The Ideas Report For Serious Investors

The February issue of Empirical Finance Research Newsletter has been published. We're pleased to bring it to you absolutely FREE in partnership with Wes Gray and Andy Kern of Empirical Finance, LLC. This month's newsletter includes the results of a stock screen that should not be missed.

February 2009 — Empirical Finance Research Newsletter on Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers, a paper by Joseph Piotroski

Abstract:

This paper examines whether a simple accounting-based fundamental analysis strategy, when applied to a broad portfolio of high book-to-market firms, can shift the distribution of returns earned by an investor. I show that the mean return earned by a high book-to-market investor can be increased by at least 7 percent annually through the selection of financially strong high BM firms while the entire distribution of realized returns is shifted to the right. In addition, an investment strategy that buys expected winners and shorts expected losers generates a 23 percent annual return between 1976 and 1996 and the strategy appears to be robust across time and to controls for alternative investment strategies. Within the portfolio of high BM firms, the benefits to financial statement analysis are concentrated in small and medium sized firms, companies with low share turnover and firms with no analyst following, yet this superior performance is not dependent on purchasing firms with low share prices. A positive relationship between the sign of the initial historical information and both future firm performance and subsequent quarterly earnings announcement reactions suggests that the market initially underreacts to the historical information. In particular, 1/6th of the annual return difference between ex ante strong and weak firms is earned over the four three-day periods surrounding these quarterly earnings announcements. Overall, the evidence suggests that the market does not fully incorporate historical financial information into prices in a timely manner.

Conclusions:

The paper goes into great detail and outlines many tests to see if the results are dependent on size factors, liquidity factors, analyst following factors, etc. The bottom line is that fundamental analysis works no matter how you cut it and the FSCORE works extremely well. Nevertheless, as the paper shows, the scale of how well the FSCORE will work really depends on where you implement it. Not surprisingly, the best place to implement the FSCORE is in underfollowed, low liquidity, small cap stocks. If you do this, you will probably make a small fortune over time. Caveat: Past performance is no guarantee of future results.

Find out more about the FREE Empirical Finance Research Newsletter.

Disclosure: No position.

Posted by manualofideas at 10:18 PM | Permalink | Comments (0)

Looking for a free copy of Ben Graham's classic The Intelligent Investor? Or free copies of other popular investment and business books, such as Porter's Competitive Strategy, Graham's Security Analysis, Soros's Alchemy of Finance, or Hagstrom's The Warren Buffett Way?

There's a website that apparently says, "No problem!" Take a look at the venture-backed startup Scribd.com and do some keyword searching. You'll be amazed at what you'll find. What's more, you won't have to read entire books on your screen -- the site lets you print and save documents in PDF and other formats.

To us, Scribd today feels like the early days of YouTube or Napster. While the site prohibits users from posting copyrighted material, there is apparently little in the way of proactive enforcement. Copyright owners can demand that certain content be removed from the site, but it appears most owners are way behind the curve in realizing that their content is even available without permission.

While it seems likely that Scribd will have to reign in some of the content on the site as owners wake up to the goings-on, this may be another example of traditional business models upended by disruptive technology.

Several years ago, Napster's free service was mostly shut down following legal action by the music industry, but music distribution and pricing models were changed forever. Similarly, while YouTube draws fewer infringement complaints from video content producers than in the past, owners now post much of their content on YouTube for free anyway -- to generate ad revenue, drive website traffic, or boost sales of higher-quality versions of the free videos.

For example, a YouTube search for "Michael Jackson Thriller" will take you to a free video posted by content owner Epic/Legacy Recordings and so far viewed more than 28 million times. A Charles Schwab ad was running at the bottom of the screen as we enjoyed another recent viewing of the video. Whether YouTube targeted the ad specifically to me based on our profile, or whether Thriller is popular with investors generally these days, we don't know.

The publishing industry simply does not seem to be getting a break. First, newspapers started losing classifieds revenue to sites like eBay. Then papers started losing readers to sites such as The Huffington Post and a sea of blogs, many written by individuals with the deadly combination of passion for a particular subject and little expectation of income from blogging. Now, sites such as Scribd may be on their way to pushing traditional book publishers into a new dilemma -- whether to try to put the genie of free electronic content back into the bottle, or to start preparing for new business models. We'll be watching.

Posted by manualofideas at 09:07 PM | Permalink | Comments (0)

Harvard economics professor Kenneth Rogoff has published a paper (13-page PDF file) and study (82-page PDF file) examining the potential aftermath of the financial implosion we've experienced in recent months. Here's an overview of the two most recent publications, both of which provide a level of analysis and insight that is rarely found in analyses of the ongoing crisis.

The Aftermath of Financial Crises (with Carmen M. Reinhart), manuscript, Harvard University, December 2008. Paper prepared for the American Economic Association Meetings in San Francisco, January 3, 2009.

Introduction:

A year ago, we (Carmen M. Reinhart and Kenneth S. Rogoff, 2008a) presented a historical analysis comparing the run-up to the 2007 U.S. subprime financial crisis with the antecedents of other banking crises in advanced economies since World War II. We showed that standard indicators for the United States, such as asset price inflation, rising leverage, large sustained current account deficits, and a slowing trajectory of economic growth, exhibited virtually all the signs of a country on the verge of a financial crisis—indeed, a severe one. In this paper, we engage in a similar comparative historical analysis that is focused on the aftermath of systemic banking crises.

In our earlier analysis, we deliberately excluded emerging market countries from the comparison set, in order not to appear to engage in hyperbole. After all, the United States is a highly sophisticated global financial center. What can advanced economies possibly have in common with emerging markets when it comes to banking crises? In fact, as Reinhart and Rogoff (2008b) demonstrate, the antecedents and aftermath of banking crises in rich countries and emerging markets have a surprising amount in common. There are broadly similar patterns in housing and equity prices,  unemployment, government revenues and debt. Furthermore, the frequency or incidence of crises does not differ much historically, even if comparisons are limited to the post–World War II period (provided the ongoing late-2000s global financial crisis is taken into account). Thus, this study of the aftermath of severe financial crises includes a number of recent emerging market cases to expand the relevant set of comparators. Also included in the comparisons are two prewar developed country episodes for which we have housing price and other relevant data.

Broadly speaking, financial crises are protracted affairs. More often than not, the aftermath of severe financial crises share three characteristics.

• First, asset market collapses are deep and prolonged. Real housing price declines average 35 percent stretched out over six years, while equity price collapses average 55 percent over a downturn of about three and a half years.
  

• Second, the aftermath of banking crises is associated with profound declines in output and employment. The unemployment rate rises an average of 7 percentage points over the down phase of the cycle, which lasts on average over four years. Output falls (from peak to trough) an average of over 9 percent, although the duration of the downturn, averaging roughly two years, is considerably shorter than for unemployment.
  

• Third, the real value of government debt tends to explode, rising an average of 86 percent in the major post–World War II episodes. Interestingly, the main cause of debt explosions is not the widely cited costs of bailing out and recapitalizing the banking system. Admittedly, bailout costs are difficult to measure, and there is considerable divergence among estimates from competing studies. But even upper-bound estimates pale next to actual measured rises in public debt. In fact, the big drivers of debt increases are the inevitable collapse in tax revenues that governments suffer in the wake of deep and prolonged output contractions, as well as often ambitious countercyclical fiscal policies aimed at mitigating the downturn.

Banking Crises: An Equal Opportunity Menace (with Carmen M. Reinhart), manuscript, Harvard University, December 2008. Also available as NBER Working Paper No. 14587, December 2008.

Abstract:

The historical frequency of banking crises is quite similar in high- and middle-to-low income countries, with quantitative and qualitative parallels in both the run-ups and the aftermath. We establish these regularities using a unique dataset spanning from Denmark’s financial panic during the Napoleonic War to the ongoing global financial crisis sparked by subprime mortgage defaults in the United States.

Banking crises dramatically weaken fiscal positions in both groups, with government revenues invariably contracting, and fiscal expenditures often expanding sharply. Three years after a financial crisis central government debt increases, on average, by about 86 percent. Thus the fiscal burden of banking crisis extends far beyond the commonly cited cost of the bailouts.

