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January 2012   Vol.1   Monthly Education Brief




Short-Term Focus: Coping with Near-
Term Fluctuations
                         Instant access to real-time quotes and media reports can
                         make it difficult for investors with a long-term
                         investment horizon to stay focused on their goals. In
                         reality, these daily market movements may not be as
                         extreme as they seem. As investors look longer term,
                         their perception often changes. Short-term market
                         fluctuations can be quite volatile, and the probability of
                         realizing a loss within any given day is high. However,
                         the likelihood of realizing a loss has historically
                         decreased over longer holding periods. The image
                         illustrates that while the probability of losing money on
                         a daily basis over the past 20 years was 46%, the
                         probability dropped dramatically when analyzing an
                         annual time period—20%. Periodic review of an
                         investment portfolio is necessary, but investors
                         shouldn’t let short-term swings affect their view of the
                         future.




                                                          About Keating Capital

                                                          Keating Capital, Inc. is a business   that has historically been          *Kabam
                                                          development company that              reserved for institutional          *Livescribe
                                                          specializes in making pre-IPO         investors.                          *MBA Polymers
                                                          investments in innovative, high                                           *Metabolon
                                                                                                Keating Capital shares are traded
                                                          growth private companies that                                             *NeoPhotonics
                                                                                                on Nasdaq under the ticker
                                                          are committed to and capable of                                           *Solazyme
                                                                                                symbol KIPO.
                                                          becoming public. We provide                                               *Suniva
                          mb@keatinginvestments.com       individual investors with the         Portfolio Companies:                *Tremor Video
                          (720) 889-0139                  ability to participate in a unique    *Agilyx                             *TrueCar
                          www.KeatingCapital.com          fund that invests in a private        *BrightSource Energy                *XTime
                                                          company's later stage, pre-IPO        *Corsair Components
                                                          financing round — an opportunity      *Harvest Power
Monthly Education Brief January 2012                                                                          2




Economic Outlook for 2012
                                                                    China Slowing Is an Issue for Some, but
                                                                    Potentially Good News for the U.S.: China
                                                                    certainly remains an issue, too, as growth there
                                                                    slows modestly and the construction industry
            The U.S. economy grew in 2011, but at a slower          pulls back from its breakneck pace. Slowing there
            rate than everyone expected. Even more                  is bad news for a lot of high-profile capital goods
            surprising than the overall growth rate was the         manufacturers in the U.S but, overall, China is an
            pattern of that growth rate throughout the year.        even smaller part of U.S. GDP than Europe.
            Growth plunged to 0.4% in the first quarter and         Furthermore, slowing growth in China could
            accelerated throughout the year, with the fourth        mean significantly lower commodity prices,
            quarter now likely to produce annualized growth         especially in the U.S., which would be good news
            well in excess of 3%.                                   for low-end U.S. consumers, who were
                                                                    particularly crippled by rising commodity prices
            More Upside than Downside (Though the                   in 2011.
            Downside Is Scary): Morningstar economists’
            overall forecast for 2012 sees slightly higher          A Savvy Consumer May Limit Profit Growth:
            growth than the consensus of other economists,          Corporate margins could begin to shrink in the
            but not by a lot. However, the odds of an upside        future as consumers start to gain the upper hand.
            surprise are substantially higher than those of a       Consumers are fighting every price increase tooth
            downside surprise. Potential sources of an upside       and nail, with the possible exception of the very
            surprise include increased U.S. oil production, a       high end of the market. The most recent example
            sharper rebound in automotive and aircraft              comes in the banking industry, where a pushback
            production, and a stronger housing market.              by consumers forced several major banks to cancel
                                                                    proposed increases in debit card fees.
            Corporations Are Scared Even as Consumers
            Accelerate Spending: It looks like U.S. corporate       Europe Will Hurt Big Firms More Than U.S.
            managers are far more scared about Europe and           GDP: Although U.S. GDP growth may escape
            the economy in general than the U.S. consumer           the worst of the effect of a slowing Europe, U.S.
            is. Recent reports seem to suggest at least some        multinationals may not. Many of these firms
            precautionary spending cuts by corporations in          derive 20%-40% of their revenues from Europe.
            the software arena. Managers also seem to be            Since many of those goods are produced in
            paring inventories to the bone. However, it             Europe or in other non-U.S. markets, they are not
            appears that U.S. consumers are accelerating            counted in the U.S. GDP calculations, and they
            spending; they seem to be "thrifted out" and can        don't directly add to U.S. employment.
            no longer delay certain purchases, especially autos.    Therefore, a weak Europe could significantly
            This leads Morningstar economists to predict            affect U.S. companies even if it doesn't make a
            greater production both in the U.S. and in other        dent in the U.S. GDP growth rate.
            world economies that export to the U.S. in 2012.
                                                                    Looking forward to 2012, the U.S. economy is
            Europe Remains at the Top of the Worry List:            probably better positioned than most of the rest
            The main concern here is the potential of the           of the world economies, showing accelerating
            European sovereign debt crisis to wreak havoc on        growth even as Europe falls into a recession and
            the worldwide financial system. U.S. exports to         as growth in Asian economies slows to a more
            Europe represent just 3% of U.S. GDP, and a lot         modest pace.
            of that is for basic necessities that can't be bought
            elsewhere. However, with a web of lending in
            which European banks lend to sovereign
            governments, and those governments lend the
            money back to the undercapitalized banks, the
            failure of any one link could bring down a healthy
            chunk of the European banking system.
Monthly Education Brief January 2012                                                                        3




