Creating a World Without Poverty: Social Business and the Future of Capitalism - by Muhammad Yunus

I listened to the unabridged audio CDs of Creating a World Without Poverty, in which Muhammad Yunus outlines his ideas for creating a new class of organizations called Social Businesses.  Yunus sees a problem with the current situation where an organization is either not-for-profit, or profit-maximizing.  He claims that those for-profit businesses that claim to also serve social needs will always be at the mercy of profit-demanding shareholders.

He says that what the world needs, is something that fits nicely into our capitalistic society.  He outlines the social business, which is essentially the same as a for profit enterprise, but instead of trying to make a profit, they try to break even.  He tries to make a case for a stock market, and for all business infrastructure to be created for Social Businesses.  Although he doesn't really explain how a stock market would work (maybe more like a bond market?), he really makes a good case for non-profit companies to be more like normal businesses, creating products, marketing them, and being self-sustaining.

The book outlines Grameen's work with Danone to create Gameen Danone, a social business dedicated to provide better nourishment to poor children.  The book is a little slow, compared to his amazing prior work, Banker to the Poor.  That said, the idea outlined in this book to create Social Businesses is one that will probably significantly change the world.  Just imagine if one suggestion he mentions in the book happened:  If Warren Buffett spent some of his money he plans on donating, and obviously his wealth of knowledge in the insurance industry, to establish a Social Business to provide health care to the millions of Americans who don't have any.  Good luck Muhammad on promoting your idea.  I'm totally behind it.

Banker to the Poor: Micro-Lending and the Battle Against World Poverty - by Muhammad Yunus

I just finished the unabridged audio version of Banker to the Poor and I highly recommend it.  The book details how in 1983 Yunus established a micro-loan bank devoted to the serving the poorest people in Bangladesh.  Yunus has amazing stories to tell of the history of Bangladesh, including its oppressive culture, the struggles facing the poorest people in the world, and the role of government in his efforts.

He tells about how he realized that many of the poorest people just needed a few cents to get out of their current situation of borrowing from loan sharks, and buying meager amounts of food with any money earned after paying back the loan.  Most of the borrowers at his Grameen bank are women, who otherwise would not be earners for their families.  Yunus found that giving to women helped the state of families much more than giving money to men, who tended to waste the money or spend it on themselves.  Lending to women presented a major challenge in Bangladesh because the women followed the tradition of Purdah, which limited their ability to do business.  He got help from students at the local University where he worked, and started on his quest to convince them to take small loans that would enable them to dramatically improve their economic situation.

Yunus's experience with government has led him to believe that it should be as small as possible, and that non-profit organizations should be the preferred mechanism of helping the poor.  He found that the government was very frequently a hindrance to all the good he wanted to do.  Besides that, he found that the programs that they implement tend to not be targeted exclusively at the poorest, and when that happens, the non-poor tend to maneuver to receive the majority of benefits, and leave nothing for the poor.

I'd like to have seen more statistics, and implementation details, but that's not really the purpose of the book.  Apparently 94% of clients are women, and repayment rates are nearly 100%.  Loans are only given to individuals who've formed a group of 5 people who reinforce re-payment among themselves.

Yunus closes with inspiring thoughts on our real ability to live in a poverty-free world.  He thinks that poverty belongs only in a museum, and that we should all work towards making sure that everyone has enough resources for their basic survival.  He's dissatisfied at the ways in which current aids to the poor are spent, and thinks that a market infrastructure should be built up to aid in finding the best ideas to support the poor.  Again, I highly recommend this insightful and inspirational look at the challenges and amazing results of the Grameen organization.

After working in MSN/Windows Live for nearly 5 years, and Windows Live ID for over 2 years, I've decided to transition to the Xbox console team. 

I've worked with quite a breadth of technologies at Microsoft: On the billing and subscription platform, I worked heavily with SQL databases, and with C# and xml tools.  Then on Windows Live ID, I was able to learn a lot about how to build a performant, scaleable service, and worked on the sign-in page (HTML, JS, CSS, C++), admin services (SOAP, C++), and Delegated Authentication (C#, ASP.NET).  I realized that my passion was around making sure users have great experiences.