Our new dataset includes housing price data for emerging markets; these allow us to show that the real estate price cycles around banking crises are similar in duration and amplitude to those in advanced economies, with the busts averaging four to six years. Corroborating earlier work, we find that systemic banking crises are typically preceded by asset price bubbles, large capital inflows and credit booms, in rich and poor  countries alike.

Introduction:

Until very recently, the study of banking crises has typically focused either on earlier historical experiences in advanced countries, mainly the banking panics before World War II, or else has focused on modern-day emerging market experiences. This dichotomy is perhaps shaped by the belief that for advanced economies, destabilizing, systemic, multi-country financial crises were a relic of the past. Of course, the recent global financial crisis emanating out of the United States and Europe has dashed this misconception, albeit at great social cost.

As this paper will demonstrate, banking crises have long been an equal opportunity menace. We develop this finding using a core sample of sixty-six countries (plus a broader extended sample for some exercises).  We examine banking crises ranging from Denmark’s financial panic during the Napoleonic War to the current “first global financial crisis of the 21st century.” The incidence of banking crises proves to be remarkably similar in the high- and middle-to-low-income countries. Indeed, the tally of crises is particularly high for the world’s financial centers: the United Kingdom, the United States, and France. Perhaps more surprising still are the qualitative and quantitative parallels across disparate income groups. These parallels arise despite the relatively pristine modern sovereign default records of the rich countries.

Three features of our expansive dataset are of particular note.

• First, our data on global banking crises go back to 1800, extending the careful study of Bordo, et al. (2001) that covers back to 1880.
  

• Second, to our knowledge, we are the first to examine the patterns of housing prices around major banking crises in emerging markets, including Asia, Europe and Latin America. Our emerging market data set facilitates comparisons, across both duration and magnitude, with the better-documented housing price cycles in the advanced economies, which have long been known to play a central role in financial crises. We find that real estate price cycles around banking crises are similar in duration and amplitude across the two groups of countries. This result is surprising given that almost all other macroeconomic and financial time series (income, consumption, government spending, interest rates, etc.) exhibit higher volatility in emerging markets.

• Third, our analysis employs the comprehensive historical data on central government tax revenues and debt compiled in Reinhart and Rogoff (2008). These new data afford a new perspective on the tax and debt consequences of the banking crises (Previously, the kind of historical data on debt necessary to analyze the aftermath of banking crises across countries was virtually non-existent for years prior to 1990.)

We find that banking crises almost invariably lead to sharp declines in tax revenues as well significant increases in government spending (a share of which is presumably dissipative). On average, government debt rises by 86 percent during the three years following a banking crisis. These indirect fiscal consequences are thus an order of magnitude larger than the usual bank bailout costs that are the centerpiece of most previous studies. That fact that the magnitudes are comparable in advanced and emerging market economies is also quite remarkable. Obviously, both the bailout costs and the fiscal costs depend on a host of political and economic factors, including especially the policy response as well as the severity of the real shock which, typically, triggers the crisis.

The paper proceeds as follows. Section II provides an overview of the history of banking crises, with particular emphasis on the post-1900 experience. We also document the incidence and frequency of banking crises by country and by region. We discuss the links between banking crises, financial liberalization, the degree of capital mobility, and sovereign debt crises and discuss international financial contagion.

Section III examines some of the common features in the run-up to banking crises across countries and regions over time. The focus is on the systematic links between cycles in international capital flows, credit, and asset prices—specifically, home and equity prices. The next section examines some of the common features of the aftermath of banking crises. We document the toll that the crisis takes on output and government revenues, as well as the typically profound effect on the evolution of government debt during the years following the crisis. The concluding section takes up the question of “graduation.” Specifically, to what extent do countries ever “graduate” from (stop experiencing) serial major financial crises as they seem to graduate from serial sovereign debt crises?

The Harvard Economics Department hosts a collection of Kenneth Rogoff's recent writings.

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Economics Nobel laureate Joseph Stiglitz spoke to Bloomberg at Davos. Stiglitz favors quick government action the bailout. He also calls the IMF and U.S. Fed hypocritical.

Watch the interview.

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Russian prime minister Vladimir Putin spoke during the opening session at Davos today. The speech was quite an exercise in oratory. First, Putin stated the following:

In the last few months, virtually every speech on this subject started with criticism of the United States. But I will do nothing of the kind.

Putin then went on to criticize the U.S., though not by name. Here is a dig at the dollar-centric global financial system, with Putin asserting that the days of the supremacy of the U.S. Federal Reserve are numbered:

The entire economic growth system, where one regional centre prints money without respite and consumes material wealth, while another regional centre manufactures inexpensive goods and saves money printed by other governments, has suffered a major setback.

For the record, we find this kind of Soviet-era style oratory, where you say one thing but mean another, unacceptable. If Putin has a problem with the U.S., he should say so clearly and then propose some equally clear solutions. Nobody will resolve anything with the kind of two-faced approach Putin put forth today.

With this criticism of Putin's speech out of the way, we have to admit the U.S. deserves to be criticized. Our financial system has failed miserably. Our banks and corporations have failed, our regulators have failed, our Yale- and Harvard-educated executives have failed, and our investors have failed. Did we leave out anyone?

So, we don't blame Putin for having taken the U.S. to task in his speech. we just disagree with the way he did it. Oh, and have we made it clear that we don't think Putin is the guy to offer credible solutions?

Read the speech.  Watch the speech.  Listen to the podcast.

Posted by manualofideas at 04:18 PM | Permalink | Comments (0)

George Soros spoke with Bloomberg at the World Economic Forum in Davos, Switzerland this morning.  He commented on a number of topics, including the U.S. government's plan to set up a "bad bank".

According to Soros, the plan to run a government-owned bank that would buy up toxic assets could help stabilize the financial system but is probably not going to cause banks to start lending. Soros believes that banks need to be recapitalized, with the government needing to inject perhaps as much as $1 trillion of new capital into the banks.

Soros also commented on the recent sharp drop in oil prices to roughly $40 a barrel. The drop represents a "sudden reversal of fortunes for the oil-producing countries," with several direct and indirect consequences.  Dubai's real estate bubble is bursting, and other bubbles in oil-producing countries are also coming to an end. A positive effect of lower oil prices is that the strongmen of Venezuela and Iran are likely to be weakened as a result.  In fact, Soros is predicting Hugo Chavez to be out of office within a year.  Such a development would probably bode well for Western oil companies with assets in Venezuela.

Posted by manualofideas at 01:42 PM | Permalink | Comments (0)

Economist John Maynard Keynes (1883-1946) wrote an essay in 1930 entitled The Great Slump. While the structure of the economy of the 1930s was quite different from that of the U.S. economy today, there are some parallels in terms of ordinary people's perception of the crises.  Wrote Keynes:

The world has been slow to realize that we are living this year in the shadow of one of the greatest economic catastrophes of modern history. But now that the man in the street has become aware of what is happening, he, not knowing the why and wherefore, is as full to-day of what may prove excessive fears as, previously, when the trouble was first coming on, he was lacking in what would have been a reasonable anxiety. He begins to doubt the future. Is he now awakening from a pleasant dream to face the darkness of facts? Or dropping off into a nightmare which will pass away?

He need not be doubtful. The other was not a dream. This is a nightmare, which will pass away with the morning. For the resources of nature and men's devices are just as fertile and productive as they were. The rate of our progress towards solving the material problems of life is not less rapid. We are as capable as before of affording for everyone a high standard of life—high, I mean, compared with, say, twenty years ago—and will soon learn to afford a standard higher still. We were not previously deceived. But to-day we have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand. The result is that our possibilities of wealth may run to waste for a time—perhaps for a long time.

I doubt whether I can hope, in these articles, to bring what is in my mind into fully effective touch with the mind of the reader. I shall be saying too much for the layman, too little for the expert. For—though no one will believe it—economics is a technical and difficult subject. It is even becoming a science. However, I will do my best—at the cost of leaving out, because it is too complicated, much that is necessary to a complete understanding of contemporary events.

