Most of you are probably looking at stocks and thinking about moving averages, technical analysis, and probably running some scanner application to find the latest and greatest stock to invest in. Maybe some of you will use fundamental analysis to figure out what the cash flow or earnings per share is. Regardless of what kind of investor you are you will use some kind of indicator.

In the technical analysis or fundamental analysis world there are literally oodles and oodles of indicators. Yet if you thought about it the indicators digest the same data over and over again in different manners.

I’ll discuss why traditional technical indicators and fundamentals can be misleading. Then I’ll give you two macro-economic indicators I’ve been using lately: In-house software, and Remanufacturing.

Out of with the Old
Let me illustrate a common problem with TA. You have the indicators: simple moving average, exponential moving average, and weighted moving average. Each moving average has its strength and weaknesses, but each uses the same abstract mathematics of calculating the average price over a period of time. Some will assume that if two moving average indicators point to a buy then it must be a buy. The problem is that you are creating a biased answer because the calculations are based on the same data. What you need to do is diversify your calculations and figure out what the data actually means. All too often I see people using this and that indicator in the hopes of gaining an edge. Yet my question is are you truly understanding what the data is telling you?

Fundamentals to the Rescue? Maybe Not
When I determine to invest in a company I look at two things; Macro-Economics, and Technical Analysis. I don’t look too hard at fundamentals because fundamentals are extremely misleading. The problem with fundamentals is that if you have a great company with great record of making money the stock can still drop like a rock because the overall sector is in a tailwind.

Imagine the year is 1910, and the car has been introduced. The car industry is still small in comparison to the horse buggy business. Let’s say that company AAA makes the best darn buggies there are. Do you invest in the buggy company AAA? After all it is a great company with great results. Of course you would say no because the car has been invented and even though company AAA might be the last remaining buggy company its fate is sealed. Take a moment and think about how you made your decision. You used macro type indicators. Macro-indicators are powerful because they can point to where things are going. When a sector is booming even “idiot” companies will have an increasing stock price (Remember the talking sock in the late 90’s)!

New Indicator #1: In-house Software
In-house software is software that is developed by the company itself. In-house software means to create a project team, hire developers, and write software. This way of building software has been on the decline because it is perceived as being inefficient, and wasteful. Yet this way of building software can actually be an advantage. My wife sent me a link to a study carried out in Switzerland. If you happen to read German, then read away, but if you cannot read German then let me tell give you a link to the original study which happens to be in English. Following are the highlights of the study:

  • Economies of scale only work to a certain level. In the study the economies of scale in the banking sector only worked to a 1,000 employees. If the bank had more employees then the problems associated with internal processes cancelled out any benefits of economies of scale.
  • Internally developed software worked better than off the shelf made software. The banks that developed their own software and then administrated it did the best in contrast to banks that bought off the shelf and managed that software.

Many of you readers are probably software developers who have been devasted by this drive to out-source. All I can say is that it is part of globalization, and that things will get better. For example, the Japanese car makers did destroy the American car makers, yet the Japanese are building car plants in America, and selling American made cars to Americans. The study does not say if those companies that are successfully building and managing their own software use techniques like agile, and focusing on building software that solves a business purpose.

This study seems to say that those companies that have a functional IT department will beat those companies that have a functional IT department and buy software externally. And it means that we should always be wary if larger companies merger and say, “economies of scale will bring about synergies.”

From an investor perspective it would seem that smaller companies that have a functioning IT department could be potentially explosive in terms of share value. I say potentially explosive because these companies can use IT to serve their customer in unique and innovative ways that their competitors cannot.

If I may point out a simple example; Google Search, and Microsoft Search. Google initially a small and fully functional IT company focused on doing search right. Microsoft a large company which has too much overhead to realize any projects needs billions of dollars. Now I worry that Google is too big and becoming dysfunctional like Microsoft.

New Indicator #2: Remanufacturing and Sustainable Manufacturing
Consumption is good, but too much consumption and you have problems. The name of the game is sustained consumption. For a bit of history, did you know Bismarck invested in trees because he thought it was the best value investment for his money. The traditional thinking best value for your money is a fixed income product like bonds. Though Bismarck understood bonds, and fixed income products, and you can say what you want about Bismarck he was a visionary and understood economic policies. So why did he invest in trees? His thinking was that trees is better than money in the bank because regardless of economic times people will always need wood. And if people need less wood then the trees will grow bigger getting a better return. Bismarck lived until 1898 and if you calculated his return since then using trees it showed that Bismarck was indeed very intelligent. Since 1898 there have been wars and depressions which would have devastated any value or stock investment.

