FT Special on Warren Buffett
The Financial Times has published a special report on Warren Buffett, provided by Alice Schroeder. Download the full report.
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April 30, 2009
Is Buffett a "Buy and Hold" Investor?
By Zain Griffith, Research Associate, The Manual of Ideas
Betty Lui of Bloomberg recently conducted an interview with Mohnish Pabrai and Jean-Marie Eveillard, two well respected value-oriented investment managers. Lui questioned whether the "buy and hold" investment strategy was still worth pursuing. Specifically, Lui asks, "Have there been times when Warren Buffett should have sold out or done shorter-term strategies in order to maximize returns?"
Pabrai responds by saying that it is a common misnomer that Buffett is a "buy and hold" investor. If one were to study Buffett's investment history over the past 50-55 years, there are very few stocks he has held for many years. Pabrai states that the reason why Buffett appears to "buy and hold" investments is due to Berkshire's large capital base. He states that investors with smaller amounts of capital might be better served by following Buffett's early strategy of buying "forty to fifty-cent dollars" and selling those assets once they reach fair value. He also warns that comparing value investing to "buy and hold" is like comparing apples to oranges.
Jean-Marie Eveillard disagrees with Pabrai's assessment. He states that the reason Buffett moved to "buy and hold" was "not due to the size of AUM, but rather because he moved from a Benjamin Graham-type approach early in his career, to his own approach" of buying good businesses for the long term.
So, is Buffett really a "buy and hold" investor? I would postulate that this question depends on the type of company in Berkshire's portfolio. Investments made in Coca-Cola (Nasdaq: KO), Moody's (NYSE:MCO) and The Washington Post (NYSE: WPO) were initially made because Buffett thought each company would be worth much more in 20 to 30 years than it was worth at the time of purchase. These positions now represent large core holdings of Berkshire Hathaway. It might be costly to dispose of these investments in most market environments.
I think it would serve us well to look at Berkshire Hathaway's recent past and some of Buffett's commentary in a couple of his annual shareholder letters to get an idea of how he views investments.
On page 20 of Buffett's 2003 Annual Letter to shareholders, he writes, "...I made a big mistake in not selling several of our larger holdings during The Great Bubble. If these stocks are fully priced now, you may wonder what I was thinking four years ago when their intrinsic value was lower and their prices far higher. So do I."
In his 2007 Annual Letter, Buffett comments on selling PetroChina (NYSE: PTR), "We made one large sale last year. In 2002 and 2003 Berkshire bought 1.3% of PetroChina for $488 million, a price that valued the entire business at about $37 billion. Charlie and I then felt that the company was worth about $100 billion. By 2007, two factors had materially increased its value: the price of oil had climbed significantly, and PetroChina’s management had done a great job in building oil and gas reserves. In the second half of last year, the market value of the company rose to $275 billion, about what we thought it was worth compared to other giant oil companies. So we sold our holdings for $4 billion. A footnote: We paid the IRS tax of $1.2 billion on our PetroChina gain. This sum paid all costs of the U.S. government – defense, social security, you name it – for about four hours."
As can be witnessed by the PetroChina investment, Buffett fundamentally believes in purchasing assets that are undervalued and selling them when they exceed fair value. Therefore, Buffett should probably not be typecast as a "buy and hold" investor. He is an amazing capital allocator who purchases undervalued assets he hopes to sell when prices reflect fair value.
Disclosure: Long BRK-B, no other positions.
April 29, 2009
Getting Ready For Berkshire's Annual Meeting: Mohnish Pabrai, Jean-Marie Eveillard, David Sokol, Bill Gates, Byron Trott, Tom Russo (Bloomberg Videos)
Mohnish Pabrai, Jean-Marie Eveillard, David Sokol, Bill Gates, Byron Trott and Tom Russo talk about Warren Buffett and Berkshire Hathaway ahead of the upcoming Annual Meeting.
John Malone in wide-ranging interview with Denver Business Journal
Cable industry pioneer John Malone, founder and chairman of Liberty Media (NASDAQ: LCAPA), spoke with the Denver Business Journal in a three-part interview published on April 27-29, 2009. In the interview, Malone shares some interesting views on the cable industry, Liberty Media, Sirius Satellite Radio (Nasdaq: SIRI), EchoStar (Nasdaq: SATS), and IAC/InterActiveCorp (Nasdaq: IACI). Malone also talks "big picture," putting himself in the camp of those who believe the government's actions are likely to trigger higher inflation.Malone and Liberty Media are large shareholders or outright owners of a portfolio of media-related businesses, including satellite broadcaster DirecTV (Nasdaq: DTV), Expedia (Nasdaq: EXPE), Home Shopping Network, QVC home shopping channel, Starz Entertainment movie channel, Ticketmaster (Nasdaq: TKTM), and Ascent Media (Nasdaq: ASCMA).
Malone on the market outlook assuming improvement in the credit environment:
- "The simplistic thing is if interest rates come back, and cash availability — leverage availability — comes back, then multiples will come back. Entrepreneurs will always be able to take an asset, leverage it up, operate it tightly and make it worth money to them and get good equity returns. If you see debt capacity return, you’ll see private equity come in and swallow these businesses that are trading at low multiples because they can generate very high returns. Even if you don’t postulate high growth rates, you can generate high equity returns if you can leverage them up. That’s why the past four or five years had been huge for private equity."
On the likely solution to the government's debt problem:
- "I’m a believer that — and this becomes philosophical as opposed to mathematical — that we will end up monetizing our deficit and monetizing our future commitments as a country. There’s just no available source of funding. The administration can talk about raising taxes on rich people, but therich people just aren’t very rich any more, in case anybody’s looked."
On how Liberty is positioned to take advantage of his macro view:
- "...most of Liberty’s liabilities are very long term and fixed, and those represent a pretty darned good bet on inflation. Our cash is basically all very liquid, very short term, very safe. We’re sitting with cash looking for opportunity and with liabilities looking to be devalued by government policy. That’s our philosophical view of how we sit right at the moment. Where we are using cash, we’re using it both strategically and with high yields. The Sirius deal is a great example. We’re sitting in a senior position in a business that’s clearly worth more than the senior liabilities, and [we’re] yielding quite attractive current interest rates. So, high yield, senior secured and strategic."
On the competitive landscape today:
- On DirecTV versus Comcast: "DirecTV has that national footprint now, which is a huge advantage for DirecTV relative to any cable company, ... even in the case of Comcast, which covers only 22 percent of the country. This is a story yet to play out, because, as 4G, or wireless broadband, comes in and becomes more potent in terms of its data-rate capacities and its ubiquitousness, the bundle of 4G services with satellite and DSL or an enhanced DSL starts to become a very competitive service relative to cable."
- On Charlie Ergen of EchoStar (Nasdaq: SATS) and his pursuit of Sirius Satellite Radio (Nasdaq: SIRI): "Nobody’s really put Charlie on the couch to figure out why, but the theory is that there may be some applications there for mobile video. They have their terrestrial repeating network, which is 800 sites now, and the frequencies they have. The question is: can you blend that all together? And obviously we’re now deeply involved in theSirius thing, and we think we’re going to win."
- On Liberty's "counter-pursuit" of Sirius: "Initially it’s a financial play, but it’s also strategic. Obviously we have a large stake in DirecTV, and how Sirius could play into that is an important consideration, but it’s not on the table today. What’s on the table today is, let’s understand Sirius and its assets. Let’s help it avoid either bankruptcy or a takeover by somebody they didn’t want to be taken over by, and let’s study it for a while and then decide what the right moves forward are. ...if Charlie [Ergen] has a great idea on how to exploit the [Sirius] asset, we may end up doing something with Charlie. Our skills here, internally, are very much in financial engineering. We thought it was an opportunity to use our financial engineering skills to help keep a company alive and independent and see where it goes."
- On IAC/InterActiveCorp. (Nasdaq: IACI): "...there’s not a lot of downside risk in IAC because the shares are trading pretty close to cash. Even if their operating business turns around, it’ll have relatively small effect on their stock value. The real issue in IAC is, what does Barry spend the cash on? If he finds something really terrific, watch us pile back into the stock. If he just sits on the cash, there’s no particular reason for us to own the stock. We might as well own the cash ourselves as own a pro rata share of his cash, which is where it trades right now. As Greg [Maffie, Liberty Media’s CEO] has said, it really no longer has much strategic element for us. The businesses inside IAC — which are principally Ask.com, which really needs to combine with other search engines; and then there’s Match.com, unless we all want dates ... and most of us are married, so Match.com’s not really strategic for us — there’s really not much in IAC that would be strategic with our businesses. The businesses that [Diller] spun off, on average, are really more synergistic with us than the ones that he kept."