One of my favorite books, Good to Great, talks about how when building a business (or following a career), you need to focus on the intersection of 3 circles: What you're passionate about, what you can be the best in the world at, and what you can make a lot of money doing.  As I looked at these three circles, and what they meant for Microsoft, and what they meant for me, I realized that Xbox was the perfect fit.

Today was my first day on the Xbox console team, where I'll be working on the UI and User Experience of the guide and dashboard.  I'm really excited to work on a product I love and that is best in class, and to be able to help make user experiences on the console even better.

Wikinomics - How Mass Collaboration Changes Everything - by Don Tapscott and Anthony Williams

I finished the unabridged audio CD version of this book recently.  In general I agree with the Amazon reviewers that this book covers the topic of collaboration much too superficially.  The book discusses topics such as Wikipedia, open source software (particularly IBM's use of them), InnoCentive, Boeing, and Amazon.

I've grown accustomed to reading more academic books, and particularly economic books which really use a lot of data to back up their conclusions.  This book really doesn't do anything of the sort, but instead seems to assume that since collaboration has worked in several recent cases, it's obviously the wave of the future.  It's not that I disagree with the conclusion, in fact, I agree with it, it's that the authors don't go to any lengths to actually prove the assertion.

I was surprised that the authors essentially dismiss non-open source software and how highly they praise IBM.  I think things are heading the direction of open source, but I would have liked to see a better discussion of the pros and cons.

Regarding Boeing, the authors raved about how much better the new business model is for the 787--how Boeing gets help from its partners to design parts rather than do all the specifications in house.  However, in reality this has led to the worst schedule slip in Boeing's history, and as I understand it, people internally aren't huge fans of the change because of the huge challenge in working with suppliers.  This challenge was not discussed.

The authors also cite EBay's purchase of Skype as proof of the importance of collaboration.  Well, since the book was released, EBay has pretty much admitted that buying Skype was a mistake.

In summary, this book does present some interesting facts that I wasn't aware of, such as Proctor and Gamble outsourcing 30% of the design for new products, or Gold Corp's idea to publish all its data to get people on the internet to help find the best places to dig for gold.  However, the book spends too much time looking at collaboration through rose-colored glasses, and spends too little time on solid evidences and conclusions to warrant a recommendation.  Despite the shortcomings of the book though, I definitely think it's wise to start looking for ways to encourage more collaboration in every business.  Either through accepting more input from outside the company, or just increasing collaboration inside a company.

While I sometimes say that I'd like to start my own business, sometimes it's pretty clear that if I am, I'm not going about it the right way.  After all, Hewlett and Packard started an electronics company without an idea of what products they would create.   I guess I think I could manage a fairly successful small business well, I'm just waiting for the right product to come along.  A successful business needs to fill a specific need in society, not necessarily create a new product, which is what I typically think about when starting a business.  Sometimes I think it'd be fun to own a small paper store, or laundry mat, to see if I really have business management skills.

Another great idea is to take an ok product, with a mediocre process around it, and improve the product and the process.  My friends just created a business around eye patches for kids.  They're making higher quality and more attractive patches, and selling them online and in doctor's offices.  Since they're relatively easy to make, once they really start selling, they'll be able to enlist the help of local teenagers in creating the simple product.  A business that scales at the rate of teenage labor is pretty good.  Not quite the margins of software, but without all the pesky disruptiveness.

We've had some small trials this week.

On Tuesday night, while getting ready for bed, Emma was playing in our house, and fell, catching herself with her hands, and broke her elbow.  Apparenly when kids fall on their hands, they don't break their hands or wrists, they break their elbows.  You couldn't see the fracture in the x-ray, and it must have been small, but they put her in a half-cast and sling anyway.  See pictures on flickr.  The emergency room was recently updated, and pretty nice, but it still took 2 hours from check-in to check-out, and it seemed to be a slow night anyway.

