a few weeks. It's possible some of the Diet Coke could go bad and have to be thrown out. On the other hand, if inventories got low and our office had a bunch of late meetings, the store might lose sales because it runs out. Inventory changes are potential problems.

Most people pay as soon as they buy from the store. A few people put in extra so that they don't have to deal with paying a few hours later. But some people run a tab or use IOUs. Unfortunately, people aren't always honest, sometimes forget how much they owe, or leave the company before repaying. These risks increase as the amount owed increases. On the other hand, if my coworker forced people to pay as they go, he might lose some sales, so changes in receivables (either increases or decreases) are worth investigation.

Suppose my coworker decided to buy a bigger refrigerator. Since the business doesn't make enough to pay for one out of its cash flow, he'd have to borrow money. In and of itself that isn't a bad thing, but it would be important to monitor how big an impact the new equipment and new debt is making on the sales and earnings. Big spending projects, especially those that involve adding debt, should be watched closely.

All of these are extremely simple to monitor in public companies, just by reading the most recent quarterly report. The mainstream press rapidly reports earnings and sales, but rarely digs much deaper. But simple danger signs like this can warn of trouble a quarter or two in advance. I plan to go over all the companies I directly own to see what signs or trouble they might have.

Wednesday, February 09, 2005

Why Google isn't worried about Microsoft

I was look for information about the Blaster worm and I found a link labeled: What You Should Know About the Blaster Worm and Its Variants. Google says that there are 248 links to that page. But if you follow it, you read, "We’re sorry, but there is no Web page that matches your entry. It is possible you typed the address incorrectly, or the page may no longer exist."

I found that the correct link is, which is only different in the extension. When you search Google for "What You Should Know About the Blaster Worm and Its Variants", the third entry is a Microsoft page that has the correct link. On MSN, the bad link is listed first.

Why did Microsoft decide to move things around like that? If this were the only example, I'd assume it was an oversight or something. But as long as I can remember, the Microsoft website has been "a maze of twisty little passages, all alike." Ultimately it says to me that Microsoft still doesn't understand the Internet and probably never will.

Why I bought Select Comfort

For our first bed, Joy and I bought a expanded queen Sleep Number mattress and foundation from Select Comfort. I think you can guess where I'm headed. Our bed has performed flawlessly. My sleep number is 55 (0 is the softest and 100 is the firmest) and Joy's is about 35, we never would have found a conventional mattress that would have worked for us. When Joy was pregnant, she could adjust so that she had good support, but still be comfortable. I sometimes have a sore neck, but it goes away if I make my side a bit more firm. (I set it softer if I have sore shoulder muscles.)

At the time, I looked into buying Select Comfort stock for my portfolio. Peter Lynch talks about how much effort people go to buying things like pantyhose, microwaves and cars, yet they throw money at companies they don't understand or research. He suggests people would be better off buying shares of the companies that make the products they buy. If I had followed that advice, I would have had a four-bagger or more. But I was worried about both our bed and the company. Now I feel pretty comfortable about both.

At the time, Select Comfort was a "penny stock", which hovered around $5. It also was owned in large part by a St. Paul Venture Capital that had bought the bed maker and turned it around. Eventually it would want to cash out, and I wasn't comfortable with what it might do to shareholder value. In fact, in May 2003 Select Comfort had a secondary offering at $13 a share which diluted shares significantly. (Oddly it didn't hurt the price of those shares. I suspect that I wasn't the only one waiting to see what the "exit strategy" would be.)

Meanwhile, I heard that one of my cousins had bought a Select Comfort bed that he replaced a little while later. I don't know the details, but it made me wonder if getting an air bed was really such a good idea. Traditional mattresses, whatever their weaknesses, just seem more "solid" than air-, water-, and foam-filled mattresses.

Time corrected my view of these factors. My bed works great and I don't see why other people won't have the same sort of experience. I think the VC has done most of its damage. (Though in fairness, it really did turn a failing company around.) At the same time, Select Comfort's remarkable advantages are becoming more clear. It control's most of its distribution channels, it avoids holding much finished inventory by direct shipping products to the customer, and it has a unique and growing brand name. Unlike its department store and showroom competitors, Select Comfort needs only a little mall storefront to demonstrate a handful of models. On average each locatation generates over a million dollars in revenue per year. I recently noticed their logo on the Extreme Home Makeover TV show.