Read the complete essay.

Posted by manualofideas at 12:10 AM | Permalink | Comments (0)

Ray Dalio's letter is always an interesting read given Bridgewater's size and stature among institutional investors.  The letter starts out as follows:

2008 was a year to remember, so now is a good time to reflect on it and to extract the important lessons from it. Most importantly, it was a year in which a lot of mistakes occurred, so there is lots of learning and improvement that can come from looking at these mistakes analytically. It was a year in which all investors were stress–tested, and big differences surfaced, which are important to understand. It was also a year that has embedded in it lots of clues about the risks and opportunities that lie ahead, which we want to be sure to mine. So please indulge me while I attempt to do this reflecting in my usual circuitous and opinionated way.

It seems to me that, above all else, what happened last year reflected human nature. No exogenous shocks caused what happened. The crisis was completely caused by people operating in a manner consistent with their individual natures and together in ways typical of group dynamics. In other words, people caused their circumstances, which they reacted to, which caused new circumstances that they reacted to, and so on. And they did this in ways that weren’t very complex or unique.

Read Ray Dalio's full letter.

Posted by manualofideas at 09:10 PM | Permalink | Comments (0)

It appears Warren Buffett has motivated Bill Gates to try to emulate the Berkshire chairman's annual letter to shareholders.  While the Gates Foundation has no shareholders, it has millions of stakeholders, as the work of the Foundation reaches far around the world.

For those of us who seem to be enveloped in our daily work and find little time to stay abreast of the needs of those less fortunate than ourselves, Gates's annual letter might be a good way to keep up with the initiatives of charities such as the Gates Foundation.  Unlike most other heads of large non-profit organizations, Bill Gates has a "business mind" and may bring unique perspective to the challenges and opportunities of foundation work. We will be bringing you Bill's letters every year right here at The Ideas Report For Serious Investors.

Says Gates in the introductory paragraph:

This is the first annual letter I plan to write about my work at the Gates Foundation. In this letter I want to share in a frank way what our goals are and where progress is being made and where it is not. Soon after Warren Buffett made his incredible gift, which doubled the resources of the foundation, he encouraged me to follow his lead by writing an annual letter. I won’t be quoting Mae West or trying to match his humor, but I will try to be equally candid.

Read Bill Gates's  annual letter.

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We are pleased to bring our subscribers a special edition of Downside Protection Report, featuring an exclusive interview with up-and-coming value fund manager Peter Lindmark, founder and managing partner of Lindmark Capital Fund, LP.

If you’ve never heard of Peter, you’re not alone. Peter manages a small investment partnership in Birmingham, Alabama and has stayed out of the limelight. This may be about to change. Unlike most fund managers, Peter not only managed to avoid major losses in 2008 but also posted rather impressive gains—his fund was up 47%, net of fees.

We would normally chalk up such performance by a relatively unknown manager to luck, but Peter strikes us as the real deal. From what we can tell, his treatment of limited partners has been exemplary; his focus on minimizing costs speaks volumes; and his investment approach is built on Graham and Buffett principles while allowing his macroeconomic views to be expressed creatively in the makeup of the investment portfolio.

The following interview is "fresh off the presses" — Peter responded to our questions by email this morning, January 26th.

Q: In a year when most value investors lost significant amounts of money, your fund was up 47% net of fees. How was your portfolio different from that of the typical Buffett-style buy-and-hold value investor?

A: Unlike the typical long only buy and hold value investor my fund will go anywhere it sees “value.” I follow the macroeconomic picture more than the typical buy and hold value investor. This can mean selling securities short, buying or selling foreign currencies, commodities, or various other macroeconomic investments. The fund was positioned to take advantage of the severity of the credit crisis as it significantly worsened. This was done by maintaining a portfolio which was neutral to net short, holding our cash in yen, and having very little long exposure. Like most value investors, we lost money on a few long positions, but luckily I realized the credit crisis would have a larger impact on their intrinsic value than I had originally thought.

Q: Are you positioned similarly for 2009? If not, what has brought about the change?

Read the full interview when you start your 30-day free trial of our acclaimed monthly investing newsletter, Downside Protection Report.  Subscribers, please log into the members-only website.

Posted by manualofideas at 02:11 PM | Permalink | Comments (0)

In an exclusive interview with Downside Protection Report, Peter Lindmark recommended the following books, which he has read or re-read recently:

• Changing Fortunes by Paul Volcker and Toyoo Gyohten

• Speculative Contagion by Frank Martin

• A Demon of Our Own Design by Richard Bookstaber

• The Power of Gold: The History of an Obsession by Peter Bernstein

• Simple But Not Easy by Richard Oldfield

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It may be time for investors to dust off their copy of Ben Graham and David Dodd's classic Security Analysis.  Graham and Dodd paid a lot of attention to the liquidation value of companies as a way of lowering the risk of loss even under a worst-case scenario.  They reasoned that even if a company fails as a going concern and is forced to liquidate, shareholders may get their money back -- or even make money -- assuming the company's balance sheet is strong and liquid enough to yield a material amount of cash for shareholders in the event of a liquidation of all of the company's assets.

The Financial Times argues in an article entitled "Liquidation risk grows as finance dries up" that liquidations -- rather than reorganizations under Chapter 11 -- may become more common as bankruptcy financing disappears or becomes prohibitively expensive.  According to the FT,

...the credit crunch has severely limited the availability of so-called ‘debtor in possession’ financing that is vital to give [bankrupt companies] this second chance.

With previous big providers of DIP financing, such as GE Capital, shying away from the market, companies may have to rely on their existing lenders...

...there had been no substantial increase in DIP volumes in 2008, in spite of a jump in the number of bankruptcies...

“The lack of DIP financing available is an issue for the American economy because of the potential job destruction that could result.” [according to Steven Smith, global head of leveraged finance and restructuring at UBS in New York]

Debtors also face the highest rates yet for DIP financing. The risk premium a debtor has to pay on the loan has more than doubled since 2001-2002, the height of the last downturn, according to Dealogic. In 2001 the spread over Libor was 429bp versus 900bp now.

Despite the anticipated rise in liquidations, investors following Graham and Dodd principles may do well, assuming they invest in companies trading meaningfully below estimated liquidation values.  While such companies are sometimes impossible to find -- and always hard to find -- they do exist, particularly in the small- and micro-cap arena.

We've unearthed 20 interesting Graham and Dodd "net nets" for you.  In doing so, we used the following screening criteria:

1. Stock exchange: NYSE, Amex or Nasdaq (not Pink Sheets or OTC BB)
2. Current assets minus total liabilities equal to at least 125% of market value
3. Positive trailing earnings or positive estimated forward earnings
4. Market value greater than $10 million
5. Net cash equal to at least 60% of market value
6. Recent insider buying equal to or greater than insider selling
7. Insider ownership less than 20% (we want non-controlled companies, with shareholders able to compel management to liquidate or take other steps to unlock value)

Disclosure: No position.

Posted by manualofideas at 09:06 PM | Permalink | Comments (0)

This year's World Economic Forum meeting at Davos, Switzerland takes place from January 28th to February 1st.  The Forum has just published an interesting report entitled "The Future of the Global Financial System: A Near-Term Outlook and Long-Term Scenarios." 

The 88-page report puts the current crisis in perspective by providing some interesting charts and statistics.  The conclusions of the report are not earth-shattering, but the report does provide some long-term scenarios intended to spur thought and debate.

The World Economic Forum has also published  worthwhile briefing materials in preparation for this year's Davos meeting.

We will be bringing you highlights of this year's meeting at Davos in real time right here at The Ideas Report For Serious Investors, so stay tuned in the coming days.

Visit the World Economic Forum website.