- On the IAC/InterActiveCorp. spinoffs completed in 2008: "...the timing couldn’t have been worse. You’re creating low-cap type businesses that original shareholders couldn’t continue to own, so there was a lot of redistribution going on. Those companies are all in a space where the economy is hurting their current results, and their stocks are trading at ridiculously cheap multiples. But you can’t buy the company. You can buy some shares."
On the evolution of the cable industry:
- On moving out to Denver to join TCI in the early 70s: "I was running the largest division of General Instruments, but — that would’ve been 1972, so I was 31 years old — and they thought I was too young to be the CEO of GI... I decided it would be better to bring up a young family here than it would in New York..."
- On lessons learned at TCI in the 70s: The difficult financing environment taught TCI and Malone to "not expose yourself to one financial source, diversification of every kind, isolation of financial risk, and how to bootstrap. It taught us a lot of things. It taught us survival skills, I think that is the No. 1 thing."
- On picking a valuation metric for the nascent cable industry: "We decided... to go on a cash flow metric very much like real estate. Levered cash flow growth became the mantra out here. A number of our eastern competitors early on were still large industrial companies — Westinghouse, GE, — and they were on an earnings metric. It became obvious to us that if you were going to be measured on earnings, it would be real tough to stay in the cable industry and grow. We needed to be measured much more like real estate as anindustry."
- On using debt as a way to fund growth: TCI and others were expanding by leverage; we were buying assets for cash, basically. It made our earnings look awful, but it meant were sheltered from income tax and we weren’t diluting that common equity. ...in the cable industry, if you start generating earnings that means you’ve stopped growing and the government is now participating in what otherwise should be your growth metric."
- On the power of leveraged financing: "I used to say in the cable industry that if your interest rate was lower than your growth rate, your present value is infinite. That’s why the cable industry created so many rich guys. It was the combination of tax-sheltered cash-flow growth that was, in effect, growing faster than the interest rate under which you could borrow money. If you do any arithmetic at all, the present value calculationtends toward infinity under that thesis."
- On cable operators and content providers: "... [if] there’s money flowing in to create programming that’s going to differentiate cable from broadcast — we were 100 percent in favor of that. But the downside of that was these entities, be it ESPN or MTV, were going to developleverage over us and be able to extract large fees."
- On content providers capturing a bigger share of the economics: "...there’s been a big shift in the economics of the business to the programming conglomerates. Once the government passed retransmission consent, there was this huge sucking sound... It was wealth going from the cable industry to the programming conglomerates, whether it was Disney or News Corp. When all of a sudden, Fox News costs a cable operator a buck a month [per subscriber] and you used to think it was free, all of that is size driven. It’s the law of nature. Big bubbles get bigger, small bubbles disappear — it’s surface tension, the law of physics; and in business it’s scale economics."
- In 1999, AT&T acquired Malone's TCI for $46 billion. Following the TCI acquisition, AT&T bought US West cable spinoff MediaOne for $58 billion, outbidding Comcast. On AT&T's decision not to create a tracking stock for TCI -- and the impact of that decision on the MediaOne deal: "...they didn’t do a tracker for the cable thing. So right up front, because [of] internal politics inside AT&T, they couldn’t get to it. They thought they could live without it. As a result, when the telephone business started to go to hell, they didn’t have a currency other than cash. They wanted to keep growing but they didn’t have a currency, so their deals — like the MediaOne deal ... that was the Rubicon that they crossed that they shouldn’t have crossed — they didn’t have a currency to buy MediaOne and to out-compete Comcast, so they did it with a very cash-heavy guaranteed deal: guaranteed their stock price, put too much cash in it and financed all of it with short-term money, all of which was a disaster and led them to have to, basically, liquidate all of AT&T. Great strategy and terrible execution led to what I would regard, personally, as a fiasco."
Read the full interview at the Denver Business Journal website.
Disclosure: No positions.
April 28, 2009
Ori Eyal's Letters to Investors
By John Mihaljevic, CFA, Managing Editor of The Manual of Ideas
I met Ori Eyal a few years ago at a dinner hosted by Shai Dardashti in New York City. Ori worked for a large bank at the time but immediately struck me as someone who would sooner or later have his own investment firm. His independent way of thinking was much more in line with that of someone managing a fund than working for a large institution.
Ori recently launched a private investment firm, Emerging Value Capital Management. I believe those investing in such vehicles should read Ori's letters to investors closely. His approach is heavily influenced by the teachings of Warren Buffett, yet he applies it with a unique focus.
Read Ori's letters to investors:
Travelzoo's Performance Impresses
Internet media company Travelzoo impressed with its 1Q09 results, primarily because it managed to stabilize the U.S. business amid a continuing downturn in the travel industry. This should not have come as a surprise to those familiar with the company, however, as Travelzoo's Top 20 weekly newsletter represents a preferred capacity liquidation vehicle for many travel providers. When travel companies are forced to sell their inventory on the cheap, they turn to Travelzoo. (Travel companies can't "force" Travelzoo to include them in the newsletter, but they can make their deals so compelling that Travelzoo chooses to include them. Of course, Travelzoo gets paid for each deal it includes in the Top 20.)
Also of note was the fact that Travelzoo grew 1Q09 European revenue by roughly 50% y-y while cutting the European operating loss by roughly in half. With both revenue and profit moving in the right direction, it appears Europe is on the cusp of becoming a contributor to profit rather than a drain on it.
We analyzed Travelzoo in the November 2008 issue of Portfolio Manager's Review and pointed out a number of this we liked about the company:
"Travelzoo (TZOO) is a good business run by capable insiders who have loaded up on shares this year. The market values Travelzoo’s international startup operations materially below zero even though the company has a proven model and management knows Europe well (founder Ralph Bartel was educated in Germany and Switzerland). The downside appears limited as the Bartel brothers are heavily incentivized to create shareholder value. If international operations do not achieve desired profitability, management may shut them down and sell the U.S. business to a competitor such as Priceline.com. We value Travelzoo at $25-26 per share, based on a probability-weighted scenario analysis that includes estimated ranges of annualized EBIT for North America and the rest of the world."
We presented a synopsis of our Travelzoo analysis in a Seeking Alpha article in December 2008.
Disclosure: No position.
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Is GM Worth $125 Billion?
Investors cheered GM's debt exchange offer yesterday, but are buyers of GM stock making a mistake? Consider the following language from the company's press release:
"The aggregate amount of GM common stock to be issued to the U.S. Treasury (or its designee) pursuant to the U.S. Treasury debt conversion and to the new VEBA pursuant to the VEBA modifications would represent approximately 89 percent of the pro forma GM common stock (assuming full participation in the exchange offers), with the final allocation between the U.S. Treasury (or its designee) and the new VEBA to be determined in the future. Of the remaining pro forma outstanding GM common stock, noteholders would represent approximately 10 percent, and existing GM common stockholders would represent approximately 1 percent. [emphasis added] We determined the foregoing GM common stock allocations following discussions with the U.S. Treasury where the U.S. Treasury indicated that it would not be supportive of higher allocations to the holders of notes or to existing GM common stockholders."
Let's pause for a minute to let this sink in: Even without a bankruptcy filing, GM shareholders will be left with 1% of the company. While this is certainly better than 0%, it is not much better. Post-debt exchange GM would need to have a market cap of $125 billion for the stock price to simply stay unchanged at the recent quote of $2.04 per share. This is because the share count would go from roughly 600 million shares to 60 billion shares!
If you have any money invested in GM common stock, the time is now to consider what those shares are worth. As Warren Buffett has said, the market is there to serve you, not to instruct you. The market's jubilant response yesterday to the GM debt exchange offer proves Buffett's point.
One cautionary note: If you are thinking of selling GM shares short, be very careful. It appears there is already a monster short position in the stock (which most likely got a lot bigger yesterday). A Volkswagen-style short squeeze could make even the best-laid short plans blow up if your position size is too large.
DIsclosure: No position.