What Is an Economic Moat?
                                                                     4. Cost advantages: This type of competitive
                                                                     advantage is probably the simplest, and yet the
                                                                     most difficult to achieve. Companies can build a
                                                                     cost-based economic moat by improving their
Commentary   Historical data shows that stocks might be the          business processes (Dell and Southwest Airlines),
             best investment to help you build wealth over           optimizing their supply chains (Wal-Mart), or by
             time. However, with so many stocks available out        outsourcing in order to reduce labor costs (“made
             there, how do you decide which one to pick? What        in China,” anyone?). Cost-cutting can be a two-
             makes a stock a good or a bad investment? The           edged sword, however, and, once the competitive
             answer lies in carefully scrutinizing the company.      advantage is achieved, it may prove difficult to
                                                                     maintain.
             A company’s stock is likely to generate attractive
             returns if the company outperforms its                  In Morningstar’s database, stocks are assigned an
             competitors. The advantage a company builds             economic moat rating: wide (denoting a strong
             over its rivals in the marketplace is called            competitive advantage), narrow (weaker), or none
             competitive advantage. Morningstar has                  (no competitive advantage). The image shows
             developed a rating to measure this competitive          that wide-moat stocks have outperformed
             advantage, the “economic moat.” There are four          narrow- and no-moat stocks, as well as the S&P
             main types of economic moats, examined below.           500 index, over the five time periods analyzed.

             1. Intangible assets: Intangible assets like brands,
             patents, and regulatory licenses can provide a
             company with a unique position in the
             marketplace and a significant advantage over its
             competitors. A powerful brand like Apple or Nike
             can bring in more revenue and increase customer
             retention. Patents are especially important for
             technology companies and companies in
             industries where innovation is critical
             (pharmaceuticals, for example). Regulatory
             licenses provide a competitive edge in the sense
             that they can prevent competitors from entering
             a market.


             2. High customer switching costs: Basically, if a
             company makes it difficult (and, ideally,
             impossible!) for customers to switch to a
             competitor, that company will have a much easier
             time growing revenues and expanding. Examples
             of industries with high switching costs include
             banks and software companies.


             3. The network effect: The network effect is based
             on the simple premise that the more users a
             product or service has, the higher its value will be.
             The most popular example of this type of moat is
             Microsoft: its success is highly dependent on its
             enormous user base. In fact, this network effect
             occurs mainly in businesses based on sharing
             information and connecting people (eBay is a
             good example).
Monthly Education Brief January 2012                                                                                                                                     4




Chasing Performance

              Investors often endure poor timing and planning
              as many chase past performance. They buy into
              funds that are performing well and initiate a selling
              spree following a decline. This becomes evident
              when evaluating a fund’s total return compared
              with the investor return. Overall, the investor
              return translates to the average investor’s
              experience as measured by the timing decisions of
              all investors in the fund.


              The image illustrates the investor return relative to
              the total return for a given fund. Over the short
              term, both the total and investor returns were
              positive, with the investor return ending slightly
              lower. Over a 10-year period, however, total return
              greatly exceeded investor return. Investors who
              attempted to time the market ran the risk of
              missing periods of exceptional returns.