Posted by manualofideas at 06:05 PM | Permalink | Comments (0)

Suppose you were on the cover of a popular business magazine with Uma Thurman on your arm and the headline read, "Charmed Life."  You're a bigshot fund of funds manager, you give "millions to charities," jet between mansions, and your ex is Elle Macpherson.  You're the poster boy for success in the world of money and influence.  Clients have entrusted you with more than $10 billion, and you like to rip into underperforming hedge fund managers to show that you are different.  Bloomberg quotes you as saying, "If these managers are not focused on preservation of capital, they should not have the right to manage other people's money." 

Then, your facade is blown.  Your clients are told that, despite the fact that it's your job to perform due diligence on other fund managers, you just lost them $230 million by investing with Bernie Madoff.  Yes, that Madoff -- the one who had red flags following him everywhere.  The Bernie Madoff that was the subject of Harry Markopolos's decade-long whistleblower effort, the Bernie Madoff that Goldman Sachs wouldn't touch with a ten-foot pole, the Bernie Madoff that Yale chief investment officer David Swensen says Yale was not even close to investing with because of the many red flags.

What would happen?  What if you dismissed it by saying, "There's only so much due diligence you can do."  Surely you would not still be in business, or would you?

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In an opinion piece in the Financial Times, George Soros argues that the government should consider taking over banks by buying their equity capital and use the GSEs more aggressively to bring about a recovery in housing.  Highlights:

...the Obama administration may be close to devoting as much as $100bn of the second tranche of the troubled asset relief programme funds to creating an “aggregator bank” that would remove toxic securities from the balance sheets of banks.

These measures – if enacted – would provide artificial life support for the banks at considerable expense to the taxpayer, but would not put the banks in a position to resume lending at competitive rates. The banks would need fat margins and steep yield curves for a long time to rebuild their equity.

In my view, an equity injection scheme based on realistic valuations, followed by a cut in minimum capital requirements for banks, would be much more effective in restarting the economy. The downside is that it would require significantly more than $1,000bn of new capital. It would involve a good bank/bad bank solution, where appropriate. That would heavily dilute existing shareholders and risk putting the majority of bank equity into government hands.

The hard choice facing the Obama administration is between partially nationalising the banks, or leaving them in private hands but nationalising their toxic assets. Choosing the first course would inflict great pain on a broad segment of the population – not only on bank shareholders but also on the beneficiaries of pension funds. However, it would clear the air and restart the economy.

President Barack Obama can fulfil his promise of a bold new approach only by establishing a discontinuity with the previous team. Congress and the public are right in feeling that too much has been done for the banks and not enough for beleaguered householders. The government ought to take the GSEs out of limbo and use them more actively to stabilise the housing market. Having done so, it could go back to Congress for authorisation to recapitalise the banking system the right way.

Posted by manualofideas at 01:19 PM | Permalink | Comments (0)

Jeremy Grantham's 4Q 2008 letter is in two parts this quarter. The first part is a collection of topics peripheral to the global financial crisis, including Jeremy's thoughts on President Obama's appointments in the financial arena. Part 2 will be published in a few weeks.

On his level of confidence and feelings toward the incoming Administration:

With economies and financial markets, it seems that if you stare hard enough and long enough at the fog of battle, you occasionally get a glimpse of what may be going on when a favorable wind blows. This, for me, is decidedly not one of those occasions. It is obvious to all of us that these are momentous days in which government actions may well have make-or-break impact, but my confidence in government and leadership is at a low ebb. (Although I must admit my confidence has increased enormously in recent weeks in all areas outside of finance. Even in finance it has increased a little.)

Greed and reckless overconfidence on the part of almost everyone caused us to ignore risk to a degree that is probably unparalleled in breadth and depth in American history. Even more remarkable was the lack of insight and basic competence of our leadership, which led them to ignore this development, or worse, to encourage it. Ingenious new financial instruments certainly facilitated and exaggerated these weaknesses, but they were not the most potent ingredient in our toxic stew. That honor goes to the economic establishment for building over many decades a belief in rational expectations: reasonable, economically-induced behavior that would always guarantee approximately efficient markets.

Never underestimate the power of a dominant academic idea to choke off competing ideas, and never underestimate the unwillingness of academics to change their views in the face of evidence.

If in real terms we assume write-downs of 50% in U.S. equities, 35% in U.S. housing, and 35% to 40% in commercial real estate, we will have had a total loss of about $20 trillion of perceived wealth from a peak total of about $50 trillion. This relates to a GDP of about $13 trillion, the annual value of all U.S. produced goods and services. These write-downs not only mean that we perceive ourselves as shockingly poorer, they also dramatically increase our real debt ratios.

Slowly and carefully invest your cash reserves into global equities, preferring high quality U.S. blue chips and emerging market equities. Imputed 7-year returns are moderately above normal and much above the average of the last 15 years. But be prepared for a decline to new lows this year or next, for that would be the most likely historical pattern, as markets love to overcorrect on the downside after major bubbles. 600 or below on the S&P 500 would be a more typical low than the 750 we reached for one day.

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The following are the ten members of the S&P 500 Index gaining the most in price during 2008.  It's an interesting list because some of the companies on it are quite economically sensitive.  At the end of the day, each stock represents an individual company rather than a sector or industry.  If a company does well, the stock will -- or shall we say, "may" -- follow.

Here is another interesting view of global stock markets in 2008.

Posted by manualofideas at 12:17 AM | Permalink | Comments (0)

Warren Buffett comments on the economy, the market outlook and inflation in a January 22nd interview with Susie Gharib of Nightly Business Report. Watch the interview or read the transcript.

Posted by manualofideas at 12:00 AM | Permalink | Comments (0)

David Einhorn's Greenlight Capital has amassed an impressive track record buying and selling short stocks based on value-oriented, bottom-up fundamental analysis.  For the first time, Einhorn is making what looks like a macro bet: He is buying gold.  Einhorn's 2008 letter to investors explains why.

Also noteworthy is Einhorn's new long position in MEMC Electronic Materials (NYSE: WFR), one of the Top 10 ideas recommended by The Manual of Ideas in the most recent issue of Portfolio Manager's Outlook.  Greenlight established its position in WFR at $13.68 per share, roughly equal to today's closing price, at what Einhorn describes as "6x cyclically depressed estimated 2009 earnings net of cash."

Disclosure: No position in WFR, gold.

Posted by manualofideas at 06:29 PM | Permalink | Comments (0)

If you've never heard of Peter Lindmark, you're not alone.  Peter manages a small investment partnership based in Birmingham, Alabama and has stayed out of the limelight.  This may be about to change.  To find out why, take a look at Peter's 2008 letter to partners.  Even if you gloss over his 2008 performance -- which should be quite difficult -- you'll be impressed by the thoughtfulness of Peter's market commentary.  It's rare to find a Buffett-style investor who can synthesize his view of the macro economy so well and then translate that view into investment performance.

Peter Lindmark's 2008 Letter to Limited Partners of Lindmark Capital

Posted by manualofideas at 11:44 AM | Permalink | Comments (0)

Yale Chief Investment Officer David Swensen spoke with Charlie Rose on Wednesday.

Date of interview: January 21, 2009.

Posted by manualofideas at 12:10 AM | Permalink | Comments (0)

Andrew Dubinsky of Columbia Business School has put together a great resource looking back at significant academic research into value-oriented investing.  The paper, published by the Heilbrunn Center for Graham & Dodd Investing, contains a wealth of links and pointers to interesting reading material.

What does the latest academic research reveal about outperforming the broader market?  Find out in the monthly Empirical Finance Research Newsletter, brought to you for free by The Manual of Ideas.

Posted by manualofideas at 08:58 PM | Permalink | Comments (0)

...much of the chess master's advantage over the novice derives from the first few seconds of thought. This rapid, knowledge-guided perception, sometimes called apperception, can be seen in experts in other fields as well. Just as a master can recall all the moves in a game he has played, so can an accomplished musician often reconstruct the score to a sonata heard just once. And just as the chess master often finds the best move in a flash, an expert physician can sometimes make an accurate diagnosis within moments of laying eyes on a patient.

But how do the experts in these various subjects acquire their extraordinary skills? How much can be credited to innate talent and how much to intensive training? Psychologists have sought answers in studies of chess masters. The collected results of a century of such research have led to new theories explaining how the mind organizes and retrieves information.

