President Lincoln enacted the first taxes in 1862 to pay for the civil war. The lowest tax bracket was 3%, while the highest was 5%. It was later repealed in 1872 until 1894 when it reintroduced again.

In 1913, the highest tax bracket was 7%.

In 1945, the highest tax bracket was a whopping 94%. Why do politicians love other peoples money?

Click on the graphic to make it larger.

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“I think it’s over-valued”, I told him.

“I don’t care. I just want to invest in Facebook. It’s a great company. It’s growing”.

“Yeah, but it’s over-valued”, I argued. “You should go work for them. But don’t buy the stock”.

“I think it will do well”, was his reply. “It’s profitable”.

“Do you know how much it’s worth?”, I countered.

“I think its worth $100 Billion”.

“No, that’s the IPO price. What’s it’s worth? What’s the revenue and profit?”

“I don’t know. And I don’t care”, he admitted.

Apparently my friend is so enamored with Facebook that he’s willing to pay any price to own the stock.

It’s widely believed that Facebook will be offered at a valuation of $100 Billion. With about $3.7 billion in sales and $1 billion in net income, it’s a bit to pricey for me.

The fact that it’s being offered at 30 times sales and 100 times earnings is not relevant to my friend’s decision.

Like most people, he doesn’t even understand what it means when a company sells for a 100 times earnings.

Suppose you were going to buy a sandwich shop. You paid $100,000 to own it outright. At the end of the year, the manager sent you a check for your share of the profits — and it was a only $1,000. Would you invest in that sandwich shop? Well, that’s just like investing in a company like Facebook.

Ah, but what about growth? Surely there’s a lot of growth considering that the whole world will eventually be using FB, right?

Well let’s take a look at that.

Assuming the company has 800 million users, their per customer revenue is about $4.65, with a net income of $1.25.

And let’s assume that even if every person in Asia joins in, they’ll have 5 times the customers.

But these customers only have 1/10th the spending power as Americans. But I’ll be generous and say they have 1/5th the spending power.

So basically, FB’s user base will surpass 5 billion, while their net income will only double to $2 billion. In which case their PE will be 50 instead of a 100. It’s still way too expensive! Using the sandwich shop analogy, you’d now get a check for $2,000!

If it was going public at a $10 billion market cap and paying at least a 1% dividend, I think I might be interested.  But as someone already said, Facebook already went public – only you weren’t invited!

What about your friends? Are they falling over themselves to get in on the FB IPO?

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Studies have proven that investment returns are largely due to asset allocation and not individual stock selection. Needless to say, I was quite excited to get them.

One of them called Frontiers of Modern Asset Allocationand looked like a finance textbook I studied in business school, complete with graphs and equations. (And a hefty price tag).

The other one, called The Flexible Investing Playbook: Asset Allocation Strategies for Long-Term Success, seemed like an easier read. So I decided to tackle that one first.

The book was an easy read. Maybe, a bit too easy!

The author, Robert Isbitts – an investment advisor, spent the first half of the book talking about the big market crash of 2008, and had interesting stories about investors getting caught up in the excitement of investing. He also talked about the various ways wall street rips off investors, which was quite good.

The author made several good points about using diverse investments to reduce your risk (ie loss or drawdown) and improve your overall long-term results. He included a comprehensive list of 50 different asset classes.

However, the actual meat of the book (in my opinion) on asset allocation wasn’t as well fleshed out as it could have been. He talked a big talk, offering the Keys to successful asset allocation – simple rules like avoiding the big loss, cutting your losers early, finding the bull market (whether it’s long or short in equities, bonds, or commodities), being flexible, and other pieces of simple advice.

He didn’t however offer easy to implement instructions on these rules. For example, an instruction like selling any investments that’s declined 20% from your purchase price, or maybe has dropped below its 200-day moving average is actionable. Just as simple, but easy to implement. That was the part that was missing in the book.

