Mutual Finance

Oil price rebounds on Thursday October 5th, 2006 on the news that OPEC will cut 1 Million barrels per day production effective immediately. Saudi Arabia, the largest OPEC oil producer, will reduce its output by 300,000 barrels per day. Will this production cut help oil price? OPEC members certainly hope so.

In the short to medium term, I feel that it is a futile effort. For starters, after a nearly harmless hurricane season over the summer, winter is predicted to be warmer this year. As a result, energy consumption is expected to be less burdening.

Secondly, the US crude distillate stocks rose by 3.3 Million barrels last week. That signals the buildup in inventory which is bearish for oil price going forward. Furthermore, the rise of oil price this past year was accompanied with rising inventory, which is puzzling. Therefore, it is about time that oil price declines, no matter what the inventory figure is. That being said, it will take a lot of declining inventory to help prop up oil price.

Thirdly, the rise of oil price has triggered a new oil exploration that would otherwise will not be funded. This project will bear fruit after five to ten years. It is expected that the first batch of this new project will come online within the next one or two years. To recover the huge capital expenditure, it will be best for this new oil production field to keep producing oil. That will put pressure on oil price further.

Fourth, the federal fund interest rate is at 5.25% versus 1.00% several years ago. This would scale down speculations which we believe has contributed significantly to the rise of oil futures. When you can get 5.25% by doing nothing, you would be inclined to not borrow huge and simply put your money in the bank. Furthermore, the effect of interest rate change is felt 9 to 12 months ahead. The Federal Reserve started lifting its fed fund rate on June 30th 2004, until now. Therefore, the effect of 5.25% interest rate will still be felt around one year from now.

Fifth, housing market in the United States has slowed down considerably. Home builders had reported declining profit expectation in the midst of severe slowdown in some areas. There are some bold predictions that forecast a double digit decline in home price until 2009, however, even the most optimistic forecast still foresees a modest decline in home price. This is a picture of a slowing economy, which will dampen demand for oil.

Sixth, natural gas blown out by Amaranth hedge fund, showed how dangerous speculating in commodity market is. This will temper down speculative bet on oil, natural gas for quite some time. We feel that those speculative bet has helped prop up oil price in recent past. Further, the Amaranth blow out clearly shows that commodity price has many speculative excess that can burst anytime.

Seventh, natural gas price and other energy sources has declined sharply. Energy price will generally go hand in hand. If natural gas price has dropped by more than 60% while oil price dropped merely 25%, it brings us two possibilities. Either natural gas price will rise while oil stays constant, or natural gas price will stay constant while oil price will drop. With the action of OPEC members to hastily cut production immediately, we believe that it is the latter.

Eighth, technologies has helped companies getting smarter in locating oil patch. On September 5th, 2006, Chevron announced that it has successfully discovered oil in deep Gulf waters that boost US’s oil reserve by 50%. Yes, you heard it right. 50% more. While it will need billions of dollars to extract the oil and distribute it, it shows that high price of oil will stimulate more exploration and deep drilling. Therefore, oil price cannot rise indefinitely.

Ninth, OPEC members are as addicted to oil as we are to our SUV. They need the oil money. Who would oversee that OPEC members reallly abide by the production cut? In the past, some OPEC members will ‘cheat’ by overproducing and sell it on the black market. While price has dropped over the last two month, oil price by historical standards is still quite high.

Tenth, one of the culprit for high oil price is China, where it has been gulping up oil for its rapid economic growth. That may be true, but China’s economy has grown in the double digit each year way before oil price gets this high. We believe that the recent commodity sharp rise has anything to do with China hosting the Olympics on 2008. It built up its infrastructure ahead of the game and as 2007 approaches, I believe that the construction is almost complete and commodity demand will slacken in the next year, including oil.

In the long run, as oil is in limited supply, its price should rise. However, in the short to medium term, oil price may have taken a breather due to the ten reasons above. All these forces has made it extremely difficult for us to be in the bullish mode for oil, at least for the next twelve months or so.

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It’s interesting to consider the ways in which the computer and the Internet have changed our lives. Tasks that once required visiting certain locations and interacting with specific people, such as booking a holiday or accessing your bank account can now be performed online. Often when you do go somewhere to talk to an assistant they end up performing the task online in the same way you could have done yourself.