Thursday we had a non-stop flight to Salt Lake from Seattle that happened to arrive just at the same time as a blizzard.  They had us circle a few times, and I think they were going to have us approach to land, but ended up pulling up and diverted to Boise to refuel.  In all that turbulence, Emma, who's typically a great flyer, really started complaining.  We thought it was mostly lack of sleep, but then she threw up all over herself and me. 

We cleaned ourselves off with paper towels, and Emma changed into a clean set of clothes that we had handy.  I frequently get dizzy in flights and cars, and so I had to endure the 2 hour round-trip to Boise feeling terrible.  I was able to get off in Boise and buy a new T-shirt so I didn't stink too much.  We gave Emma some water, which prompted more vomiting, and we finally arrived in Salt Lake about 3 hours late.  FYI: We looked it up, and after vomiting, you shouldn't eat anything for 8 hours, and only have tiny amounts of water if you really need it.

Emma was feeling fine the next day, and is using her arm a lot more now so we'll try taking the cast off tomorrow.

       

This one has Downloadable Content songs:

      

For the complete song listing, check out Wikipedia.

The Long Tail: Why the Future of Business is Selling Less of More - Chris Anderson

I listened to the audio CD of The Long Tail and I recommend it.  I didn't expect too much from the book, after all, the principle seemed obvious:  Now that the internet can be used to sell books, music, and used goods, people are able to buy more niche goods, rather than settle for more mainstream goods.  However, Anderson is able to provide a good amount of analysis, including a history of media and hits, and statistical trends, and I think I actually liked the book more and more as I kept listening.

I thought the chapter entitled The Paradise of Choice was particularly interesting.  He quoted Shwartz's book, and reinterpreted the results of the study.  I haven't read The Paradox of Choice, but I watched the interesting video (1 hr) online, and its premise is that lots of choices make it hard to choose, and leave you less satisfied after you do choose.  Anderson responds that it's not choice that is bad, but unfiltered choice.  Typically we do have filters, even if it's just the amount of shelf space that an item takes up in the grocery store.  Online, there are all types of filters to make our choices better and easier.

I think I'll skip a long summary or critique of the book aside this time (it's always hard when you can't take notes as you listen), and let you check out the Amazon reviews if you're interested.

Irrational Exuberance - Robert Shiller 2005.

I just finished Irrational Exuberance by the Robert Shiller, the Yale Professor of Economics.  In short, the book discusses the recent stock and housing market bubbles, their history and contributing causes.  Since Shiller is a professor, the book is careful about citing each point made, and exploring opposing lines of thought.  The book is fairly dry reading, as Shiller provides significantly more data than precise conclusions about the data.  (Not that I disagree with this decision, it's just dry).

The first edition of this book was published in early 2000, right at the height of the stock market bubble, and was recently expanded in 2005 to cover the housing bubble.  Pretty good timing.  The first 2 chapters cover the recent stock and housing market bubbles, and the subsequent chapters cover the structural, cultural and psychological factors contributing to bubbles.  It concludes with a somewhat critical analysis of Efficient Markets, and a mostly tame Call to Action.

The most important element in Shiller's stock market analysis that I see, is how he uses 10 years of trailing earnings when calculating P/E ratios.  This smoothes out the choppy business cycle, and while his quoted P/E number will always appear higher than others, it is consistent over time.  Unexpected Returns covered the problem with the business cycle thoroughly.  In short, we're at a time of ultra-high margins right now, that makes the P/E ratio rational.  However, once you realize that there's no way that earnings will be able to increase at a high rate from here, and typically they'll fall.  It's worth it as an aside to note that the Beyond the Horizon article at Crestmont Research was recently updated with new data, and the following quote: "If profit margins return to the historical average, corporate profits in 2016 will be 10% higher than their lofty levels today. That represents 1% annual growth on average."  In my mind there's no way that profit margins can remain significantly above their historical average for long--competition and politics being probably the 2 most significant reasons.

Anyway, at the time of writing in 2005, the trailing 10 year P/E ratio was 25, which is pretty much where the market was at the top of the bull markets of 1901, 1929, and 1966.  The ratio surpassed 40 in the year 2000.  From a historical earnings perspective, stocks are clearly overpriced.

