The Economist Who Made Your World Better

 
The Economist Who Made Your World Better

IPO Excitement

Great Name, Good Stock

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It's easy to give economists a hard time.  Like academics, it's hard to figure out what they really do besides sit around and think about the economy.  They don't run businesses or make anything useful.  Of course most big corporations have one on the payroll to look into the crystal ball and we all know that we need a few tame economists to deliver stern warnings during market bubbles and to run the Fed.  But can you name a single thing that an economist has ever done that actually benefits you?

(I'm going to lay off the potential downside of economic thinking, including Karl Marx.  I'm also not going to touch Fischer Black and Myron Scholes, the guys who figured out the formula used to price options.  Even though their 1973 work paved the way for the leveraging and hedging excesses that caused the markets to cough up a hair-ball last year, I think they've paid their debt to society.)  

But I do have an unsung hero-economist to tell you about, and if you've taken a flight on a major airline in the past 30 years, you've reaped the rewards of this man's work.

The guy is Julian Simon, an economist who took his PhD at the University of Chicago and made many of his biggest contributions to the study of economics as a professor at the University of Illinois at Urbana-Champaign.

If you're beyond a certain age, you may remember that having an airline ticket and getting bumped off an airline flight--which airlines used to do without offering any compensation--was a rage-inducing catastrophe.

Because flying with empty seats was a huge money loser, airlines routinely sold more tickets than they had seats.  They saw overbooking their flights as the only possible solution to the problem of no-shows, and when more people than expected showed up, down came the ax.

Simon's big idea was that airlines should essentially auction off the option of being bumped voluntarily.  By offering an increasing amount of money to the volunteer bumpees, airlines could keep both full flights and satisfied customers.

It took a long time for this new system to catch on.  Simon had the idea in the late 1960s and finally got it adopted in 1979 as part of the Carter administration's deregulation of the airline industry.  

The power of a good economic idea isn't always obvious in the short term.  But the "get paid to get bumped" idea allowed airlines to run fuller flights, make more profits, pay more taxes and have people happy to get bumped.  One economist has estimated that the switch to this system has contributed $100 billion to the U.S. economy over the years.

Simon is an interesting figure in his own right, although his insistence on having actual data to support policies made him unpopular at times.  But he's a great illustration of the power of a good idea and a shining example of an economist who made a difference.

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It's always exciting when a new stock comes public.  Well, maybe "exciting" is a little too strong a word, lets just say that it's interesting.  

When the mood of the markets turns bearish and the global economy is going over a cliff, initial public offerings dry up quickly.  After all, nobody wants to put a big chunk of their company up for sale when buyers are running for the safety of government bonds.

One of the bigger stories this week for those of us who follow emerging markets stocks is the public offering of Shanda Games (GAME), the new, wholly owned subsidiary of Shanda Interactive (SNDA).

Shanda Games' parent company is following the lead of Sohu.com (SOHU), a Chinese Internet portal that spun off its game division as Changyou.com (CYOU) earlier this year.  

Shanda Games will represent more than 90% of its parent company's revenue, but Shanda Interactive will still own a major chunk of Shanda Games.  

IPOs have a reputation for offering huge gains for those who are granted a chunk of the stock at the open.  The really big money is often made by those who own the stock at the stated IPO price at the market open, then sell later that same day as excited speculators try to buy in.  

It's not unusual for a stock to jump by big multiples in one day.  As an example, VA Software (LNUX) came public at 30 near the tail end of the Internet Bubble.  By the end of the day the stock was up 698%!  (Once the Bubble collapsed LNUX was back below 30 within a year, and today SourceForge (LNUX) can be bought for a buck thirty and change.  How the mighty are fallen.)

Cabot doesn't recommend playing IPOs, and neither do I.  This is mostly because IPOs are pushed around by forces that have nothing to do with either fundamental or technical factors.  You can make big money if you're 1) nimble and 2) lucky.  But most people don't.

I asked my online broker whether it would be possible to buy a small chunk of GAME before its actual IPO and was told that I'd have to be prepared to put up at least $50,000 and have a total market position of at least twice that.  

The classic IPO story is of the pros getting in early and then cashing in as the amateurs start throwing their money at the new issue.  Not really my style.

(If you do take a flyer on GAME, let me know how you do.)

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Every investment choice is a compromise.  Either you accept high risks in the hope of high gains, or you dial back your expectations and accept relatively small returns in exchange for increased safety.  

I don't think there are any exceptions to this rule.  None.  And if there were, I'm betting that the SEC would probably want to have a nice, long chat with whoever found it.

So my idea for today's stock is a bit of a compromise.  It isn't the hottest Chinese stock on the market.  But neither is it a boring Red Chip stock that you have to hold for years to get a good return.  

The company is Mindray Medical (MR), which surely has one of the best company names ever.  This Chinese manufacturer of medical devices started out in 1991, making knock-offs of ultrasound and other medical imaging machines.  It took 10 years, but the company concentrated on R&D, and kept finding small, patentable improvements to existing technologies.  

It used to be that the only markets for Mindray's machines were the smaller regional and local hospitals and clinics around China.  But the gradual improvements in both quality control and design coupled with inexpensive Chinese labor soon made the company's devices attractive to international customers.  

Today, China accounts for just 43% of Mindray's revenue, with the U.S. contributing 16%, and 41% coming from the rest of the world.

Patient monitoring and life support systems are the biggest product line, bringing in nearly half of the company's sales.  Imaging systems and in-vitro diagnostic products each contribute about a quarter.

Mindray is a great example of a well-run company that has raised itself out of the low-quality, low end of the medical device market.  By spending the money to create intellectual capital, the company has broadened its market.  Q2 results showed a gain of 10% in both revenues and earnings, and the recovering global economy will likely bring back the much bigger gains that characterized 2007 and 2008.

The chart for MR shows an attractive six-week base at 31 and signs of a breakout in recent days.  

Sincerely,

Paul Goodwin
For Cabot Wealth Advisory

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Paul Goodwin can be found on Google Plus.

Stock Picks

Tesla Motors

If Tesla ever begins to cut back on development and innovation costs, earnings will soar.

Alibaba

China seems to be raising up its very own version of Amazon in Alibaba (BABA.

Facebook

Roy Ward uses the PEG ratio to determine if the stock is undervalued or overvalued.

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