          ©2012 Morningstar, Inc. All Rights Reserved. The information contained herein (1) is intended solely for informational purposes; (2) is proprietary to Morningstar and/or
          the content providers; (3) is not warranted to be accurate, complete, or timely; and (4) does not constitute investment advice of any kind. Neither Morningstar nor the
          content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. "Morningstar"
          and the Morningstar logo are registered trademarks of Morningstar, Inc. Morningstar Market Commentary originally published by Robert Johnson, CFA, Director of
          Economic Analysis with Morningstar and has been modified for Morningstar Newsletter Builder.


                                                                               5251 DTC Parkway                  mb@keatinginvestments.com                   Tel:(720) 889-0139
                                                                               Suite 1100                        www.KeatingCapital.com
                                                                               Greenwood Village, Colorado 80111

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Education Brief January 2012

  • 1. January 2012 Vol.1 Monthly Education Brief Short-Term Focus: Coping with Near- Term Fluctuations Instant access to real-time quotes and media reports can make it difficult for investors with a long-term investment horizon to stay focused on their goals. In reality, these daily market movements may not be as extreme as they seem. As investors look longer term, their perception often changes. Short-term market fluctuations can be quite volatile, and the probability of realizing a loss within any given day is high. However, the likelihood of realizing a loss has historically decreased over longer holding periods. The image illustrates that while the probability of losing money on a daily basis over the past 20 years was 46%, the probability dropped dramatically when analyzing an annual time period—20%. Periodic review of an investment portfolio is necessary, but investors shouldn’t let short-term swings affect their view of the future. About Keating Capital Keating Capital, Inc. is a business that has historically been *Kabam development company that reserved for institutional *Livescribe specializes in making pre-IPO investors. *MBA Polymers investments in innovative, high *Metabolon Keating Capital shares are traded growth private companies that *NeoPhotonics on Nasdaq under the ticker are committed to and capable of *Solazyme symbol KIPO. becoming public. We provide *Suniva mb@keatinginvestments.com individual investors with the Portfolio Companies: *Tremor Video (720) 889-0139 ability to participate in a unique *Agilyx *TrueCar www.KeatingCapital.com fund that invests in a private *BrightSource Energy *XTime company's later stage, pre-IPO *Corsair Components financing round — an opportunity *Harvest Power
  • 2. Monthly Education Brief January 2012 2 Economic Outlook for 2012 China Slowing Is an Issue for Some, but Potentially Good News for the U.S.: China certainly remains an issue, too, as growth there slows modestly and the construction industry The U.S. economy grew in 2011, but at a slower pulls back from its breakneck pace. Slowing there rate than everyone expected. Even more is bad news for a lot of high-profile capital goods surprising than the overall growth rate was the manufacturers in the U.S but, overall, China is an pattern of that growth rate throughout the year. even smaller part of U.S. GDP than Europe. Growth plunged to 0.4% in the first quarter and Furthermore, slowing growth in China could accelerated throughout the year, with the fourth mean significantly lower commodity prices, quarter now likely to produce annualized growth especially in the U.S., which would be good news well in excess of 3%. for low-end U.S. consumers, who were particularly crippled by rising commodity prices More Upside than Downside (Though the in 2011. Downside Is Scary): Morningstar economists’ overall forecast for 2012 sees slightly higher A Savvy Consumer May Limit Profit Growth: growth than the consensus of other economists, Corporate margins could begin to shrink in the but not by a lot. However, the odds of an upside future as consumers start to gain the upper hand. surprise are substantially higher than those of a Consumers are fighting every price increase tooth downside surprise. Potential sources of an upside and nail, with the possible exception of the very surprise include increased U.S. oil production, a high end of the market. The most recent example sharper rebound in automotive and aircraft comes in the banking industry, where a pushback production, and a stronger housing market. by consumers forced several major banks to cancel proposed increases in debit card fees. Corporations Are Scared Even as Consumers Accelerate Spending: It looks like U.S. corporate Europe Will Hurt Big Firms More Than U.S. managers are far more scared about Europe and GDP: Although U.S. GDP growth may escape the economy in general than the U.S. consumer the worst of the effect of a slowing Europe, U.S. is. Recent reports seem to suggest at least some multinationals may not. Many of these firms precautionary spending cuts by corporations in derive 20%-40% of their revenues from Europe. the software arena. Managers also seem to be Since many of those goods are produced in paring inventories to the bone. However, it Europe or in other non-U.S. markets, they are not appears that U.S. consumers are accelerating counted in the U.S. GDP calculations, and they spending; they