Regarding housing, he shows his famous chart, which is replicated below from an unknown source, and I've created my own from public government data to compare.  It needs very little explanation of the significance (but the book has a page long footnote describing the methods used).  I'd love to also do the series deflated by average income.

Shiller's data:

Data I collected from govt websites.

Besides his interesting way of looking at the data, I found the psychological chapters pretty interesting.  He cites several studies that "demonstrated that people are ready to believe the majority view or to believe authorities even when they plainly contradict matter-of-fact judgement" (Pg. 159).  He also has an interesting take on the Efficient Market Theory, suggesting that markets have plenty of inefficiencies, but sometimes there's not a clear way for the "smart money" to eliminate such inefficiencies. (Such as Shiller's belief that the market will do poorly over the next 10-20 years).  One good example he proposes relates to people analyzing neighboring restaurants.  The first person sees 2 empty restaurants, and has no basis for making a decision, and randomly chooses one.  The next people who come along will be persuaded by the fact that the one restaurant has a customer, and be more likely to choose it, which is a completely rational decision on their part.  They all may end up eating in the same restaurant, but it wasn't their collective knowledge that came to this agreement, since the subsequent people were essentially acting on misinformation.

What do you think will happen to the green or blue line in the graph going forward?  Are we at a permanently higher level, or are we going to see a massive decline in nominal or real prices?

Check out the fancy meal created by my friend Thayn for Mothers Day.

Below is just the main course.  Check out his blog for details and all of the 8 courses.

Unexpected Returns: Understanding Secular Stock Market Cycles - Ed Easterling

In Unexpected Returns, Ed Easterling takes a look at what drives stock market prices, and what we can expect in the future.  The book proves how stock and bond returns are tied to inflation, and are actually quite predictable long-term.  I recommend the book if you're really into this stuff.  Otherwise, checking out his PDFs on his website would be sufficient.  Ed maintains a comprehensive website at www.crestmontresearch.com, and even publishes an executive summary of his work.  His work revolves around the fact that Price = EPS x P/E, and EPS is predictable, and P/E is related to inflation. 

EPS

He is absolutely convincing that EPS is directly tied to GDP growth, and thus that future EPS is predictable.  This essentially means profit margins remain consistent over time, as shown by actual profits revolving around average profits in the image below.  Profit margins are at an all time high right now, and analysts are predicting that businesses will have an even higher profit margin in 2007.  The free market will not allow this to continue.  New businesses will start in hoards, seeking this high profit margin, which will cause profit margins to decrease due to the competition.

Currently, total S&P 500 EPS is about $82 for 2006, and estimated to be $89 for 2007 (from S&P).  According to historical profit margins (which have been remarkably consistent since 1900), the top line of the following table is what EPS would be:

As you can see, at the end of 2007, EPS is going to be 47% higher than it should be according to historical models.  This is downright SCARY seeing how predictable this has been in the past.   Another way of looking at this is that while today's S&P 500 P/E ratio is 17.74, using the historical model puts it at an expensive 26.  Note that the EPS typically doesn't take too long to significantly undershoot the regression line after rising above it, which means we could see something like 2010 EPS < $70 (not a prediction, just an example).  Also note that there wouldn't have to be a recession for EPS to decline, the E would just have to be shared by more companies, but I don't see how we could have a soft landing from this huge profit margin explosion.

P/E and Inflation

P/E ratios are related to inflation.  The best inflation scenario, is when it is low and stable, like it has been for the last decade or so.  The only time we've had stock market bubbles, and high P/Es, is when inflation is low.  Once inflation goes negative, or high, people lose confidence in stocks, or seek higher or safer returns in bonds, and avoid the market, sending the P/E lower.  The book gives the impression that inflation is going to stray from stability, as it always has.  I'm not convinced, since we've only understood inflation well for the last couple of decades, and we're controlling it very aggressively now.

Random Facts from the book:

P12: Too often investors believe that higher returns are available by simply taking more risk.

Long term interest rates are based on the future expectation of inflation.

