The Critical Difference Between Intelligence and Noise

By Andy Obermueller Wednesday, June 02, 2010

In this market, or any other, for that matter, investors will primarily find two and only two things to help them as they consider their investing options: Intelligence and noise.

The best definition I could find for intelligence was "discrete information with currency and relevance, and the abstraction, evaluation, and understanding of such information for its accuracy and value."

Everything else?

It's noise.

Sometimes it gets harder and harder to tell the two apart.

Consider carbon ratings. I've never paid much attention to them, but a lot of companies have them these days, including 29 out of the 30 companies that make up the Dow Jones Industrial Average. Google Finance began making the data available in mid-April. The ratings are determined by disclosures made to the Carbon Disclosure Project, which, according to its website, holds "the largest database of primary corporate climate change information in the world." It has grown tenfold since it first began asking companies about their emissions in 2003.

Clearly this can be considered important information. After all, H.R. 2454, the Waxman-Markey proposal known popularly as the "cap-and-trade" bill, would offer carrots to clean companies and sticks to dirtier ones. The bill would require companies to license their emissions, paying a certain amount per ton of emitted carbon dioxide.

If it gets passed, that is. The bill has actually morphed in the past months from the original text written by Congressmen Edward Markey of Massachusetts and Henry Waxman of California, which was passed by the House in July 2009, and has since been revamped by Senators Joe Lieberman, Lindsey Graham and John Kerry.  Its future is unclear. 

The new version of the bill mandates limits on greenhouse-gas emissions in several industries, with a 2020 goal of reducing emissions to 17% below 2005 levels with an 80% decrease by 2050. Most industries would see the rules take effect in 2016, but utilities would see regulation in 2012. The price tag per ton of emitted carbon? Twelve bucks.

From a microeconomic standpoint, twelve bucks isn't very high on anyone's radar. But writ large it presents a serious chunk of change. It's an undisputed fact that the United States emits some 5.7 billion metric tons of CO₂ a year. If half comes from cars and half comes from industry -- a good breakdown -- then this legislation's new "tax" would add $34.2 billion in costs to American business. That's roughly equivalent to twice the combined annual profit of Google and Apple -- from just one country, and not even the world's largest carbon emitter, either.

Well-meaning people, of course, can debate global warming ad infinitum.  The only worthwhile question for investors, whether they mean well or just want to make a few bucks, is whether these carbon disclosure ratings are intelligence or noise.

The data speaks for itself. I examined 29 of the 30 companies that make up the Dow [(Caterpillar (NYSE: CAT)] does not disclose its information). So far this year, the Dow overall is down -1.7%. Twelve companies are either unchanged or in the plus column, 18 have lost ground.

The biggest winner is The Boeing Co. (NYSE: BA) -- rated an 87 out of 100 on the Carbon scale -- with an +18% year-to-date performance. No. 2 was The Home Depot (NYSE: HD), which has the lowest Carbon Disclosure rating in the Dow but returned +16.4%.

If you divide the blue-chip index into quintiles, the best performing bloc of companies, with an average gain of +10.8%, had the lowest average carbon rating, at 51.3 out of 100. This highest carbon rating, an average 78.2, was the middle quintile, which generated an average -3.4% loss, a showing worse than the overall index.



As far as Carbon Disclosure ratings are concerned, my vote is that they're noise. The reporting system is unregulated and voluntary. Serious managers will deal with cap-and-trade adroitly and in a timely way when they need to. These dynamic companies are the crème de la crème of Corporate America. They can adapt. 

I used intelligence to pick Boeing, the top performer in the Dow, for my Government-Driven Investing portfolio. It has returned 34% since I added in September. I didn't know that it had one of the highest carbon ratings in the Dow, but I did know that half of its business, commercial aviation, was getting great assistance from the U.S. Import-Export Bank, an almost totally unheard of government agency that helps arrange the financing of major U.S. exports like aircraft. The rest of its revenue comes from defense projects, both from the United States and her allies. The world gets smaller every day and the hot spots continue to add to global tensions. That means wealthy countries want to protect what they have and developing countries want to protect what they're building. Both of these business segments are producing strong results that have led Boeing to the top of the Dow.

Boeing CEO Jim McNerney deserves some credit, but I based my call on a much stronger factor: The U.S. federal government. Uncle Sam supports all of Boeing's business, in good times and bad.

During the recession, for example, it was government employees who were inking big orders for Boeing, not just Boeing salesmen. When credit dried up and financing was tight, the Import-Export Bank stepped in to guarantee loans. Banks don't mind lending to even the riskiest customers if they have a strong cosigner, and no one's credit is better than the federal government's. In fact, not only did the Export-Import Bank give the assist to Boeing, but it's one of the few agencies of the government that not only pays for itself but turns a profit!

When I studied Boeing and analyzed its business, I had to assimilate a lot of information. I had to look at current data and decide what was most relevant. I had to evaluate the prospects of the broader market and to assess Boeing's relative potential. I made my call and shared it with my subscribers, and the understanding I communicated to them delivered significant value. Not only does a YTD +18.1% gain greatly exceed the Dow's performance, it also surpasses the historical long-term average return of the broader market, as measured by the Standard & Poor's 500 Index.

I seek to deliver such results to my readers each month. I invite you to take a look at how you can add this market intelligence to your investment decisions. Take a look here.