seem to be "thrifted out" and can don't directly add to U.S. employment. no longer delay certain purchases, especially autos. Therefore, a weak Europe could significantly This leads Morningstar economists to predict affect U.S. companies even if it doesn't make a greater production both in the U.S. and in other dent in the U.S. GDP growth rate. world economies that export to the U.S. in 2012. Looking forward to 2012, the U.S. economy is Europe Remains at the Top of the Worry List: probably better positioned than most of the rest The main concern here is the potential of the of the world economies, showing accelerating European sovereign debt crisis to wreak havoc on growth even as Europe falls into a recession and the worldwide financial system. U.S. exports to as growth in Asian economies slows to a more Europe represent just 3% of U.S. GDP, and a lot modest pace. of that is for basic necessities that can't be bought elsewhere. However, with a web of lending in which European banks lend to sovereign governments, and those governments lend the money back to the undercapitalized banks, the failure of any one link could bring down a healthy chunk of the European banking system.
  • 3. Monthly Education Brief January 2012 3 What Is an Economic Moat? 4. Cost advantages: This type of competitive advantage is probably the simplest, and yet the most difficult to achieve. Companies can build a cost-based economic moat by improving their Commentary Historical data shows that stocks might be the business processes (Dell and Southwest Airlines), best investment to help you build wealth over optimizing their supply chains (Wal-Mart), or by time. However, with so many stocks available out outsourcing in order to reduce labor costs (“made there, how do you decide which one to pick? What in China,” anyone?). Cost-cutting can be a two- makes a stock a good or a bad investment? The edged sword, however, and, once the competitive answer lies in carefully scrutinizing the company. advantage is achieved, it may prove difficult to maintain. A company’s stock is likely to generate attractive returns if the company outperforms its In Morningstar’s database, stocks are assigned an competitors. The advantage a company builds economic moat rating: wide (denoting a strong over its rivals in the marketplace is called competitive advantage), narrow (weaker), or none competitive advantage. Morningstar has (no competitive advantage). The image shows developed a rating to measure this competitive that wide-moat stocks have outperformed advantage, the “economic moat.” There are four narrow- and no-moat stocks, as well as the S&P main types of economic moats, examined below. 500 index, over the five time periods analyzed. 1. Intangible assets: Intangible assets like brands, patents, and regulatory licenses can provide a company with a unique position in the marketplace and a significant advantage over its competitors. A powerful brand like Apple or Nike can bring in more revenue and increase customer retention. Patents are especially important for technology companies and companies in industries where innovation is critical (pharmaceuticals, for example). Regulatory licenses provide a competitive edge in the sense that they can prevent competitors from entering a market. 2. High customer switching costs: Basically, if a company makes it difficult (and, ideally, impossible!) for customers to switch to a competitor, that company will have a much easier time growing revenues and expanding. Examples of industries with high switching costs include banks and software companies. 3. The network effect: The network effect is based on the simple premise that the more users a product or service has, the higher its value will be. The most popular example of this type of moat is Microsoft: its success is highly dependent on its enormous user base. In fact, this network effect occurs mainly in businesses based on sharing information and connecting people (eBay is a good example).
  • 4. Monthly Education Brief January 2012 4 Chasing Performance Investors often endure poor timing and planning as many chase past performance. They buy into funds that are performing well and initiate a selling spree following a decline. This becomes evident when evaluating a fund’s total return compared with the investor return. Overall, the investor return translates to the average investor’s experience as measured by the timing decisions of all investors in the fund. The image illustrates the investor return relative to the total return for a given fund. Over the short term, both the total and investor returns were positive, with the investor return ending slightly lower. Over a 10-year period, however, total return greatly exceeded investor return. Investors who attempted to time the market ran the risk of missing periods of exceptional returns. ©2012 Morningstar, Inc. All Rights Reserved. The information contained herein (1) is intended solely for informational purposes; (2) is proprietary to Morningstar and/or the content providers; (3) is not warranted to be accurate, complete, or timely; and (4) does not constitute investment advice of any kind. Neither Morningstar nor the content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. "Morningstar" and the Morningstar logo are registered trademarks of Morningstar, Inc. Morningstar Market Commentary originally published by Robert Johnson, CFA, Director of Economic Analysis with Morningstar and has been modified for Morningstar Newsletter Builder. 5251 DTC Parkway mb@keatinginvestments.com Tel:(720) 889-0139 Suite 1100 www.KeatingCapital.com Greenwood Village, Colorado 80111