The Fall of GM -- Visualized
April 27, 2009
Portfolio Manager's Review Picks Top 5 Ben Graham-Style Deep Value Investments
The Manual of Ideas has published a new, 135-page issue of Portfolio Manager's Review, entitled, "Ben Graham-Style Investing: The Deep Value Report."In the report, the Manual of Ideas research team lists 100 companies passing a deep value screen modeled after the balance sheet-driven valuation approach practiced by the late Ben Graham, author of The Intelligent Investor and widely regarded as the "father of security analysis." The report analyzes 30 public companies and selects the Top 5 timely deep value investment opportunities.
Click here to preview the 135-page report.
To view the full report, purchase a one-year subscription to Portfolio Manager's Review for $999 (12 issues) or buy the single report for $199. Subscribers, log into the members-only area.
About Ben Graham's Approach to Equity Investing
Graham's value-oriented approach has outperformed other approaches to investment selection over long periods of time. Perhaps the most famous disciple of Ben Graham is none other than Berkshire Hathaway (NYSE: BRK.A, BRK.B) chairman Warren Buffett. For more information on Graham's investment approach, read a recent article by Mark Hulbert, a Forbes piece on Ben Graham's timeless investment principles or a Ben Graham-style critique of the efficient market hypothesis.
Companies Included in the Report
Companies mentioned in the report include A.C. Moore Arts (Nasdaq: ACMR), ACADIA Pharma (Nasdaq: ACAD), Acorn International (NYSE: ATV), Actions Semiconductor (Nasdaq: ACTS), Adaptec (Nasdaq: ADPT), Anadigics (Nasdaq: ANAD), Arctic Cat (Nasdaq: ACAT), Ascent Media (Nasdaq: ASCMA), Audiovox (Nasdaq: VOXX), AuthenTec (Nasdaq: AUTH), Avanex (Nasdaq: AVNX), Avigen (Nasdaq: AVGN), Axcelis Technologies (Nasdaq: ACLS), BE Semiconductor (OTC: BESIY), Benchmark Electron. (NYSE: BHE), BioForm Medical (Nasdaq: BFRM), Bookham (Nasdaq: BKHM), Cascade Microtech (Nasdaq: CSCD), CCA Industries (AMEX: CAW), CE Franklin (Nasdaq: CFK), Clarus Corp. (OTC: CLRS), Communications Systems (Nasdaq: JCS), Comverse Technology (OTC: CMVT), Crocs (Nasdaq: CROX), Cutera (Nasdaq: CUTR), Cynosure (Nasdaq: CYNO), Dot Hill Systems (Nasdaq: HILL), Electro Scientific (Nasdaq: ESIO), Facet Biotech (Nasdaq: FACT), Flexsteel Industries (Nasdaq: FLXS), Footstar (OTC: FTAR), Fuqi International (Nasdaq: FUQI), Gencor Industries (Nasdaq: GENC), Gravity (Nasdaq: GRVY), GTSI (Nasdaq: GTSI), Gushan Environmental (NYSE: GU), Hardinge (Nasdaq: HDNG), Harvest Natural (NYSE: HNR), Heelys (Nasdaq: HLYS), Himax Technologies (Nasdaq: HIMX), Horsehead (Nasdaq: ZINC), Hudson Highland (Nasdaq: HHGP), Hurray! (Nasdaq: HRAY), Hutchison Telecom (NYSE: HTX), Ikanos Comms (Nasdaq: IKAN), Imation (NYSE: IMN), Ingram Micro (NYSE: IM), Integrated Silicon (Nasdaq: ISSI), Intellon (Nasdaq: ITLN), iPass (Nasdaq: IPAS), KHD Humboldt Wedag (NYSE: KHD), K-Swiss (Nasdaq: KSWS), L.S. Starrett (NYSE: SCX), LeapFrog (NYSE: LF), Linktone (Nasdaq: LTON), LookSmart (Nasdaq: LOOK), MarineMax (NYSE: HZO), Mattson Technology (Nasdaq: MTSN), MEMSIC (Nasdaq: MEMS), ModusLink Global (Nasdaq: MLNK), Movado Group (NYSE: MOV), Nam Tai Electronics (NYSE: NTE), Natuzzi (NYSE: NTZ), Noah Education (NYSE: NED), Northstar Neuroscience (Nasdaq: NSTR), Nu Horizons (Nasdaq: NUHC), Opnext (Nasdaq: OPXT), PC Connection (Nasdaq: PCCC), PDF Solutions (Nasdaq: PDFS), PDI (Nasdaq: PDII), Pomeroy IT Solutions (Nasdaq: PMRY), QLT (Nasdaq: QLTI), Rackable Systems (Nasdaq: RACK), Rewards Network (Nasdaq: DINE), Rocky Brands (Nasdaq: RCKY), Rudolph Technologies (Nasdaq: RTEC), Schuff International (OTC: SHFK), Sierra Wireless (Nasdaq: SWIR), Skechers (NYSE: SKX), SMART Modular (Nasdaq: SMOD), Soapstone Networks (Nasdaq: SOAP), Superior Uniform (Nasdaq: SGC), Syneron Medical (Nasdaq: ELOS), Tech Data (Nasdaq: TECD), The9 Limited (Nasdaq: NCTY), TheStreet.com (Nasdaq: TSCM), TomoTherapy (Nasdaq: TOMO), Trans World (Nasdaq: TWMC), Trident Microsystems (Nasdaq: TRID), Tuesday Morning (Nasdaq: TUES), Ultra Clean Holdings (Nasdaq: UCTT), Universal Stainless (Nasdaq: USAP), Volt Information (NYSE: VOL), Voltaire (Nasdaq: VOLT), Voyager Learning (OTC: VLCY), West Marine (Nasdaq: WMAR), Xyratex (Nasdaq: XRTX), Zapata (NYSE: ZAP), Zygo (Nasdaq: ZIGO), and more.
Note: 30 of the above companies are profiled in the report, with five companies selected as the top investment opportunities. We also highlight the next ten stocks that appear to have investment merit and deserve closer scrutiny.
April 26, 2009
Eric Rosenfeld of LTCM on Lessons Learned
The blog Zero Hedge has posted a lecture by Eric Rosenfeld of Long-Term Capital Management fame. Says Zero Hedge about the video,
"A great way to spend an hour and a half and understand just how black swans can annihilate seemingly riskless portfolios, especially those with a preponderance of Ph.D.'s as portfolio managers who claim to understand "risk". If nothing else fast forward to the 1 hour mark to listen to Eric's discussion of endogenous risk and LTCM's trading of liquidity in a crisis, and how it can all go horribly wrong when you have too many people on the same side of the trade. Prime Brokers, especially those of preferential banks, likely can see all the "liquidity" exposure from their counterparties and nudge their own institutions to react appropriately. (hat tip *.*)."
April 25, 2009
Commercial Real Estate: Delinquencies About to Surpass Peak of Previous Recession
click on image to enlarge (source: Deutsche Bank, Wall Street Journal)
The Wall Street Journal has made available a report by Deutsche Bank on the outlook for commercial real estate. The presentation is an eye-opener, as it presents a lot of data on the coming depression in commercial real estate prices.
Milton Friedman's Remarks at Hoover Institution in 2006
While we don't agree with many of Milton Friedman's conclusions on economic policy, he is undoubtedly one of the foremost economic minds of the 20th century. If nothing else, Friedman's uncompromising views and the clarity with which he expresses them challenge us to underpin our own views with sound judgment.
Free to Choose: A Conversation with Milton Friedman, 2006 (video)
April 23, 2009
American Express Earns 16% ROE in Q1 (not bad!)
Value investors know that the time to buy into wide-moat, high-ROIC businesses is when they are on sale, i.e., when the rest of the world goes into fear mode. Fear often blinds investors from judging objectively underlying value, preventing them from buying businesses well below instrinsic value. We have argued in recent weeks that American Express (NYSE: AXP) represents such a wide-moat, high-ROIC business -- and that investors have been running away from the shares based on fear rather than thorough analysis of the underlying fundamentals.
The Q1 results American Express reported today confirm the strength of the company's franchise even as the business continues to deal with unprecedented weakness in consumer spending and consumer credit. Despite rising delinquencies and lower cardmember spending, American Express earned a 16% return on equity in the quarter, a number that many companies would loveto report in good times. In the case of American Express, good times come with ROEs of 35% or more. That's quite a business.
