How I Invest Part II

Linear Technology had their Q4 2010 conference call last Wednesday. I have been a Linear investor off and on since 2000. Linear has the best management in semiconductors. I remember in a 2000 conference call, Linear fiscal 2001 Q1, the CFO said, I forget the exact words, but I took what he said to mean the customers were double or triple ordering, and I sold the stock. I didn’t make out like a bandit but I didn’t loose anything either.

I wanted to upload an excel spreasheet which contains the DCF analysis I did for Linear, but unfortunately wordpress does not allow upload of excel files (!)  So, I exported it as a pdf.   dcf_example   If you want the spreadsheet email me and I’ll send it to you.  I promise I won’t put a macro virus on it.  Anyway, DCF of course is the forecast of the future cashflows of an investment (in this case Linear), discounted for the time value of money, in this case: inflation, riskiness of investment.

The first line lists the year. Up to 2010 are actuals and are not used (directly) for the forecast. Below the year is the discount rate. The discount rate here depends on the risk of the investment and the interest ratefor a risk-free (or nearly risk-free) investment.  To the right, in the K column, is the forecast for year 5->infinity.  I put it at 10% because that’s my best guess at this point.

Lines 10-33 look exactly like Linear’s Income Statement.  Or at least they should for 2008 -2010.  For 2011 and beyond, I forecast the numbers.  I think it is best to use this approach because it is easy (when you use a spreadsheet) and you can see if the company is using gimmicks to pad the earnings statement, when you look into the future and try to decide what each line should be.  I picked Linear for this DCF example because its earnings are very consistent and its margins are incredible.  If the gross margins get below 76% they start taking drastic measures to increase profitablity (fire people, shut lines down, reduce salaries and profit sharing).  Linear is very forthright in calls about what their upcoming tax rate will be and what they forecast revenue growth or decline will be for the next quarter.  They are ususally very accurate. 

DCF is the theoretically correct way to value stocks.  I’ve searched around the web and I haven’t seen a good, clear way regular investors do it.  I’ve seen some strange things in the way people do DCF analysis:

  • extrapolating future performance based upon prior performance
  • having the earnings and dividends grow forever — unless this is a utility, and you are only growing the dividend at a very slow rate, do not do this! If a company grows at 15% forever, it will eventually grow its earnings and dividends infinitely.
  • forecasting earnings for 15 years.  Really?  You know what the world will be like 15 years from now?  I think you should pick a more realistic timeframe.  I picked 5 years but you could argue for a different number.

Keep in mind you want to be pessimistic enough that you discount investments that will not pay off for you. 

You can see that I think LLTC is slightly overvalued at current share price. 

This has been a valuable tool for me and since I started using it as a tool to help screen potential investments, I’ve been much more consistent in my returns.  This is not the optimum screener for REITs and utilities.  I’m still working on that.  (time to read Damoradan again)

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Gluten-Free Buckwheat noodles (for Pizzoccheri)

I have not found a good recipe online for making buckwheat noodles without wheat flour added. Annoying! Anyway, here’s my version. It’s very simple

2 cups buckwheat flour (sift to remove buckwheat bran if desired) + more for dusting, adjusting dough
3 eggs
1 tsp xanthan gum

make a mound out of buckwheat flour. Break eggs into flour. Add xanthan gum. Whisk ingredients together. Knead the dough for several minutes. You can speed this up slightly by using a stand mixer with the bread ball attachment. You need to finish by hand though. The dough should not be sticky and should not break apart. If the dough is sticky add some buckwheat flour. After kneading, set ball aside in a bowl for 20 minutes and put a towel over the bowl. Run through pasta maker. The dough should not tear or break apart when run through the maker. Boil for about 3 minutes.

sunset

How to solve the California municipal budget crisis: Outsource

The city of San Carlos is outsourcing its police force to the San Mateo County Sheriff’s Department. San Carlos is a small city with about 28,000 people. At $6.8 million per year, outsourcing police services will save the city $2 Million annually. On its website, the city has notes on its budget. Last year, the police services accounted for approximately 31% of general fund expenses, but will decrease to 25% if the plan goes through. State law prevents the Sheriff’s Department from passing on fee increases to the city except if they relate to costs of patrolling or administering the contract. The city seems to be doing more of the right things, such as creating a second benefit tier for new employees, and winning pay reductions from management employees. Cities in California should look to San Carlos’ example and outsource city services wherever possible.

Interesting article on Chinese workers in 2010

NY Times has an interesting article on the shift in motivation, education, and ambitions of China’s factory workers. Two years ago, a factory with unskilled laborers doing piecework would be pay its employees approximately $5.50 per day. (source: personal conversation with factory manager). Today, her salary would be about $10 per day. Three years ago, factory workers built but had no idea* what it was they were working on exactly. It looks like with the new generation of Chinese factory worker, that that has changed. Quite a change in a few years.

*Bunnie Huang has an excellent blog

bought an SSD drive

I bought an 80GB Intel X25-M Solid State Drive (SSD). Microcenter had a special where the Apricorn clone tool with EZ Gig II disk imaging software was included with the purchase. The problem is that EZ Gig II does not allow you to image the HDD if it is larger than the SSD, which is almost guaranteed to be the case. I re-installed the OS (which goes surprisingly quick) and all of my software (most of which is freeware except Lightroom, which I bought). Anyway, once I got it installed, I ran Crystal Disk Mark:

CrystalDiskMark 3.0 x64 (C) 2007-2010 hiyohiyo
Crystal Dew World : http://crystalmark.info/
———————————————————————–
* MB/s = 1,000,000 byte/s [SATA/300 = 300,000,000 byte/s]

Sequential Read : 179.443 MB/s
Sequential Write : 82.494 MB/s
Random Read 512KB : 137.902 MB/s
Random Write 512KB : 82.524 MB/s
Random Read 4KB (QD=1) : 11.492 MB/s [ 2805.6 IOPS]
Random Write 4KB (QD=1) : 17.018 MB/s [ 4154.8 IOPS]
Random Read 4KB (QD=32) : 13.399 MB/s [ 3271.4 IOPS]
Random Write 4KB (QD=32) : 36.552 MB/s [ 8923.8 IOPS]

Test : 1000 MB [G: 1.0% (0.7/74.5 GB)] (x5)
Date : 2010/07/11 2:37:11
OS : Windows Vista Business Edition SP2 [6.0 Build 6002] (x64)

The write numbers are in the ballpark but the read numbers are a little low. It probably has to do with the AMD 780G rev. 00 Northbridge in my mobo.
The Intel drives are not the fastest with writes but are quite fast with reads, which I think is most important with OS and application images, so it’s kind of a bummer that it’s a little slow. Even still, applications launch instantaneously now (even Lightroom).

Special Purpose Hardware for the Web

Ashlee Vance wrote an interesting article, Big Web Operations Turn to Tiny Chips describing some new startups using netbook chips as the CPU in webservers. SeaMicro virtualizes the I/O. Several companies have have designed I/O virtualization producs such as Xsigo Systems, Next IO, and Vertensys but these products are top of rack. SeaMicro points out that only 1/3 of the total power consumption of a server is used by the CPU. Virtualization of I/O will help with that. SeaMicro stuffs 512 1.6GHz Atom z530 chips in a 10u chassis.

A search of the careers on their website indicates they are targeting running nginx or apache webservers with MySql. I wonder what 10 systems each with 10 gig Ethernet, solid state storage and dual sockets populated with AMD Phenom II X6 1090T CPUs which have a passmark of 6,527 would compare to SeaMicro’s 512 z530s with a passmark of 299 with 64 gigabit ethernet ports. It will be interesting to see the benchmarks.