...what matters is not experience per se but "effortful study," which entails continually tackling challenges that lie just beyond one's competence. That is why it is possible for enthusiasts to spend tens of thousands of hours playing chess or golf or a musical instrument without ever advancing beyond the amateur level and why a properly trained student can overtake them in a relatively short time. It is interesting to note that time spent playing chess, even in tournaments, appears to contribute less than such study to a player's progress; the main training value of such games is to point up weaknesses for future study.

Even the novice engages in effortful study at first, which is why beginners so often improve rapidly in playing golf, say, or in driving a car. But having reached an acceptable performance--for instance, keeping up with one's golf buddies or passing a driver's exam--most people relax. Their performance then becomes automatic and therefore impervious to further improvement. In contrast, experts-in-training keep the lid of their mind's box open all the time, so that they can inspect, criticize and augment its contents and thereby approach the standard set by leaders in their fields.

...motivation appears to be a more important factor than innate ability in the development of expertise. It is no accident that in music, chess and sports--all domains in which expertise is defined by competitive performance rather than academic credentialing--professionalism has been emerging at ever younger ages...

Posted by manualofideas at 12:01 AM | Permalink | Comments (0)

Value Investors Club is an exclusive community of about 200 value-oriented investors. Anyone can get guest access with a 45-day read-only delay, but only members get to exchange views in real-time, both in the form of idea write-ups and message board discussion.

Value Investors Club memberships have become a coveted commodity, and rightfully so.  Consider the outperformance of stocks recommended by members.

So how does one get into Value Investors Club?  Membership is free, but you must submit an investment idea for consideration by the Club's management.  The admission rate seems to be very low, but a compelling investment idea write-up may just be enough to get you in.

Here's how you might go about writing a successful stock recommendation:

• Go to Magic Formula Investing and search for the Top 100 companies with market values of at least $100 million
• Write down five companies that look most interesting to you, either because you recognize them from prior research or you have some knowledge of the industry in which they operate
• Research the five companies and decide which one you consider to be the most compelling investment opportunity
• Visit the Value Investors Club website to get some pointers on writing up a stock.  You'll also be able to see some past write-ups by Club members.
  
• Write a 2-3 page report, including a discussion of the following:

1. Why is the company a good business, i.e., why do you believe it will be able to sustain high returns on capital employed?
2. How cheap is the company on an absolute basis and versus industry comparables?  What is your estimate of fair value?
   
3. If the company has a lot of net cash, have they stated plans for the cash?  Note any stock repurchases, as they might be accretive to per-share value.
4. What is the track record of the company's management?  Do they own a large enough equity stake to make them interested in the long-term success of the company?  A good rule of thumb is that a CEO should have more than five times his annual compensation in shares of stock (not options).
5. What are the key risks facing the company and why do you believe the shares are a good buy despite the risks?
   
6. What are the catalysts that will make the stock price converge with your estimate of intrinsic value per share?

• Submit your report on the Value Investors Club website.

Finally, if you don't think you're quite ready to write a convincing report but would like to learn, we encourage you to read Joel Greenblatt's two books on investing, The Little Book That Beats The Market and You Can Be A Stock Market Genius.  These books will teach you how to look for outperformers.  The books describe the investment approach espoused by the management of the Club.  Good luck!

Disclosure: The author of this post is a member of Value Investors Club. The views expressed are those of the author.

Posted by manualofideas at 12:01 AM | Permalink | Comments (0)

The Congressional Budget Office recently published testimony entitled, The Budget and Economic Outlook: 2009-2019.  We've been critical of the CBO's TARP accounting, but the budget outlook report contains some interesting economic data series. 

We disagree, however, with the CBO's estimate that the economy will grow by 1.5% in 2010.  This strikes us as too optimistic given the enormity of the challenges before us and the negative cascading effects that have yet to play out.

Posted by manualofideas at 12:00 AM | Permalink | Comments (0)

Posted by manualofideas at 11:48 PM | Permalink | Comments (0)

Here's an excerpt from the editor's commentary contained in the latest issue of Downside Protection Report, the monthly newsletter that is setting a new standard in idea generation for serious investors:

Dear Fellow Idea Seekers,

     Be careful what you wish for. Until fairly recently, the ancient Chinese proverb, “May you live in interesting times,” sounded pretty good. Who wouldn’t prefer interesting times to the alternative, right? Well, not quite, if the alternative isn’t dull times but times that are a bit too interesting.

     Another wish we’ve heard from investors over the years can be paraphrased as follows: I wish I’ll have a chance to buy my favorite stocks at a bargain price! Until recently, this seemed like an ambitious wish, especially for value-oriented investors who didn’t like the idea of paying twenty times earnings or more for wide-moat companies like Disney (NYSE: DIS), McGraw-Hill (NYSE: MHP), Viacom (NYSE: VIA-B), or Microsoft (Nasdaq: MSFT).

     Investors are now getting their wish, perhaps a bit too much so. Many are now frozen in their tracks, waiting for some sort of “uncertainty to lift.” Never mind that when those same investors made their original wish, they acknowledged that whenever their wish was granted, they would almost certainly have to accept some near-term uncertainty in exchange for getting a bargain.

     One such bargain hiding in plain sight is Microsoft, which we are buying this month. Microsoft can credibly lay claim to being the world’s best large business. It has a near-monopoly in operating systems, high margins, high returns on capital, a respected global brand, and continued prospects for long-term growth.

     Since going public in 1986, Microsoft has never been as cheap on a P/E basis, trading at less than ten times forward earnings. This is even more noteworthy when we consider that the headline P/E doesn’t give the company credit for several growth businesses, including MSN.com and Xbox.

Our valuation analysis of Microsoft and our other top pick of the month is disclosed in the new issue of Downside Protection Report. Read the full issue now by starting your 30-day free trial.

Disclosure: DOWNSIDE PROTECTION REPORT is published monthly by BeyondProxy LLC, P.O. Box 1375, New York, NY 10150. Website: www.manualofideas.com. Email: support@manualofideas.com. Please email or call if you have any subscription questions. Managing Editor: John Mihaljevic. Subscription $149 per year. © Copyright 2008 by BeyondProxy LLC. All rights reserved. Photocopying, reproduction, quotation, or redistribution of any kind is strictly prohibited without written permission from the publisher. This newsletter bases recommendations and forecasts on techniques and sources believed to be reliable in the past and cannot guarantee future accuracy and results. BeyondProxy’s officers, directors, employees and/or principals (collectively “Related Persons”) may have positions in and may, from time to time, make purchases or sales of the securities or other investments discussed or evaluated in this newsletter. John Mihaljevic, Chairman of BeyondProxy, is also a principal of Mihaljevic Capital Management LLC (“MCM”), which serves as the general partner of a private investment partnership. MCM may purchase or sell securities and financial instruments discussed in this newsletter on behalf of the investment partnership or other accounts it manages. It is the policy of MCM and all Related Persons to allow a full trading day to elapse after the publication of this newsletter before purchases or sales of any securities or financial instruments discussed herein are made. Use of this newsletter and its content is governed by the Terms of Use described in detail at www.manualofideas.com/terms.html. 

Posted by manualofideas at 07:19 PM | Permalink | Comments (0)

Warren Buffett speaks with Tom Brokaw, January 18, 2008:

Read the full transcript.

Buffett seemed a bit more definitive about the depth of the economic crisis than he had been in his previous interview with Brokaw on October 31, 2007.

Posted by manualofideas at 03:26 PM | Permalink | Comments (0)

The Congressional Budget Office has released its first statutory report on transactions under the Troubled Asset Relief Program (TARP). It appears the government managed to spend $247 billion in cash under TARP through December 31st. But this is not Washington’s only “accomplishment.” The bureaucrats score major points for creativity as well. Consider CBO’s attempt to portray more than $180 billion of the bailout as something other than a subsidy:

“[TARP] transactions totaled $247 billion. Valuing those assets using procedures similar to those specified in the Federal Credit Reform Act (FCRA), but adjusting for market risk as specified in the EESA, CBO estimates that the subsidy cost of those transactions (broadly speaking, the difference between what the Treasury paid for the investments or lent to the firms and the market value of those transactions) amounts to $64 billion.”