Undoubtedly, bears will continue to focus on what's not to like. They can do so quite easily -- all you have to do is quote management:
While we did see some recent improvement in early delinquency rates, overall credit indicators reflected rising unemployment levels and the broad-scale weakness in the economy. Based on current indicators, we expect second quarter U.S. lending write-off rates on a managed basis to rise between 200 and 250 basis points over the first quarter levels. We expect an additional increase of 50 basis points or less in the third quarter, before leveling off during the fourth quarter. We continue to be very cautious about the economic outlook and plan to initiate additional reengineering efforts in the second quarter to help further reduce our operating costs. Our goal is to remain in a position to generate profits in excess of our dividend and be able to take competitive advantage of opportunities as the economy begins to rebound.
We have never disputed that the near-term outlook is grim and will remain grim for some time. But for American Express to be able to cover its dividend with current earnings when the business is going through one of the most difficult periods in company history is quite an achievement.
More importantly, as value investors, we know that successful investing is neither about fundamentals nor price. It is about connecting fundamentals to price in a way that allows investors to make a judgment on the risk-reward of a particular company as a long-term investment. In the case of American Express, the risk-reward remains exceedingly favorable.
Disclosure: No position.
April 22, 2009
Top 12 Distressed Brands Likely to Survive
A recent Seeking Alpha post surveyed the Top 12 Brands Likely to Disappear. While we don't disagree with any of the selections on that list, we believe it might be useful for investors to consider a list of brands that are currently under fire but appear likely to survive -- and eventually thrive. Investors who successfully invest in undervalued companies that own valuable brands should do quite well over time.
1. Playboy adult entertainment: The brand is owned by Playboy Enterprises (NYSE: PLA), which also owns the Playboy Mansion, a unique real estate propery in Bel Air, California. Playboy is much more than a publishing business, with future value likely to come primarily from brand licensing. The latter is already a significant and growing generator of operating income. The company needs to reposition itself as a lifestyle company rather than a publishing business.
2. American Express payment cards: While American Express (NYSE: AXP) is close to the eye of the ongoing credit storm, the company appears to have sufficient liquidity to weather the storm. The brand remains strong, and the franchise enjoys sustainable competitive advantage, both with consumers and merchants. Having Warren Buffett and Bruce Berkowitz as major shareholders doesn't hurt, either.
3. Zale jewelry: Zale (NYSE: ZLC) has a leveraged balance sheet, but also substantial tangible book value backed by an appreciating asset -- jewelry. If inflation ever rears its ugly head, a company like Zale may help investors keep up, as the company's significant inventory would likely keep pace with consumer price increases.
4. Sony consumer electronics: The Japanese giant Sony (NYSE: SNE) enjoys one of the most recognized brand names in the world. With shares trading at a fraction of revenue and a low multiple of normalized earning power, Sony may not only thrive as a brand but may also reward investors for their patience.
5. Steinway & Sons grand pianos: Steinway Musical (NYSE: LVB) owns the venerable piano brand as well as a number of band instrument brands, including Conn-Selmer and Leblanc. Perhaps unknown to many investors, Steinway also owns a large office building in Midtown Manhattan and significant real estate on Long Island, New York. Depending on the value of those real estate holdings, investors may be in a position to own the musical brands virtually for free.
6. Sears stores: Eddie Lampert-run Sears Holdings (Nasdaq: SHLD) owns the Sears, K-Mart, Die Hard, Land's End and other consumer brands. While Sears and K-Mart are seriously challenged as brands, the company itself has everything in place to maximize shareholder value, most of all a master capital allocator at the helm.
7. Sotheby's auction services: The respected auction house Sotheby's (NYSE: BID) shares the top of the high-end auction world with Christie's. It appears highly likely that Sotheby's will remain a go-to place in the auction business for a long time to come. The company owns its headquarters building in Manhattan and recently attracted the attention of investor Steven Cohen of SAC Capital.
8. Skechers footwear: The Skechers (NYSE: SKX) brand retains a wide following and is owned by a company with one of the strongest balance sheets in the footwear industry. The company is a borderline Ben Graham-style "net net," with current assets minus total liabilities approximating recent market value.
9. K-Swiss athletic footwear: K-Swiss (Nasdaq: KSWS) invented the leather tennis shoe in the 1960s and maintains a classic look that has not changed much over the decades. While K-Swiss is a tired brand right now, CEO Steven Nichols has managed to revive the brand twice before, and we would not bet against him. (K-Swiss was written up in a recent issue of Downside Protection Report -- read it now with your 30-day free trial.)
10. Dell computers: Dell (Nasdaq: DELL) faces many challenges, ranging from weak global PC demand to the advent of low-cost netbooks. Nonetheless, the company's direct model continues to give it a cost advantage. With a solid balance sheet and capable management, Dell is certain to survive. The only question is whether it will ever again reach its prior heights.
11. LendingTree online loan marketplace: Owned by InterActiveCorp spinoff Tree.com (Nasdaq: TREE), LendingTree is seeing a resurgence in business due to low refi rates. Tree.com has a large net cash position and also owns the website RealEstate.com, providing a strong foundation for future value creation.
12. New York Times newspapers: While the writing seems to be on the proverbial wall for the newspaper business, the New York Times (NYSE: NYT) brand will survive -- the only question is in what form. The company may have to find a way to charge for online content or to monetize its vast content library.
Disclosure: Long PLA. No position in other companies mentioned in this post.
Peek Inside American Express Earnings Machine
The Manual of Ideas has put together a one-page snapshot of how American Express (NYSE: AXP) actually makes money. We have tied some of the company's key operating metrics to AXP's income statement to show you the key drivers of AXP's profitability.
Our Bottom Line on American Express
American Express is a quintessential Buffett company—a high-ROIC business with a wide, defensible moat and favorable long-term growth prospects. The ongoing financial crisis has created a rare opportunity to buy this business for less than 10x trailing earnings and less than 2x tangible book value. While it is instructive to contemplate worst-case scenarios for AmEx in the current crisis, we have little doubt the company will survive without material dilution of equity holders. Meanwhile, AmEx’s long-term earning power and competitive advantages have not been impaired. As a result, the shares deserve serious consideration.
Investment Highlights
- Premium brand in payments industry, focused on prime customers. Since launching the American Express card in 1958, the company has built a brand that today encompasses 70+ million cardmembers.
- “Spend-centric” business model. AmEx focuses primarily on member spending and secondarily on finance charges. Spending per cardmember is higher than at Visa or Mastercard, enabling AmEx to charge a higher discount rate. This allows AmEx to offer rewards to cardmembers and marketing programs to merchants, which help boost spending.
- Targeting long-term revenue growth in high single digits, EPS growth in mid teens, and ROE in the mid thirties. Management has articulated the goal of growing revenue, net of interest expense, by at least 8%, and EPS by 12%-15%, “on average and over time.” The company targets 33-36% ROE.
- Ken Chenault has been chairman/CEO since 2001.
- Improved liquidity by raising $6 billion from new retail CD program and $3 billion from the Treasury.
Investment Risks
- Operating environment “among the harshest we have seen in decades.” The company has recently fallen well short of its prior forecast of 4-6% EPS growth. Loss reserves have increased to highest level in three years. Nonetheless, the company remained profitable in Q4 and full-year 2008.
- Maintains “cautious” outlook for ‘09 and expects cardmember spending to “remain soft with past-due loans and write-offs rising from current levels.”
Major Holders
Insiders 1% │ Berkshire Hathaway 13% │ Davis 7%
Business Overview
Founded in 1850, American Express is a global payments and travel company. It operates in two groups:
Global Consumer (67% of revenue) includes proprietary consumer cards, customer service, small-business services, prepaid products, and consumer travel. Sub-segments are U.S. Card Services and International Card Services.
Global Business-to-Business (29% of revenue) includes the merchant business, network services, commercial card, and business travel. Sub-segments are Global Commercial Services and Global Network & Merchant Services.
AXP became a bank holding company last November.
Disclosure: No position.
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Buffett on Evaluating People: Reference Checks vs. Behavior
By Nadav Manham
Warren Buffett may be the most well-connected businessman around. In the past, some have argued that it's this quality that enables his great success, even more than his own intelligence and judgement. His investment results are better, this rather sinister argument goes, because his information is better.