I bought Select Comfort on Feb. 9, 2005 at $19.95 a share.

Thursday, February 03, 2005


I reran my fund screen for the options in my 401(k) at the beginning of the year:

 					Non-Load Adjusted Returns
Investment Name                         1 Yr	3 Yr	5 Yr	10 Yr	LOF
---------------                         ------  ------  ------  ------  ------
Excelsior Value & Restructuring Class I	19.68%	--	--	--	32.86%
Fidelity Equity-Income Fund		11.29%	6.21%	4.31%	11.94%	13.19%
First Eagle Overseas Inst CL		22.10%	24.97%	16.88%	--	16.78%
T. Rowe Price Small Cap Stock SHS	18.77%	10.48%	10.91%	14.51%	13.74%
Vanguard PRIMECAP Fund Admiral Class	18.47%	7.28%	--	--	9.51%

S&P 500® Index Fund			10.86%	3.69%	-2.12%	12.09%	13.30%
Raytheon Stock Fund			31.78%	8.68%	10.83%	4.11%	8.81%

There aren't 10 year returns on some of these funds because they've added fund "classes" which merely change the fee structure. In each case, the expenses have gone down, so I'm not complaining. All of these funds (except the Raytheon fund) have long-tenured managers. Here is the performance (from Morningstar) of the base funds:

Excelsior Value & Restructuring		15.84%	10.86%	6.42%	17.33%	--
First Eagle Overseas 			20.90%	24.88%	17.02%	14.74%	--
Vanguard PRIMECAP Fund 			10.08%	6.24%	0.89%	15.24%	--

In an ideal world, I could just pick the best fund (probably the Value & Restructuring Fund), put all my savings in it and forget about it until I'm nearing retirement. The problem with that idea is that it is risky. Of all the funds listed, the safest is the S&P 500 index fund. It has the lowest fees, turnover, volatility, and the longest management tenure. The only major risk it has is market risk. If there is a catastrophe (either financial, like the 1987 crash, or not, such as the September 11 attacks), the fund would lose money. Of course, all the rest of the funds would probably lose money too. On the downside, the index fund has a lower return than the other options.

Probably the highest risk (and certainly for me) is the Raytheon stock fund, since it only invests in one company. Everyone who invested in Enron (especially in Enron 401(k) plans) knows how this is risky. Of course, there is a potential for disproportionate returns. An individual company might find ingenious new ways to make or to lose money. Or in Enron's case both.

Mutual funds only need to hold about a dozen uncorrelated stocks in order to eliminate the risk of owning too few stocks. (Most own many more.) But fund holdings are always related in some way or another. A small cap fund could do poorly in years when small companies in general are doing poorly. Or a fund could make a series of disastrous decisions. Or it could defraud its shareholders. Or it could slip into mediocrity. In any case, it doesn't hurt to spread your bets if you think you have several good options.

The upshot of this is that after years of being invested mostly in the S&P 500 Index, I'm going to add First Eagle Overseas and Vanguard Primecap to my 401(k).

Tuesday, February 01, 2005

Privately-held companies

One of the annoying things about investing is finding good-looking companies that are privately-held or otherwise unavailable for investing:

It can be difficult to find out who owns these companies, but the best place to start is Hoovers, which is owned by Dun & Bradstreet. Of course there is no way to know if these companies would actually make good investments. For instance, I was pretty excited about Google until I saw how much people paid in the IPO. Build-A-Bear Workshop looked pretty good until just before it went public and had to release it's finances. But these private companies look like solid businesses that could be very profitable to own.

I've done business with all of the companies listed in one way or another, and they all impress me. Except Ikea and Lego, they started in Los Angeles. I feel like I would have an edge when it comes to evaluating them. Mostlikely, few of these companies will go public, but I'm ready for them!