The CBO claims that only about $5 billion of the $20 billion it gave to Citigroup was a subsidy. Even more stunningly, of the $178 billion the government has given away to 214 different institutions, only $32 billion is considered a subsidy. The other $146 billion is “market value.” Of course, if the latter amount really reflected the fair market value of what the government received in exchange for its cash, those 200+ institutions would not have needed a government bailout in the first place.

Not only is the CBO’s accounting tortured, but it is also rather “high level.” The CBO provides no detail behind the estimates shown above. We wonder why.

One thing appears certain: If the CBO can declare that more than $180 billion of the government’s $247 billion spent in TARP funds is not a subsidy, there is little reason to believe the government will not keep spending at a furious pace. After all, it can count on the CBO to keep supplying some of the world’s most creative accountants.

Posted by manualofideas at 01:16 AM | Permalink | Comments (1)

The Manual of Ideas is pleased to partner with Empirical Finance LLC to bring our readers unique insight into the latest finance-related academic literature, with a clear emphasis on putting academic insight to work in real-world investment portfolios.

Starting today, we are bringing you the monthly Empirical Finance Research Newsletter and related content free of charge. Wesley Gray of the University of Chicago Booth School of Business and Andrew Kern of the University of Missouri are authors of Empirical Finance Research Newsletter. They are intimately familiar with the latest finance literature and espouse a Buffett-style investment approach. Value-oriented investors will find Wes and Andy's investment mindset to be quite compatible.

Wes Gray and Andy Kern also recently published a paper examining the performance of stocks recommended by members of the exclusive Value Investors Club. Their paper has already garnered tremendous attention in the industry.

To receive alerts when future issues of the Empirical Finance Research Newsletter become available, be sure to submit your email address on the website devoted to the Newsletter (not necessary if you are already a member of The Manual of Ideas email list).

Posted by manualofideas at 06:12 PM | Permalink | Comments (0)

Warren Buffett addresses students at the University of Florida in 1998 (introduction by Mason Hawkins of Longleaf):

Read the transcript.

Posted by manualofideas at 10:15 AM | Permalink | Comments (0)

By John Mihaljevic, CFA
Managing Editor, The Manual of Ideas

If you’re like me, you’ve been a subject of indoctrination. Your professors taught you that markets are efficient and that all available information is already priced into stocks. Above-average investment performance is due to luck, not skill. Reading this article is a waste of time.

Since you are reading this article, I assume you are open to the argument that markets are not always efficient. Unfortunately, your residual regard for the Efficient Markets Hypothesis (EMH) may be impacting your ability to act contrary to the conventional wisdom. You may hesitate to invest in an obviously cheap stock because you think, “It must be cheap for a reason.” (I know this line of thinking because I’ve been susceptible to it.) While cheap stocks are indeed cheap for a reason (by definition), all reasons are not created equal. If a stock is cheap because its market cap is so small that no informed investor has discovered it, you may be looking at an excellent investment opportunity. If, on the other hand, a stock is cheap because it faces significant risk of bankruptcy, you may want to stay away.

I have developed a mind trick that allows me to make the EMH work for me, and I hope it can work for you too. Next time you encounter a security that appears cheap after thorough analysis, don’t simply say “it must be cheap for a reason” and move on. Instead, consider that if the efficient markets hypothesis is true, the stock must be efficiently priced, i.e., you would be buying it at a price that fairly reflects the risks involved. Regardless of how things turned out, your decision to buy the stock would not have been obviously stupid. So use the EMH to overcome your fear of the downside when all factors point to the likelihood of nice upside.

Economist Meir Statman argues that “finance scholars would do well to accept market efficiency in the beat-the-market sense but reject it in the rational prices sense.” Statman’s argument that markets are inefficient but cannot be beat strikes me as unsatisfactory. If we know that markets are inefficient, we should have a fairly good sense of why they are inefficient, providing long-term investors with a starting point for outperformance.

Say Goodbye to the EMH

Investment success requires a departure from the EMH, as adherence to the latter results in investment strategies focused on low-cost indexing. The following few points should help you put the EMH to rest.

First, respected economists such as Yale’s Robert Shiller have by now presented significant challenges to the EMH. This makes the hypothesis more controversial in academia than only a decade ago.

In addition, the experience of investors such as George Soros and Warren Buffett cannot be ignored. Soros and Buffett have beaten the averages so consistently and for so long that the probability of their successes having been due to luck is miniscule. I would understand skepticism if Soros and Buffett’s respective approaches were based on astrology, but their approaches make sense. The only surprise is that more investors have not emulated them (perhaps thanks to widespread EMH indoctrination).

Finally, consider whether the EMH makes sense in light of past stock market crashes triggered without any major news (Black Monday is an example). The only explanation that makes sense to me includes the existence of “herd mentality,” or investor behavior that is driven not only by fundamentals. A model of herd mentality may differ from the rational expectations model by assuming a positive correlation between the actions of market participants. If I sell, you may see a slight price decline, making you slightly more likely to sell as well. If we both sell, the next person may be slightly more likely to sell than you were, and so on. Had you bought instead of sold, our effects on the next person would have canceled out — this is the reversal mechanism that typically plays out in daily market action. However, positive correlation would in rare instances produce a snowball effect, accelerating selling once a tipping point is reached. This type of model might explain Black Monday. To understand the eventual reversal of selling, we need to introduce one or more other variables that influence trading decisions. The most significant variable is fair value – at some point, investors will decide that stocks have become too cheap and will start buying. This variable is consistent with the rational expectations hypothesis of efficient markets (unfortunately, EMH ignores any correlation between the actions of market participants). Another variable that can help restore market equilibrium after panic selling or euphoric buying might be what behavioral finance calls “anchoring.” If prices at yesterday’s market close are the anchor, imagine a spring hanging off that anchor – you can pull in either direction, but the more you pull the more resistance you experience. At some point, the force of the spring will counterbalance the force of your pull, and prices will stop moving in one direction.

Before we say good-bye to the EMH, it’s fair to point out a reason for not forgetting the EMH entirely. Investors suffer from a number of cognitive biases, one of which is overconfidence. Past success or interaction with a company’s executives can make us more confident about our estimate of underlying value than we should be. Remembering the EMH ever so slightly can help us guard against overconfidence, because we will be more inclined to consider the risks to our thesis on a particular stock.

Evolved View of the Stock Market

Former Columbia professor and the father of value investing Benjamin Graham once said, “Price is what you pay; value is what you get.” Many investors agree with this statement – though only outside the investment arena. Few of us would refuse to buy an item in a department store just because it is on sale, yet many do just that when it comes to the stock market. The fear associated with buying a depressed stock, obviously, is that the price decline signifies a fundamental problem. Yet even if the decline has been caused by a decline in intrinsic value, the question is whether the price has declined more than the value erosion warrants. Disciplined investors try to estimate the intrinsic value of companies within their circle of competence and buy them when the price drops far below estimated value.

Graham’s 1949 classic The Intelligent Investor describes something akin to a free option contract available to every investor: At any time, you can choose to buy or sell a share of a business in the market at the prevailing bid price. If you believe the price is sufficiently below or above intrinsic value, you may exercise your option to buy or sell (short) the stock. Writes Graham,

"Imagine that you own a small share of a private company that cost you $1,000. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly."

If you are a prudent investor or a sensible businessman, will you let Mr. Market’s daily communication determine your view of the value of $1,000 interest in the enterprise? Only in case you agree with him, or in case you want to trade with him. You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to form your own ideas of the value of your holdings, based on your own research and company reports regarding their operations and their financial position.

Contrary to what is taught in most finance curricula, “Mr. Market,” at least in the short term, is not an infallible appraiser of businesses (a “weighing machine”) but rather the sum product of the opinions of a herd-like group of investors susceptible to subjective influences and cognitive biases (a “voting machine”).