P56: The economy and the market often move in different directions.  GDP has been 6.9% in bear markets, and 6.3% in bull markets.

P107: Between 1982 and 1999 earnings grew at 5.9%, dividends returned 3.1%, and P/E expansion caused 8% of market appreciation, for a total of 17%.

P202: The reason why the majority of advisors currently recommend a diversified buy-and-hold strategy is because of how well the market has done for the past 25 years.  The 17% return quoted above has made even advisors not take market risk seriously.

Today we released the alpha of the SDK for using Windows Live ID authentication in your client (non-web) application. Check it out:

https://connect.microsoft.com/site/sitehome.aspx?SiteID=347

I'm actually writing this blog post from the sample app in the SDK. I'm glad we're finally opening up the platform a bit more.

OK, so I had to update the formatting via the web a bit... so you won't be blown away by the sample, but hey, its a start.

An article in the August 2006 edition of AAII Journal (paid subscription), called "Analyzing Your Financial Health Using Personal Financial Ratios," got me thinking about my lifetime plan.  The article talks about three ratios that you should track to gauge your financial health:

• Savings-to-income
• Debt-to-income
• Savings-rate-to-income

The idea is that you start saving when you're 30 years old, and you have a lot of debt, due to a house or whatever, and you have little-to-no savings.  The goal of the model is to have no debt, and 12 times your income in savings when you retire.  The model assumes that the market will have a real return (inflation adjusted) of 5% per year (~2% less than average), and that you can withdraw 5% a year, which should generally last as long as you live.  (More on these assumptions below).

Given these constraints, you need to save 12% of your yearly income.  If you follow this model, you'll have paid off your debt, and you can then retire at age 65 on 60% of your income, with 20% supplemented by Social Security, and since you don't need to save the 12%, you should be fine on 80% of your income. 

The wiggle room you have, is that many of us are able to live on less than 80% of our income if required to, especially once you get housing out of the way.  There's a chance that the stock market will suck, but you can't prepare for everything, and you'll just have to reduce expenses.

Thanks to my investing hobby, I find myself being frugal to be able to have more money to invest, and I'm doing quite well on the savings-to-income and savings-rate-to-income ratios.  My mortgage is too high so I'm over on the debt (according to a table in the article, you should have 1.7 times your income in debt at age 30), but that's ok, because I'm still on track to pay it off by the time I'm 65.

As I was thinking about this, something really, really important hit me.  I realized that I'm on track, given average market returns, to have a good retirement.  Did you notice the big caveat in that sentence?  "Given average market returns."  What happens if the market doesn't achieve average returns?  Sure the 5%/5% above was slightly cautious, but it is also possible that the 5% rate of return / 5% withdrawals is too optimistic, although over 35 years, that would be surprising.  Most of my investing research and education that I've done is me trying to get the highest rate of return possible relative to the market.  Well if I achieve average market returns (7%), I'd be looking at having at somewhat luxurious retirement.  So whether I get 7% or 8% (inflation adjusted), doesn't really matter.  I'd be rich enough.  The most important thing is being protected if things go wrong, which can include poor market returns, or having the right insurance.  I don't have earthquake insurance on my house, but having it would barely reduce my standard of living (~$200 per year), but not having it could surely make me have a retirement well below my current expectations.  It's making me take a closer look at risk, which fortunately, is what the Unexpected Returns book I'm reading is covering, so I'm sure I'll be covering it in the future.

I'm not one to make short term predictions about what I think will happen, because frankly I think that's impossible.  However, I spent some time reading up on various analysts reports online and in Fortune and Business Week, and noticed surprising amount of bullishness for the year ahead; so I thought I'd summarize the points I liked, and define my strategy for the year.  12 of 12 analysts polled by Bloomberg expect a rally next year, and the last time they've done that is in forecasting 2001, which seems odd to me, given the fact that the yield curve was inverted during most of 2000.  Also, Business Week's long list of analysts' had average expectations of about 8% return.  Slightly low, but most of them were positive.  8% is probably the safest number you can pick.  Anytime the consensus is saying buy, and has been for awhile, you'll surely want to get out before they start saying sell, and it's not likely that if stocks do well this year, that many people will be able to be so bullish next year.