From the same Fortune interview, here's Buffett on how he evaluates John Stumpf, CEO of Wells Fargo:
Well, John [Stumpf] is in charge. Dick is a terrific help to John. I play bridge with John on the Internet. He plays under the name of HTUR. His wife's name is Ruth. My bridge partner, who I probably play bridge with four times a week, developed online banking for Wells. A woman named Sharon Osberg. And she's worked with those people. And she told me about John Stumpf ten years ago. I've had some insight through her on these people. But the real insight you get about a banker is how they bank. You've got to see what they do and what they don't do. Their speeches don't make any difference. It's what they do and what they don't do. And what Wells didn't do is what defines their greatness [my emphasis].
I apply this logic to the world of money manager selection. Manager selectors spend a lot of time on reference checks, talking to people they know who also know the manager they're trying to evaluate, just as Buffett talked to Sharon Osberg about John Stumpf. Manager selectors, myself especially, also spend a lot of time evaluating investors communications: their investor letters, speeches, interviews, etc.
All of these things are important, especially in a world like mine in which the lack of information about people is the singular feature. But it's important to realize that in the final analysis, reference checks and manager communications matter less than direct observation and interpretation of a money manager's behavior. The real insight you get about an investor is how they invest.
The author of this post is Nadav Manham, president of Elera Advisors LLC, an investment advisory company focused on value-oriented manager selection. Mr. Manham is also editor of The Investor's Consigliere.
Disclosure: Long Berkshire Hathaway.
April 21, 2009
Harvest Smiles As Chavez Wants To Be Our Friend
When we saw the picture of President Obama shaking hands with Hugo Chavez last weekend, with Chavez reportedly saying he wanted to be our "friend," another picture came to mind -- that of U.S. oil company Harvest Natural Resources (NYSE: HNR) perhaps deriving some value from its large Venezuelan oil and gas producing assets.
We discuss HNR in the new issue of Downside Protection Report.
Disclosure: Long HNR. For additional disclosures, see http://www.manualofideas.com/terms.html
IMF Says Bad Asset Writedowns Could Reach $4 Trillion
In a new Global Financial Stability Report, released today, the International Monetary Fund sends a stark warning to economic and political leaders, asserting that more will have to be done to shore up the financial system.
The IMF estimates that "writedowns could reach a total of around $4 trillion, about two thirds of which would be incurred by banks." Writes the IMF, "Without a thorough cleansing of banks’ balance sheets of impaired assets, accompanied by restructuring and, where needed, recapitalization, risks remain that banks’ problems will continue to exert downward pressure on economic activity."
While the IMF acknowledges that "there has been some improvement in interbank markets over the last few months," the report also states that "funding strains persist and banks’ access to longer-term funding as maturities come due is diminished."
Of course, when reading the IMF's report, it should be remembered that the IMF is hardly a disinterested bystander. Rather, the mission of the IMF is to support global economic growth and financial stability. By warning that losses could reach into the trillions, the IMF is essentially giving cover to politicians eager to increase the size of their bailouts of the financial system.
Related resource: statistical appendix to the IMF report, containing many interesting charts and figures.
Buffett: California real estate "has flattened out with good volume recently"
In an interview with CNN Money, Berkshire Hathaway chairman Warren Buffett provides interesting insight into Wells Fargo and the banking business in general. He also states that,
California residential real estate is not deteriorating. It hasn't moved up. But it has flattened out with good volume recently. So my guess is that the option ARMs will work out about as they guessed.
On Wells Fargo, Buffett comments,
Those guys have gone their own way. That doesn't mean that everything they've done has been right. But they've never felt compelled to do anything because other banks were doing it, and that's how banks get in trouble, when they say, "Everybody else is doing it, why shouldn't I?"
Buffett adds,
Wells just has a whole different attitude. That's why Kovacevich calls them retail stores. He doesn't even like the word banking. I mean, he is looking to have a maximum enduring relationship with many, many millions of people. Tens of millions. And at the base of it involves getting money in very cheap. When you do that that's a helluva start in the business. The difference between getting your money at 1-1/2 % and 2-1/2% on a trillion-dollar asset base is $10 billion a year. It's hard to overemphasize that. He thinks more like Sam Walton than he thinks like J.P. Morgan.
On book value as a metric of valuing banks, Buffett asserts,
You don't make money on tangible common equity. You make money on the funds that people give you and the difference between the cost of those funds and what you lend them out on. And that's where people get all mixed up incidentally on things like the TARP. They say, 'Well, where'd the 5 billion go or where'd the 10 billion go that was put in?' That isn't what you make money on. You make money on that deposit base of $800 billion that they've [Wells Fargo] got now.
Buffett then provides his favorite metric for valuing banks:
It's earnings on assets, as long as they're being achieved in a conservative way. But you can't say earnings on assets, because you'll get some guy who's taking all kinds of risks and will look terrific for a while. And you can have off-balance sheet stuff that contributes to earnings but doesn't show up in the assets denominator. So it has to be an intelligent view of the quality of the earnings on assets as well as the quantity of the earnings on assets. But if you're doing it in a sound way, that's what I look at.
Once again, it appears Buffett is way ahead of pundits who are declaring the banking business all but dead. Whenever there is carnage in an industry, most observers and investors have a hard time imagining that things will ever change -- even if the industry will be needed for a long time to come. This is what makes for market bottoms. It also produces attractive long-term investment opportunities for those with the imagination and patience to envision what will be rather than what is.
Disclosure: No positions.
April 20, 2009
Latest "Magic Formula" Screen Results (based on this year's EPS estimates)
"Magic Formula" investing is based on a simple yet powerful way of searching for undervalued stocks. According to Joel Greenblatt’s The Little Book That Beats The Market, portfolios of stocks selected quantitatively based on MFI criteria have handily outperformed the S&P 500 over the past couple of decades.
Why We Like Magic Formula Investing
Advocated by "super investor" Joel Greenblatt. Greenblatt invented MFI as a do-it-yourself version of the approach he has espoused while amassing one of the most impressive investment track records of all time. While reliable data on Greenblatt's complete track record is not available, some estimates put his annualized returns over the past couple of decades at well north of 20%. From 1985-1994, Greenblatt managed the Gotham Partners hedge fund, reporting annualized returns of 50% (after expenses, before performance fees). Gotham returned all outside capital in January 1995.
Simple. The MFI screen ranks companies based on only two variables: "cheapness" (pre-tax unlevered earnings yield) and "goodness" (return on capital employed). The two rankings are given equal weight in the final compilation of the MFI Top 100. This simple process stands in stark contrast to most quantitative screening methods, which rely on multiple variables and are difficult to replicate.
Makes sense. Few investors would prefer a bad business to a good one, and few would purposely ignore the price they pay for a stock. MFI seeks out good companies that are available at good prices. The result is a list of businesses that offer both a high earnings yield and a relatively high probability that capital reinvested in the business will generate high returns. It makes intuitive sense that such stocks should outperform.
Latest "Magic Formula" Stock Screen Results (based on this year's EPS estimates)
Click here to download the latest screen results.
- MCG Capital / MCGC
- Torchmark / TMK
- Web.com / WWWW
- Allied Capital / ALD
- World Acceptance / WRLD
- Walter Industries / WLT
- Unum Group / UNM
- EarthLink / ELNK
- Protective Life / PL
- Innophos / IPHS
- Endo Pharma / ENDP
- Phoenix Companies / PNX
- Prospect Capital / PSEC
- FirstEnergy / FE
- Molina Healthcare / MOH
- CNA Surety / SUR
- Terra Industries / TRA
- Southern Union / SUG
- Portland General / POR
- Pepco Holdings / POM
- Humana / HUM
- CF Industries / CF
- Ness Technologies / NSTC
- Entergy / ETR
- Cal-Maine Foods / CALM
- Joy Global / JOYG
- 3Com / COMS
- American Oriental / AOB
- Energen / EGN
- Hercules Technology / HTGC
- TECO Energy / TE
- Caraco Pharma / CPD
- True Religion / TRLG
- American Capital / ACAS
- NetScout Systems / NTCT
- GameStop / GME
- UniSource Energy / UNS
- Fuqi International / FUQI
- A-Power Energy / APWR
- Harleysville Group / HGIC
- Continucare / CNU
- CenterPoint Energy / CNP
- Sepracor / SEPR
- AgFeed Industries / FEED
- China-Biotics / CHBT
View this stock screen in PDF format.