Posted by manualofideas at 12:18 AM | Permalink | Comments (0)

As investors, we often wonder how some start-ups can grow from virtually nothing into dominant global franchises. The story of Ted Turner and CNN, while providing no definitive answers, is fascinating.

If you spend some time listening to Ted Turner, the intangibles that enabled him to become successful should become abundantly clear. We highly recommend the videos below, especially the 2004 interview with Charlie Rose. Watch this interview first, as you're bound to be enlightened as well as entertained.

Once you've seen the 2004 Charlie Rose interview, we highly recommend checking out an interview series with Ted Turner by the Archive of American Television. While the rookie interviewer is clearly out of his league, he gets better as the interview goes on -- Turner's no-nonsense style clearly has a positive effect. In the series, Turner tells his life story in engaging and inspiring fashion. You'll find yourself on a virtual trip into American business history.

Charlie Rose interview with Ted Turner, July 2004:

Charlie Rose interview with Ted Turner, April 2008:

Michael Eisner interviews Ted Turner:

Watch Ted Turner interview by Michael Eisner in Entertainment Videos  |  View More Free Videos Online at Veoh.com

Posted by manualofideas at 12:45 AM | Permalink | Comments (0)

Posted by manualofideas at 11:16 AM | Permalink | Comments (0)

Steve Wynn, CEO of Wynn Resorts (WYNN) and a Las Vegas legend, is the quintessential entrepreneur. While Wynn Resorts shares have fallen sharply over the past year, we greatly respect his life's work.

If you're an investor interested in learning what makes entrepreneur CEOs tick, or an aspiring entrepreneur, or simply in need of some motivational words, we highly recommend the following Charlie Rose interview with Steve Wynn in 2005.

Steve Wynn: "What's to be afraid of? Failure? Hell, you can fall on your ass for half the price."

If you liked the above interview, you'll like to hear more from Steve Wynn in another Charlie Rose interview -- this one dates back to 1997.

Posted by manualofideas at 12:41 AM | Permalink | Comments (0)

Here's a Warren Buffett classic -- enjoy!

Part 1:

Part 2:

Part 3:

Part 4:

Part 5:

Part 6:

Posted by manualofideas at 12:09 AM | Permalink | Comments (0)

Installment 1 of 3 of the Barron's Roundtable is here.  We're not sure why Abby Jo Cohen's opinion still matters, but a few of the other participants continue to make lucid arguments.  Our three favorites are Marc Faber, Meryl Witmer and Fred Hickey.

Posted by manualofideas at 07:50 AM | Permalink | Comments (0)

Posted by manualofideas at 12:01 AM | Permalink | Comments (0)

If you have not yet read Warren Buffett's letters to partners of Buffett Partnership, you should.  They provide a worthwhile antidote to the writings of today's investment managers whose main concern is keeping and growing assets rather than safeguarding the well-being of their investors.

You may want to start by reading Buffett's last letter, written in 1969, announcing his "retirement" and a voluntary return of all capital to limited partners.  What a difference there is between Buffett and today's hedge fund managers -- the latter have not only performed poorly, but are now coming up with all sorts of ways of preventing limited partners from getting their money back.

Can you even imagine a hedge fund manager today writing anything close to the following:

"Quite frankly, ...I would continue to operate the Partnership... if I had some really first class ideas.  Not because I want to, but simply because I would so much rather end with a good year than a poor one.  However, I just don't see anything available that gives any reasonable hope of delivering such a good year and I have no desire to grope around, hoping to "get lucky" with other people's money.  I am not attuned to this market environment, and I don't want to spoil a decent record by trying to play a game I don't understand just so I can go out a hero."

View all of Buffett's Partnership letters.

Posted by manualofideas at 12:52 AM | Permalink | Comments (0)

We've been doing some work on Japanese equities here at The Manual of Ideas and wanted to share a few quick observations.  As you know, Japanese stocks have been in the doldrums for many years.  They generally trade at low multiples of tangible book value, and many companies have significant real estate holdings that are not accurately reflected on their balance sheets.

We approached our study of Japanese stocks with the hypothesis that we should be able to find some compelling investments given the cheap valuations of a large subset of Japanese public companies.  So far, however, we have remained unimpressed.  A few points:

• Lack of focus. Most mid-cap and large-cap Japanese companies still look more like conglomerates than focused Western-style enterprises.  It's almost as if major Japanese firms exist in an era pre-dating the age of specialization.  For example, did you know that Sony has a life insurance arm and even owns a bank?
• Murky corporate governance. Many Japanese companies' org charts look like org charts of government entities in the U.S., with checks and balances and committees galore.  The bureaucracy of Japan Inc. seems stifling.  For example, Sharp argues that it is a corporate governance leader, yet its org chart  could be mistaken for that of a Chinese commune.
• Little regard for returns on investment. Japanese companies routinely spend as much as 10% of annual revenue on capex, despite being in businesses with single-digit EBIT margins. While the companies include ROE calculations prominently in their annual reports, the firms exhibit little focus on improving ROE. Most companies keep making incremental investments despite ROEs in the mid single digits.
• High-cost production base; currency mismatch. Many Japanese exporters have still not fully embraced outsourcing of manufacturing to low-cost locations, preferring instead to produce goods within Japan. This not only increases costs but also exposes the companies to yen appreciation (which has recently obliterated profits at many Japanese exporters).
• Clubbish Board rooms. So far, we've had difficulty finding female Board members at major Japanese companies. Not that we're in favor of quotas or similar concepts, but it does seem that the lack of diversity in Japanese Board rooms is emblematic of a lack of willingness to open up the culture and embrace new ways of doing business.

To be sure, Japanese stocks do not appear to have much downside. They generally enjoy significant asset protection, and their businesses appear sustainable.  However, investors are likely to achieve impressive returns from investing in Japanese stocks only during short time periods of revaluation of price-to-book or enterprise value-to-revenue multiples. Assuming constant multiples, investors are likely to be disappointed, as they'll be earning returns similar to the companies' returns on equity. The latter generally range in the low to mid single digits and appear unlikely to rise any time soon.

So as not to disparage Japan Inc. unduly, we also point out that Japanese companies have many good things going for them, including access to a highly skilled, hardworking labor force; superior technology and manufacturing processes; and a forward-thinking attitude on environmental matters.

A final note:

We are beginning to understand what Warren Buffett meant when he told University of Florida students some years back that he had not found any investable companies in Japan.  Buffett said something to the effect that Berkshire Hathaway could borrow money in Japan at only 1%.  He then reasoned that all he needed to do was to find a company that would give him more than 1% per year over the long term.  He concluded: "So far, I haven't found anything."

The following is the full video of Buffett's University of Florida speech.  If you've never seen it, don't miss it.  It is one of the best ways to spend an hour. Buffett's comments on Japan start around the 10-minute mark.

Posted by manualofideas at 03:28 PM | Permalink | Comments (0)

A highly respected fund manager who shall remain nameless because he doesn't disclose his identity on his blog has written a thoughtful piece on keeping recent market turmoil in perspective.  He addresses the recent suicides of several wealthy individuals and writes,

"Our ego mind lies to us. It convinces us that what is important is the kind of clothes on our backs, the shoes that we wear, the car that we drive, the house that we live in is paramount in our lives. The ego mind convinces us that our business stature and how other people regard us is what is important. But this is all a lie. Is this what our soul really wants? Is this who we are? Of course not, but years of listening to our ego and worrying what other people think create habits of mind and this is what we become. So that in the end, if suddenly our business, money and fame is taken from us, we are left with nothing. And what else is there to live for?"

He goes on to say,

"In 2008, I had the worst business performance of my life. It was terrible and it hurt me greatly that the clients that had entrusted money to me had lost so much money. And things are very uncertain now in many ways in my life. But what I have learned is that I can only do my best, work hard, learn from my mistakes and move forward. In the meantime, there is way too much for me to do that isn’t business, including: service, volunteering and good deeds. There are friends and family that may need me for a myriad of problems or advice or just to listen."