Fortune's annual "Investor's Guide" has two really good articles, one where 5 investment strategists are interviewed (video), and another about the high level of corporate profits.  The 5 strategists all pretty much agreed that 2007 is not a year to take a big risks.  They all preferred large cap, blue chip US and global companies.

One of the 5, Abby Chen says that despite the potential economic problems (which I'll get to later), yes "growth will be slower, profit growth will be slower, but the Fed can stay friendly longer, and we will have a longer-lasting economic profit cycle."  However, according to Jeremy Grantham (Chairman of GMO), who was the only one who was very cautious, suggesting a mere 5% annual return was what we should expect over the next 10 years.  (Note that I applaud Fortune for not giving silly 1 year price targets, but having the bulk of the discussion about what the long term looks like, and what short term inefficiencies that investors can take advantage of).  Grantham's explanation of his low expectations: "Basically profit margins.  I've been born and bred on the understanding that capitalism is based on competition bringing down excessive profit margins and allowing depressed margins to rise back.... If they don't go back to trend, it will be the first time in history."

The second Fortune article greatly expands the idea that "corporate profits are at their highest level since 1929," and that reversion to the mean is likely.  The article is very similar to another article I read recently, called Beyond the Horizon, by Crestmont Research.  The image below illustrates what's happening:

Fortune's numbers are slightly different, in that 2004 is at 10.1%, which is the highest ever, and 1929 peaks at 8.9%, but that's not really important.  It's clear that profit margins are cyclical, and while they may continue to be above average for a short time, they will surely fall.  I find it funny that a Banc of America advisor says this: "I think profits can stay at their loft levels as a percentage of GDP."  Apparently because the "flat world" is making companies so efficient.  Looking realistically at the economy, as new technologies arise, such as computers, the internet, and globalization, the companies that employ these technologies effectively are able to work more efficiently, and reduce costs, and increase profit margins.  The higher the profit margins, the more people will decide to start a business, rather than invest in someone else's business.  As profit margins increase, and stock prices along with them, it becomes much more profitable and less risky, to start your own business.  The more businesses, the more margin compression, which will bring the average profit margin down, most likely shooting past average to below average.  It really seems inevitable.  I'm sure I'll have more to say on this later, since I'm starting to read "Unexpected Returns" by the author of Crestmont Research.

Back to the initial Fortune article, other analysts note that it's the 3rd year of the presidential cycle, which typically yields great returns thanks to potential presidential stimulus.  A few extra insights indicate that the US consumer is in trouble, and to avoid companies that cater to the low-middle class, and that because of the likely decline of the dollar, real estate could be attractive in the long term.

Everyone pretty much agreed that risk was underpriced, especially Grantham.  After others mentioned that blue chips are cheap, Grantham said that "it's not that these guys are cheap.  It's that risky things have become extremely expensive.... Lower-quality stocks do exceptionally well when volatility is down, and high-quality stocks do exceptionally well when volatility goes up."  And volatility is really low.

Now for my strategy.  I currently have 25% of my 401K in cash, and have bought PSQ (short QQQQ) in my other accounts as a hedge (I have long-term stock holdings that I'd rather not sell).  I also have increased my 401K allocation to Royce Low Priced Stock, because it's positioned for a below average year with lots of natural resource stocks.  I'm considering going more into cash, I'm just looking for either a further rise, or a signal of a drop to make a move.  I recently heard an advisor say that the fundamentals of the market aren't that good (citing many things mentioned above) but the upward trend is so strong right now, that it's not the time to bet against it.  Tough to argue with that.

To finish off, I thought I'd mention Microsoft, which almost ended the year above $30, and almost beat the S&P 500 for the year.  I stand by my argument that MSFT is spending too much money, and that the stock is overpriced.  Although I guess it's not the high expenses that's really the problem, it's the fact that Xbox, MSN/WL, and Zune aren't producing enough profits.  I'd wager that you'll do better in a money market fund than in MSFT in 2007.