Learn more about 10x45 Bargain Hunter.
Disclosure: No positions.
Irving Kahn, Walter Schloss and Seth Glickenhaus Offer Their Unique Perspective
Noted investors Irving Kahn, Walter Schloss and Seth Glickenhaus have managed money since the Great Depression. They recently shared their perspective on today's markets in the Wall Street Journal. Reshma Kapadia starts off by taking us into the office of centenarian Kahn:
Irving Kahn sits at his cluttered desk, peering at his computer screen through thick, dark glasses. The Dow inched up 38 points today, a small move in light of its 332-point drop earlier in the week. But Kahn has made a career of betting on beaten-down stocks, and he's hard at work poring over annual reports and studying balance sheets looking for companies that have lots of cash, not much debt and good long-term growth prospects. General Electric has a solid business and looks pretty good at these prices, he muses. General Motors? Not so much.
Like a lot of us, Kahn has seen good times and bad, bull markets and bear markets, recessions and recoveries. But he's also seen something most of us haven't: the Great Depression. Kahn, who still shows up at work every day and puts in a good six hours, worked as a stock analyst and brokerage clerk on Wall Street in the 1930s. He's 103 years old.
That's right — 103. As pundits half their age dominate the airwaves with prognostications on whether the next Great Depression is just around the corner, a small group of overlooked folks who not just lived through it but worked through it — on Wall Street — are still here. What's more, they're still at it, running their own sizable portfolios and, in a few cases, managing money for clients. Despite innumerable bull and bear markets, 17 presidents, and countless economic policies, they've remained remarkably true to their investing philosophy. They've also remained remarkably true to their methods: Forget BlackBerrys; most of them hardly touch their desktop computers. And you won't find CNBC blaring in their offices throughout the day; that's more noise than news to these gentlemen. Instead, you'll find stacks of reading material (these guys actually read a firm's annual report before investing) and a lot of old-fashioned...what do you call it? Oh, right. Math.
This cohort has perspective most of us lack: They know what the Depression looked like and how it felt. They saw bread lines on the street and despair in the faces of friends and strangers. Some lost money in the stock market, while others made enough to make it through the Depression rather comfortably. A few began their 80-year careers working for a legendary investor whose investing principles are still taught in business schools. And their take on today's markets might surprise you.
April 19, 2009
More Fed Posturing on Inflation
Federal Reserve Vice Chairman Donald Kohn and New York Fed Bank President William Dudley are quoted as saying yesterday that they have virtually no worries about inflation. Writes Bloomberg,
Vice Chairman Donald Kohn, speaking yesterday in Nashville, Tennessee, said the Fed has loaned to "sound" borrowers and plans to disclose more about such credit. New York Fed Bank President William Dudley, speaking at the same conference, said he's "not worried at all that" a doubling in the central bank’s balance sheet to $2.19 trillion will spur inflation.
These are strong words from Fed officials, as "sound" may not be the first word a disinterested observer would choose to describe institutions that have recently been in need of Fed loans. And while it's nice to know that Dudley is "not worried at all," we wonder if he was at all worried about the housing market back in 2006.
One thing seems clear: When public officials sense a need to speak unequivocally on an issue that at best warrants equivocation, you know there is reason for concern. Usually, we hear this kind of talk from countries vulnerable to attacks on their currency or from desperate borrowers in need of putting on a good face to maintain the confidence of their lenders.
Bloomberg goes on to say,
The increased credit has provoked concerns prices will surge. Central bank officials are "dramatically underplaying the risks and liability side of the balance sheet," former St. Louis Fed President William Poole said in an interview at the conference.
"We are very vulnerable to an inflation explosion," said Poole, a senior economic adviser to Merk Investments LLC in Palo Alto, California.
When given a choice to believe a former government official who clearly knows the subject at hand, or a current government official with a vested interest in the success of current policy, we are inclined to choose the former. Certainly, when you have someone of Poole's stature making an unequivocal statement as to our vulnerability to accelerating inflation, one might expect Fed officials to address the concern a bit less glibly than to say they are "not worried at all."
Ironically, it was Kohn himself, perhaps speaking during a moment of unscripted freedom, who said earlier this month that "the trick will be unwinding this balance sheet in a timely way to avoid inflation."
Disclosure: Affiliates of this blog are short 30-year Treasury Bond futures in anticipation of rising yields and falling prices.
April 17, 2009
2008 "Annus Horribilis" For Leucadia
In their 2008 letter to shareholders of Leucadia National (NYSE: LUK), released on April 15th, chairman Ian Cumming and president Joe Steinberg describe 2008 as a year in which "everything came tumbling down." Leucadia reported a staggering loss of $2.5 billion on tax asset writeoffs ($1.7 billion), markdowns of investment securities ($700 million) and interest expense and other items.
Cumming and Steinberg explain the idiosyncratic nature of the tax asset writeoff by providing some color on how tax assets are accumulated in the first place and how they are monetized (hint: you need profits to derive any value from such intangible assets). The Leucadia co-heads state that in the past the company "bought assets and companies that were in extremis and as a result of shepherding them through Chapter 11 we acquired not only a good business, but also a tax loss carryforward or other tax benefit. One such company was WilTel Communications."
The letter discusses in some detail Leucadia's major investments, most of which suffered a disastrous year in 2008. Two of the more prominent investments are investment banking firm Jefferies (NYSE: JEF) and subprime auto lender AmeriCredit (NYSE: ACF).
While reflecting on the past and suggesting they might have quit after paying out a special dividend some ten years ago, Cumming and Steinberg remind shareholders about the continuity of Leucadia's business model over the past three decades:
"We tend to be buyers of assets and companies that are troubled or out of favor and as a result are selling substantially below the values, which we believe, are there. From time to time, we sell parts of these operations when prices available in the market reach what we believe to be advantageous levels. While we are not perfect in executing this strategy, we are proud of our long-term track record. We are not income statement driven and do not run your company with an undue emphasis on either quarterly or annual earnings. We believe we are conservative in our accounting practices and policies and that our balance sheet is conservatively stated."
In addition to maintaining a value discipline, "a theme of [Leucadia's] investing [over the past several years] has been to make some investments in those things which are likely to increase in value as the underdeveloped world acquires the means to increase their standard of living." This has included investments in commodity producers, including mining companies Fortescue, an iron ore miner in Australia, and Cobre Las Cruces, a Spanish copper mine. With sharp recent declines in commodity prices, Cumming and Steinberg warn that "patience will be required" to see these investments reach their full potential.
While generally sticking to their guns, the Leucadia co-heads readily admit that it will take an economic recovery for Leucadia to grow shareholder value. Cash flows from the company's manifold operating businesses do not currently cover corporate interest payments, making cash management and cost reductions a top priority. This dynamic also constrains Leucadia on the investment front at a time when true value investors like Cumming and Steinberg have got to be as excited as ever about the opportunities available to them.
While Leucadia is undoubtedly less well positioned to take advantage of the current downturn than company management would like, we have little doubt the company will survive -- and eventually thrive. Leucadia has always tried to make investments in assets that are worth substantially more than the purchase price, and they appear to have succeeded at doing so. Unfortunately, sometimes it takes years for Ben Graham's proverbial Mr. Market to come around to agreeing with those who are right. Indeed, "patience will be required."
Disclosure: No position.
April 16, 2009
Jack Bogle's Investment Advice
BusinessWeek shares some of the sage retirement investing advice of respected investor John Bogle, founder of The Vanguard Group:
The Stock Market
"If you can't afford to lose one more penny," says Bogle, "get out. But, if you're in your 20s to 40s, keep going. These are good values. The stock market has taken an awful lot of this mess into account, and it's hard for me to believe that common equities won't do better than Treasuries from this point on." Bogle thinks that a 7% nominal return -- more than twice Treasury bonds -- is realizable over the next decade.
Simple Math
Bogle's "relentless rules of humble arithmatic" show the importance of being vigilant about costs. A dollar invested over 50 years at 8% a year compounds to just under $47. But dock just 2% for expense ratios and transaction costs and you're down to $18. Back out another three percentage points for inflation and you're at $4.38 -- less than a tenth of your potential catch.