He did, however, offer a chapter on the different portfolios he uses, like Hybrid, Concentrated Equity, And Global Cycle (which is the name he gives his Global Macro fund). While he explained the composition, and various strategies (like Market Neutral, Arbtitrage, Convertible Securities) pretty well, the actual composition and construction of the portfolio was missing. He also didn’t offer any information on their recent returns or performance.

You can hardly expect me to invest my money in your strategy without seeing backtested results, or at least past performance. Especially if your strategy wasn’t easy to follow to begin with. I also think that constructing an actively-managed global macro fund shouldn’t fall under the purview of asset allocation – at least not for the type of investor he’s targeting in this book. (Although, to be fair, his portfolio management rules of such a fund where quite good – but like I said, not exactly relevant).

Maybe the idea wasn’t to get you to understand how to allocate your assets at all! Maybe the author wanted to convince you that’s it’s tricky, and you should hire him to manage your portfolio instead?

Despite it’s flaws, it’s not a bad book. It walks you through a high-level view of asset allocation and explains in detail the various strategies available to investors. Like me, you’ll probably learn (or relearn) a few things, like how to use the R-square when comparing mutual funds or ETFs, and how target-date funds aren’t all they’re trumped up to be.

But if you’re looking for definite advice on how to construct a portfolio in these various asset classes, and when and how often to rebalance, you might need to look elsewhere.

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If the video doesn’t show up, click here.

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Yesterday, the Euro closed below $1.30 – the lowest level all year. And the yield on the 10-year Italian bonds closed above 7%. The last eurozone countries who’s bonds closed at 7% were Greece, Ireland and Portugal.

The market considers these countries to be credit risks. If you have bad credit, you’d pay 30% or more on your credit card. But a sovereign nation has the ability to tax it’s citizens. So the chance for a total loss is remote – which is why it’ll pay a comparatively lower rate.

But even at a low 7%, Italy can’t pay the interest on it’s bonds. At this rate, as more of the debt rolls over at a higher interest rate,  it will eventually have to default on its debts.

The European Central Bank will make some half-hearted effort to bail out Italy and save the Euro. But in the end, the Federal Reserve will have to step in to save Europe. And it will.

The Federal Reserve will print money to buy up Eurozone bonds. This monetizing of debt will eventually result in massive inflation,

Regular readers know I’ve been talking about inflation for a while.

I’ve been moving my assets in to gold coins, silver, and globally-diversified undervalued large cap stocks like Walmart (WMT), Microsoft (MSFT), Cisco (CSCO), Johnson and Johnson (JNJ) and Berkshire Hathaway (BRK-B).

So what else is going to benefit from looming inflation?

Credit card companies like Visa and Mastercard.

These companies provide transaction-processing services. Unlike the banks that issue these credit cards, they bear no risk if the credit card holders default. They’re more like a toll booth on a bridge that collects a fee each time someone drives through.

But unlike the toll booths, which charge a fixed dollar amount, these companies charge a percentage of the transaction amount.

As the amount of money in circulation increases – and the prices of things goes up – they’ll collect more money for doing the same thing. Unlike other service companies, they don’t have to even explicitly increase their fees. Since it’s a percentage, it will automatically adjust upwards.

And if the Euro actually does collapse, travelers to Europe are more likely to use their credit cards for purchases. This is more convenient than exchanging currency at every border.

I looked at four stocks in this sector: Visa (V), Mastercard (MA), Discover Financial Services (DFS) and American Express (AXP).

Visa and Mastercards have significantly greater global appeal and penetration.

And between these two, I liked Mastercard more.

Over the past five years, it’s revenue and free cash flow has been steadily increasing. It’s currently selling for a P/E of 20 and a Price/FCF of 18.27.

As Warren Buffet demonstrated with his purchase of Lubrizol this year, paying 20 times free cash flow is a fair price to pay for a domainant company.

But unlike Lubrizol, Mastercard isn’t the market leader.  It’s second-place to Visa. But Visa’s cashflows have been somewhat erratic, and it’s stock is a bit too pricey.

So Mastercard is little expensive for my taste. I prefer to buy stocks at a discount. It’s on my watchlist – I’ll pick it up if it trades below 15 times FCF.

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