What I want to illustrate is that sustained production is the key to a good value based investment, not a traditional fixed income product. One way of implementing sustained production is remanufacturing, which is the act of taking back a product and rebuilding it. Some readers might have encountered remanufacturing as a computer that has been refurbished. You might think that refurbishing or remanufacturing is no big deal and any corporation could do it if they wanted to. Yet that is not true. To design a product for refurbishing or remanufacturing means to add in extra safety factors. In the case of Caterpillar who has an active remanufacturing program, it means designing an engine block with an extra centimeter of thickness.

Refurbishing and remanufacturing makes quite a bit of economic sense, even though the products are more expensive. I used to work in a machine shop because my father who was an old time German engineer believed that all mechanical engineers need to work on the floor. As I was studying in the US and Canada it was odd to see a University student working the floor.When I started working on the floor everything was still very mechanical, eg lathes were controlled by hand. When I finished my degree everything became computerized. Even though there was a lathe sitting in the corner of a shop floor, a machinist did not control the machine. The machinist controlled a computer that controlled the machine. The resulting change was massive in that machinists who controlled a single machine would control three to four computer controlled machines.

The ramification of the shift is that lathes, mills, grinders, etc became extremely expensive. Companies that buy computer controlled machinist machines need to run them 24×7. And this is where the discussion comes full circle. To have a machine be able to run 24×7 it has be to extremely well designed, well built, and very often is remanufactured.

Sustained manufacturing in the form of remanufacturing or refurbishments have the following advantages:

  • Product has to be higher quality and designed for robust use as said product might have two or three lifetimes.
  • Simpler designs are used so that remanufacturing is as cheap as possible.
  • Simpler designs mean less warranty issues meaning less recalls and higher profits for the company.
  • A product that can be refurbished or remanufactured has a perception of higher quality because you know the product has to last.
  • A company that remanufacturers or refurbishes has secondary income stream and increased customer loyality, even if some products turn out to be faulty.

Companies that offer sustained manufacturing are not growth companies, but value companies. Sustained production companies are the companies that customers stick to through thick or thin. And when times are tough eventually the company makes it. Following is a list of sustained manufacturing examples with great stock stories:

  • Tools for craftspeople (eg mechanics) with an example being “Snap-On” (SNA) which has an extremely loyal customer base. In the long term view you would have done ok with Snap-On. When looking at SNA remember that 1996 the stock split 3 for 2, which would have meant even with the economic downturn you still would have done well. Had you invested in SnapOn in 1985 you would have earned 14% yearly return year for year (incl the dot net bubble years), which is a great return. Additionally SnapOn gives out what seems to be a yearly 4% dividend. So overall your return with SnapOn would have been about 18%, which for a value stock is incredible.
  • Construction equipment that specializes in sustained resource harvesting with an example being Caterpillar (CAT). Caterpillar is now a bit pricey, but had you invested in the long term you would have done very well. Had you invested in Caterpiller in 1985 you would have earned 26% yearly return year for year (incl the dot net bubble years), which again is a great return. Caterpillar also gives a dividend, but not as high and more in the 3% percent per range. Thus your overal return on Caterpillar would have been about 30%, which is fantastic for a value stock.

These two examples are traditional examples that would have been great investments in the 80’s, and now are ok investments. Let me tell you about some sectors that could be growth and value at the same time.

  • Car tuners which give a client the ability to tune their car. If you don’t quite understand, think MTV’s Pimp My Ride. In the MTV show they take beat up junk cars and make them into super hero cars. That industry is young from the perspective of stock’s, but growing rapidly.
  • Computer tuners which give you the ability to customize the appearance of your computer. Please don’t confuse this with accessories. There are computer tuners that give you the ability to swap mother boards and parts. The idea is that you keep their parts and swap in new parts. Accessories on the other hand make your computer look great, but you will throw them out.
  • Free-time excercise gear with an example being bikes. Many individuals buy a bike and then “Pimp it”, and when they buy the next bike they will keep the previously bought gear. In the bike industry this is new and still fragile because it assumes that parts are interchangeable, which again is new.

With these examples you should get a picture of where I am guiding you. Find your own, and if you found an example leave me a comment or send me an email at christian {at}