Online banking intrigues me greatly. We’ve almost lost the need for real currency. I get paid by check, which goes straight into my bank account. I then access my bank account using the Internet and transfer some money over to my savings account, which is at a different bank to my regular account. If I ever need money from my savings account I log in and transfer it back to my main account. I have never given any ‘real’ money to this bank, nor have I ever received any from them. The majority of my purchases these days are made using Eftpos. I hardly ever actually have cold, hard, real cash on me. Basically we purchase things with data these days. Numbers flit all over the place, being subtracted and added from one variable to another. Presumably there is still real money somewhere being couriered between banks but I generally never see it. It makes me wonder how long it will be until we actually don’t technically have money.

The stock market similarly intrigues me. I’ve never been involved myself but it seems to me that it’s the professional equivalent of gambling. People take a punt that a certain stock will go up or down, and they either gain or lose money depending on whether or not their bet pans out. What interests me more is the fact that in essence this is an economic reality built around the concept of buying and selling absolutely nothing. What you own are theoretically ‘parts’ of a particular company. Collect enough bits and you could own the company. In actuality you transfer a few numbers that represent money and receive a few numbers that represent stocks. When these numbers become larger numbers you sell them again, and receive in return a few more money numbers. There’s usually no real product or money (that you hold in your hands) seen in any of this process.

We have moral dilemmas now that just didn’t exist in the past. For example, is piracy really stealing? All you take is a copy of data. No one actually loses anything tangible out of the theft. Stealing a handbag means that someone no longer has their handbag. Stealing a car means that someone has to catch the bus for a while. Stealing a computer program means that another copy just ‘magically’ pops into existence and becomes yours. The futuristic super-villains of the past held countries to ransom with real-life weapons of mammoth size, often floating in space. The reality of our modern world is that you could hold a nation to ransom with nothing more ‘real’ than a copy of a few files from a secure computer.

Virtual reality may not have eventuated in the way of realistic virtual worlds, but in a way reality is becoming ‘virtual’. It may not be problematic or even surprising, but I find it interesting that cold, hard cash and cold, hard facts are fast becoming anything but tangible.

Daniel Punch
M6.Net Web Helpers
http://www.m6.net

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Brand name of a product has certain value to a company. How do we value a brand and how does it affect the fair value of a common stock? There is no definite way of doing it since a brand is worth more to some than to other people.

Brand is valued in the balance sheet under ‘Intangible Assets’ or ‘Goodwill’.. Each company values their brand differently but they all agree that brand name has certain value.

What is the best way to value a brand? Nobody knows for sure. One can only give his reasoning and then value the brand accordingly. Here, I will explore the possibility of valuing a brand based on asset value and based on the value of the common stock.

Let’s use a familiar brand name. Coca Cola Company (KO) has one of the most valuable brand in the world under the Coke brand name. How much is it worth? We can go to any grocery stores to verify. Grab a bottle of Coke and a bottle of generic cola. What is the price difference? We can argue that the price difference is due to the Coke brand name. Let’s assume a price difference of 10 cents. Let’s assume that Coke sold 1 Billion bottles of Cokes each year. This implies an additional $ 100 Million due to value of Coke brand. What is the fair value of a brand? Assuming a 7.5% yield (P/E of 13.4), the value of Coke brand is $ 1.34 Billion.

Please note that this is a very rough estimation of brand value . We just assume the same 10 cents product differential everywhere. Coke sells to almost every corner of the world and the price differential is not always 10 cents every time. Furthermore, as you may know, if Coca Cola is not selling that much Coke this year, the value of the brand will drop and vice versa. Therefore, the value of the Coke brand will fluctuate depending on the sales of the product. Supply disruption will result in lower sales. If there is a disruption in supply, which has nothing to do with brand value, the value of the brand will decrease as well.

Should we care about the value of a brand when investing in the stock? Yes and No. Yes, if you are valuing the company on the basis of asset value. If the value of the brand is a significant part of the balance sheet, then you should include it to value the overall net asset of the company. If a stock is traded at $ 10 per share while the net book value with the brand value included is $ 15 per share, then investors might profit by buying the stock at $ 10 per share.

For our version of fair value, valuing a brand name is not necessary. This is because the fair value of a common stock is correlated with the profits generated by the company. What is the brand name of Enron when it cannot produce a profit under this scenario? Zero. In general, we should not care much about the value of a specific brand. All we are trying to do as investors is to buy undervalued investments. We should compare the profit generated by the company with the price of the common stock, not with the value of the brand.

Finding the fair value of a common stock is more important than the fair value of a brand. You can get free investing lesson by visiting http://www.noviceinvesting.com

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