On Timing and Chasing the Sector du Jour
"The stock market's day-to-day is actually a distraction to the business of investing," according to Bogle. His point: The past century of data show that American businesses have grown at an annual rate of about 9.5%, with 4.5% from dividend yields and the remaining 5% from earnings growth. The simultaneous aggregate return on bonds averaged 5%. These are the realistic benchmarks to focus on. "It's all simplicity, mathematics, and common sense," he says. In other words, calibrate your expectations to these long-term figures, a discipline that requires you to ignore the pull of solar, B2B, nanotech, or whatever last year's hot sector was.
Sales Ethics and Practice
Caveat emptor for investors: Don't assume your retirement provider or money management firm espouses a standard of honesty, full and fair disclosure, or putting its clients' interests first. The industry is quietly bifurcated into salesmen and professionals. That is why Bogle is urging Washington to enact a federal standard of fiduciary duty to mandate prioritizing clients, avoiding conflicts, and disclosing all fees.
Overextended Treasuries
"Bond prices are already high. Stocks should do 3 or 4 percentage points better than bonds."
Act Your Age
The percentage of your portfolio in bonds should roughly match your age. For example, a 30-year-old investor would be 30% in fixed income -- a 75-year-old, 75%.
Where's the End?
This downturn could last 1 years to 2 years. But the stock market will recover months before a turnaround comes. Don't try to time your entry.
April 15, 2009
Century Management on Inflation Risks
Michael Mauboussin: Financial Wisdom in Unconventional Places (video)
Downside Protection Report Highlights Harvest Natural Resources (NYSE: HNR), Gravity (Nasdaq: GRVY)
The latest issue of the acclaimed monthly newsletter for value-oriented investors, Downside Protection Report, has just been published. The following is the editor's commentary:
Dear Fellow Idea Seekers,
Last month, we discussed investors’ tendency to look for perfection in their investments. We argued that perfection was not achievable, as a perfect business does not come at a perfect price. As investors, we are forced to compromise, weighing the price we pay against the value we get.
The compromises we struck in the March issue appear to have been good ones, at least so far: K Swiss (Nasdaq: KSWS) and Sierra Wireless (Nasdaq: SWIR) are up 19% and 66%, respectively, since we recommended them, while the S&P 500 Index has gained 9%.
In this issue, we highlight two more imperfect candidates—Harvest Natural Resources (NYSE: HNR) and Gravity Co. (Nasdaq: GRVY). Once again, we like the compromises we are making, as it seems Mr. Market is compensating us handsomely for what’s wrong with these companies while extracting hardly any price for what’s right.
In the case of Harvest, investors appear to be focused on the fact that the company’s primary producing assets are in Chavez-ruled Venezuela, while ignoring the fact that 84% of Harvest’s market value is accounted for by cash deposited in domestic banks, with additional value tied up in several high-potential exploration projects outside of Venezuela. We show that the current valuation provides a robust margin of safety, at the same time providing us with enviable upside potential.
The case for Korean online games developer Gravity is even clearer. After repeatedly disappointing investors with operating losses and poor execution on new games, Gravity brought in a new CEO last August. While much work remains to be done, initial results have been positive. The company has restored double-digit revenue growth and turned solidly profitable. The only one not noticing this inflection point seems to be Mr. Market. Gravity still sells for $27 million, or well under five times the apparent operating income run rate. Oh, and did we mention that Gravity has more than $40 million of cash and no debt?
We do caution that Gravity is a microcap stock with low trading volume. As a result, any purchases should be made deliberately and spread out over time. There is no need to overpay—even for a good thing.
Sincerely,
John Mihaljevic, CFA
Editor, Downside Protection Report
To read this month's issue of Downside Protection Report, log in or start your 30-day FREE trial.
Disclaimer: 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.
April 14, 2009
Message to Nassim Taleb: You Can't Kill Off Black Swans
Finally self-styled investment prophet Nassim Taleb is hearing some criticism from various corners. He recently wrote an opinion piece for the Financial Times entitled Ten Principles for a Black Swan-Proof World. A few folks responded, including Felix Salmon, Connor Clarke and, most notably Charles Davi, who laments The Unbearable Lightness of Nassim Taleb. (Thanks to the blog SimoleonSense for bringing us this discussion.)
While we enjoyed Taleb's original book, Fooled by Randomness, in which he discussed the illusion of causality and aptly invoked "black swans," did he really need to put out another book to expound on those black swans? Of course, by the time the second book became an option, black swans had become fashionable in the world of finance, so why not ring the register one more time?
One doesn't need to read Taleb's Ten Principles for a Black-Swan Proof World to wonder how in the world one can black-swan proof anything by following a list. After all, black swans are not literally little black animals swimming on lakes. They are unpredictable, out-of-the-ordinary events, or what the former defense secretary might call "unknown unknowns." To have the father of the black swan theory essentially say that we can do away with black swans by following a recipe flies in the face of everything he has asserted about black swans. His recipe destroys the credibility of his entire previous train of thought.
(Not) to pile on, we observe that Taleb the investment manager appeared to be advocating losing a bit of money in your investments in normal times, presumably by buying out-of-the-money put options and the like. Then the "black swan" would come and you would make a killing -- or certainly enough to retire to a tropical island and to never be seen on the talk show circuit again. Unfortunately, there have been a few sightings of Taleb the investment manager here, here, here, here, here, here and here (no, those are not tropical islands). If he is not tanning in the Caribbean following the biggest black swan since the Great Depression, then what kind of black swan will it take? Or are we simply dealing with another author whose 15 minutes of fame have been stretched a bit too far?
April 13, 2009
Why Monkeys Outperform Most Portfolio Managers
The author of this post is hedge fund manager Nick Gogerty.
Occasionally, a bored business publication, goes to the zoo, rents a monkey and pits him or her against a mutual fund manager. Lo and behold the monkey who doesn't know a beta from a bunghole beats a significant majority of the active managers. Barron's should probably create a yearly Monkey Roundtable.
These Journalists must be pretty good monkey pickers and should probably start a MFoF (Monkey Fund of Funds) charging 2% and 20%. We are the Third Chimpanzee and it seems as if evolution must have robbed us of our stock picking skills, but boy can we pick monkeys.
So what is going on? Charlie Munger and Warren Buffett both hint at it in various writings and books, my favorite is Charlie's Poor Charlie's Almanack. Warren calls it de-worsification, or the fact that many portfolios get worse as more components are added to them. The theory which he pretty well proves via his actions is that the more holdings you have the less likely you are to know a lot about any of them. He doesn't say it, but most managers also jump the median, the investment equivalent of jumping the shark. Buffett and Munger both hint at investing being similar to pari mutuel betting.
The reason mean monkeys beat median jumping clowns is that most fund managers really don't understand the sustainable economic value drivers behind the businesses they invest in and therefore can't allocate well at the individual equity level.
Mean monkeys picked by journalists have one of the key behavioral principles in investing -- ignorance. They don't know or even pretend to know anything.
Stock returns, as exhibited on page 73 of Meb Faber's great new book, The Ivy Portfolio, show the problem. Stock returns are log normally distributed, having fat tails.
The charts are sourced from Blackstar funds and reflect data from 1983-2007.
The mean-ignorant monkeys
When I tell my wife that ignorance and apathy are key investment traits, she just rolls her eyes. Put another way, know what you don't know and be patient; activity kills in this game. Ignorant Mean Monkeys beat funds because they allocate naively, ie, equally, in their portfolios. God forbid the monkeys start running mean variance optimizers or the game is over. Mean variance portfolio allocation is probably one of the most costly rear view mirrors of all time.
Suppose that out of the Universe of 8,000 equities above Mr. Mean Monkey takes on Mr. or Ms. Median-Jumping Manager by throwing his darts. Most of these competitions stop right there. Rarely do the journalists ask the monkey about next quarter's earnings projections or where the Dow will be next week. The Monkeys bets are spread equally across the selected equities and the race with the clowns is on. The clowns' performance is usually measured by their funds' returns.
The Monkeys should perform roughly the same as a naive (unweighted) index with a small cap bias. Why? The monkeys are simply taking a random sample of the markets, so the returns should be roughly equivalent to the chart above. The smaller cap bias will reflect the greater number of smaller cap firms present in any sampled universe of investable firms.
Imagine that from the 8,000 stocks the monkey selects 8. One could think of the chart above broken into 8 bins. That is what the monkey's return will equate to. The monkey is an approximate unbiased sample of the market.