Posted by manualofideas at 12:01 AM | Permalink | Comments (0)

Robert Huebscher of Advisor Perspectives has just published an interview with Bruce Berkowitz of Fairholme Fund (FAIRX). The interview was conducted on December 24th.  Here are a few highlights:

On AmeriCredit (ACF):

"In the worst case, we will make some pretty good money."

On Leucadia National (LUK):

"They have a better track record than Berkshire Hathaway and they take their fiduciary roles very seriously."

On UnitedHealth (UNH), WellPoint (WLP) and WellCare (WCG):

"If HMOs like UnitedHealth, WellPoint, WellCare, and others cannot provide these services, then who will? The only thing government can do is to cut a check. Those that are providing these services now will be the ones providing it in the future."

On Sears Holdings (SHLD):

"We are not looking at today’s values in the real estate market. We have come to the conclusion that we cannot snap our fingers and sell. If the value from Sears comes from its real estate holdings, then it may take a while to sell those properties."

You may also want to check out Advisor Perspectives' past interviews and subscribe for their free newsletter.  We find their questioning of interviewees to be knowledgable and engaging.

Posted by manualofideas at 12:04 AM | Permalink | Comments (0)

Wes Gray of the University of Chicago and Andy Kern of the University of Missouri at Columbia have just published a draft paper in which they analyze the performance of stocks written up on Value Investors Club, an exclusive community of value-oriented investors, run by Joel Greenblatt and John Petry.

Gray and Kern analyze the performance of stocks written up by Club members from 2001-2008. They find that stocks recommended by members gained 33.46%, on average, in their first year -- performance that is vastly superior to that of the broader stock market.

Here is the abstract, as posted by Gray and Kern:

"We examine novel data on the detailed investment decisions of professional value investors. We find evidence that value investors are not easily defined: they exploit traditional tangible asset valuation discrepancies such as buying high book-to-market stocks, but spend more time analyzing intrinsic value, growth measures, and special situation investments. We also test whether fundamental value investors outperform the market in our sample (January 2000 to June 2008). Analyzing buy-and-hold abnormal returns and calendar-time portfolio regressions, we conclude that value investors have stock picking skills."

Disclosure: John Mihaljevic, managing editor of The Manual of Ideas, is a member of Value Investors Club.

Posted by manualofideas at 12:01 AM | Permalink | Comments (2)

Sears Holdings enjoys a curious distinction: It has the worst Wall Street analyst rating out of 2,678 public companies. Could this be a contrarian buy signal?

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Bloomberg's Matthew Lynn rips into hedge funds' new favorite practice of refusing to give investors their money back. He concludes:

Hedge funds can’t expect to treat their investors like this and survive. It would be reasonable to say something like this: “It’s a bad time to sell, guys. You will lose what little is left of your shirt, but if you stick with us, we believe we can turn this thing around.” Then the fund holders can make their own decisions.

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David Einhorn of Greenlight Capital and Michael Lewis, author of “Liar's Poker,” make a number of good points in an op-ed in The New York Times. A few excerpts:

On the "tyranny of the short term":

"Our financial catastrophe, like Bernard Madoff’s pyramid scheme, required all sorts of important, plugged-in people to sacrifice our collective long-term interests for short-term gain. The pressure to do this in today’s financial markets is immense. Obviously the greater the market pressure to excel in the short term, the greater the need for pressure from outside the market to consider the longer term. But that’s the problem: there is no longer any serious pressure from outside the market. The tyranny of the short term has extended itself with frightening ease into the entities that were meant to, one way or another, discipline Wall Street, and force it to consider its enlightened self-interest."

On the SEC:

"...one of the great social benefits of the Madoff scandal may be to finally reveal the S.E.C. for what it has become. Created to protect investors from financial predators, the commission has somehow evolved into a mechanism for protecting financial predators with political clout from investors. (The task it has performed most diligently during this crisis has been to question, intimidate and impose rules on short-sellers — the only market players who have a financial incentive to expose fraud and abuse.)"

On the bailout:

"In the middle of all this, Treasury Secretary Henry M. Paulson Jr. persuaded Congress that he needed $700 billion to buy distressed assets from banks — telling the senators and representatives that if they didn’t give him the money the stock market would collapse. Once handed the money, he abandoned his promised strategy, and instead of buying assets at market prices, began to overpay for preferred stocks in the banks themselves. Which is to say that he essentially began giving away billions of dollars to Citigroup, Morgan Stanley, Goldman Sachs and a few others unnaturally selected for survival."

On the pressure being exerted on FASB:

"In its latest push to compel confidence, for instance, the authorities are placing enormous pressure on the Financial Accounting Standards Board to suspend “mark-to-market” accounting. Basically, this means that the banks will not have to account for the actual value of the assets on their books but can claim instead that they are worth whatever they paid for them."

On stabilizing the housing market:

"We should begin by breaking the cycle of deteriorating housing values and resulting foreclosures. Many homeowners realize that it doesn’t make sense to make payments on a mortgage that exceeds the value of their house. As many as 20 million families face the decision of whether to make the payments or turn in the keys. Congress seems to have understood this problem, which is why last year it created a program under the Federal Housing Authority to issue homeowners new government loans based on the current appraised value of their homes."

"And yet the program, called Hope Now, seems to have become one more excellent example of the unhappy political influence of Wall Street. As it now stands, banks must initiate any new loan; and they are loath to do so because it requires them to recognize an immediate loss. They prefer to “work with borrowers” through loan modifications and payment plans that present fewer accounting and earnings problems but fail to resolve and, thereby, prolong the underlying issues. It appears that the banking lobby also somehow inserted into the law the dubious requirement that troubled homeowners repay all home equity loans before qualifying. The result: very few loans will be issued through this program."

Posted by manualofideas at 12:05 AM | Permalink | Comments (0)

Bloomberg takes a look at the plunge in long-term government bond prices last week.  We made our bearish case on long-term treasuries in a slightly satirical opinion piece on December 18th.  We still believe long-term treasuries are dramatically overvalued and represent perhaps the last remaining bubble in today's markets.

The following is a look at the implied yield on the 30-year U.S. government bond over the past five days.  Treasuries took a beating on Wednesday and especially on Friday, with yields rebounding somewhat from record lows.

Disclosure: Affiliates of BeyondProxy LLC, publisher of The Manual of Ideas, are long TBT.

Posted by manualofideas at 05:43 PM | Permalink | Comments (0)

We highly recommend Nadav Manham's blog The Investor's Consigliere.  It has a steady stream of useful information and unique insight for anyone interested in investing in hedge funds.

Nadav is president of Elera Advisors, an investment advisory firm in New York. He discovered Warren Buffett around the age of 18 and decided to become a professional investor. Having graduated from Yale in 2000, he worked for four years at a large multi-strategy hedge fund, focusing on distressed and bankruptcy-related investing.

In 2006 he founded Elera, which currently manages a small number of individual separate accounts in the Buffett value style. Elera also offers hedge fund advisory consulting to individual and family office investors.

Posted by manualofideas at 06:25 PM | Permalink | Comments (0)

Steel Partners put out an interesting press release on Wednesday. Excerpt:

WebFinancial L.P. will become a diversified holding company with interests in a variety of businesses, including industrial products, energy, aerospace and defense, banking, insurance and food & beverage. The company will be managed by Steel Partners LLC and intends to seek a listing on a national stock exchange.

Posted by manualofideas at 09:25 AM | Permalink | Comments (0)

Yale Chief Investment Officer David Swensen comments on the markets and Yale's investment approach in a new Bloomberg article. He asserts that Yale was not even close to investing in Madoff-run funds and rips into the fund-of-funds industry for failing to see the red flags surrounding Bernie Madoff's operation.

Swensen also calls corporate bonds undervalued, saying they are "priced at really extraordinarily cheap levels." Notably, he does not make the same assertion about government bonds, which we at The Manual of Ideas believe to be grossly overvalued.

Disclosure: Affiliates of BeyondProxy LLC, publisher of The Manual of Ideas, hold a long position in TBT.

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