Send in the median jumping Clowns
The active fund manager "median jumper" clown does the same thing with his or her 8 picks, ideas, gambles, allocations or whatever glossy euphemism he or she uses in their marketing literature. But the clown is at a disadvantage because they don't know what they don't know, so they decide to weight the portfolio according to the "best" picks. Uh oh, here is where the trouble starts, they just jumped the median and probably picked something closer to the mode, the most commonly occurring sample.
The median is not the mean
The statistical mean is what most people consider the average of returns. More importantly is the median and mode, the most likely sample to be chosen and the number separating the higher and lower half of the sample. It works like this. You and 7 of your friends find yourself in a room playing bridge with Bill Gates and Warren Buffett. The mean (average) net worth of the individuals in the room is measured in the billions, but you don't feel any richer because most likely you are one of the 8 representing the mode or most common sample in the room which is below the median and the mean.
The median and mode for shares' returns are actually well below the cap-weighted index, which is closer to the mean. The charts above indicate 64% of shares underperform the index. This means that managers who "tilt" or weight their portfolio to their best idea are statistically taking a random sample and doing bad things, increasing the odds of picking a sub-index performer and in so doing also diminishing the allocations to the potentially significantly positive outliers that help deliver the mean performance.
This is classic behavior flaw 101, people with more information believe they know more about something. So the fund managers take the useless sell side research reports, technical analysis and other hocus pocus that they haven't back-tested or thought through, and they park a few more chips on red.
Few managers really understand businesses. Not many money managers have actually run a competitive business and understand the dynamics of a "market for goods and services". When it comes to fund management and equity selection, I will bet on a humble person who has run a successful small business over somebody who can tell me what they think the Fed is doing.
Stock "business" selection skills are different from macro economic analysis and best learned by doing. People straight from school and fed into the investment banking world are put into an environment that demands answers even when there any. Smart people who don't have answers or admit ignorance get weeded out. This is an environment rarely interested in posing interesting new questions, which is a far more interesting and important skill requiring imagination. Even Buffett ran a gas station into the ground and probably learned as much from it as from his Columbia MBA.
Transaction and operational costs etc. also injure manager returns. This is the case of apathy/ patience proving things out. Fund managers are like trapped animals. They get caught, then get nervous and waste energy trading and allocating instead of sitting quietly and thinking about what the dynamics of the game they play truly are. My suggestion: Shut off the screen and blackberry and go fishing etc. for awhile and reflect, maybe a few answers will pop into your head, if you are truly lucky a profound question will arise.
The well-known reality is that most fund managers underperform a passive representative index. Managers don't know what they don't know. They are often in the giving answers business as they rise from analysts to portfolio managers, some are just great salesman stock brokers. Cramer is the worst public example of an analyst gone wild. He is a bottomless pit of useless answers filling the airwaves to pimp cars, cereal and pills for CNBC. Felix Salmon has his own equivalent answer hole in Ben Stein.
An answer hole (my term) is a bottomless pit where questions are thrown in and answers are always on offer. The only thing not found in the answer hole is an honest phrase such as "I don't know."
Most Mutual Fund Managers could significantly increase their long term performance with an equivalent naive asset allocation across the board and less activity, assuming they have a random sample. They could at least aspire to mean monkey performance and still get the fun of throwing darts while causing less harm.
April 12, 2009
David Dreman: Fired But Unbowed
The New York Times writes about value investor David Dreman:
David N. Dreman was a star mutual fund manager. Then he bought bank shares and held on as the financial crisis grew.
Now he has been fired from the flagship fund that bears his name, despite what remains a good long-term record. The fund’s name will be changed, and the fund will take fewer risks. A drab industry will become a little drabber.
In the past, the firings of once-celebrated fund managers have sometimes provided a market signal of its own — that the trend that led to their poor performance was about to end. If that were to happen this time, there could be a revival for so-called value stocks, and particularly for the beaten-down and almost universally disdained financial stocks.
“The success of contrarian strategies requires you at times to go against gut reactions, the prevailing beliefs in the marketplace and the experts you respect,” Mr. Dreman wrote in his best-selling 1998 book, “Contrarian Investment Strategies.”
April 10, 2009
Ben Graham's 75 Year-Old Approach to Investing Still Works
According to Mark Hulbert of Barron's, Ben Graham's investment approach would have protected an investor's portfolio through the current downturn better than other approaches.
Will Goldman Sachs Raise Equity to Repay Government?
Reuters reports that,
Goldman Sachs Group Inc is considering making a multibillion dollar share offering to investors as part of its efforts to repay a $10 billion government loan, the Wall Street Journal reported citing people familiar with the matter.
The announcement could be made as early as next week and though Goldman executives haven't determined the exact size of the offering, it is expected to be at least several billion dollars, the people told the Journal.
Normally, companies raise equity to pay down debt when they believe their stock price is inflated. In this case, however, it is a bit harder to tell what Goldman management is truly thinking because paying down TARP funds may actually be seen as a sign of increased confidence by management that the bank can go it alone.
It will be interesting to see how investors react. Our guess: Goldman shares will come under pressure in the days ahead.
Disclosure: No position.
Paul Krugman: The Global Economy
Robert Shiller: How Animal Spirits Drive the Economy (video)
Bruce Greenwald: Five Minutes on Value Investing (video)
Thanks to SimoleonSense for finding this video.
April 09, 2009
Notes, Replay and Transcript of Call with Bruce Berkowitz and Pfizer CEO, March 30, 2009
Pfizer (NYSE: PFE) is the top holding of The Fairhome Fund and accounted for 19% of fund assets as of November 30th. Fairholme chief and noted value investor Bruce Berkowitz arranged the Pfizer call on March 30th. Listen to the conference call. Read the transcript.
We have tremendous respect for Berkowitz, and his investment in Pfizer looks shrewd. Pfizer is a strong company with many good pharmaceutical businesses that earn high returns on capital. With consensus EPS estimates of $2.05 for 2009 and $2.31 for 2010, the stock looks dirt cheap at roughly $14 per share. Key events affecting value are the pending acquisition of Wyeth and the Lipitor patent expiration in 2011. Fairholme's Berkowitz likes the "quality balance sheet of a company producing vital products."
While Pfizer appears highly likely to outperform the broader market in coming years based primarily on the company's low multiple of prospective earnings, we were not very impressed by CEO Jeff Kindler and CFO Frank D'Amelio's performance on the March 30th call. They struck us as a highly polished duo steeped in business-school speak. We did not find the executives' comments specific enough to gain comfort that management truly seeks to maximize returns on capital. The Wyeth deal, for example, can easily be seen as "empire building" rather than "value building." Nothing the executives said convinced us that the Wyeth deal will grow per-share shareholder value.
Highlights -- Jeff Kindler, CEO, and Frank D'Amelio, CFO, Pfizer:
- Wyeth is a "perfect fit" for advancing strategies articulated by Pfizer a year ago
- "New Pfizer" will be "very competitively positioned" in fast-changing healthcare environment
- Deal "strengthens platform" for "stable and consistent earnings growth"
- "Long before we contemplated doing the Wyeth deal... we said to ourselves [in late 2007 and early 2008], we've got this Lipitor expiration at the end of 2011 -- what kind of company do we need to be to be successful after that event...? We concluded... that in many fundamental ways we had to change and evolve our business model to become much more relevant to a broader array of patients... with the right mix of health care product offerings."
- "Relentlessly focused on delivering value to shareholders"
- $4 billion in synergies from Wyeth (half from SG&A, half from R&D and manufacturing)
- Targeting operating cash flow in 2012 of $20+ billion.
- "Not immune to global economic downturn" (higher co-pays have an impact)
- "Seen some slowing in the emerging markets"
- How big a threat is government action to force price reductions?
- In Europe, "price pressures have been a part of the operating environment for a long time."
- The U.S. is "a very different situation..." There is a "significant effort underway in Washington to adopt health care reform..." "...see some actually encouraging signs in that regard..." It's "very encouraging" that President's budget did not include repeal of the Medicare non-interference clause. "...do not see any sign that there's going to be a really serious effort to control or restrain our prices in a way that would be damaging to innovation or to our business model."
- "Pharmaceutical spending growth is very low right now. It's at the lowest it's been in 50 years due to patent expirations and slow growth of new products."
- Insurance companies giving preferential treatment to generic drugs is "ongoing challenge."
- Dividend was cut in half to $0.64 per share per year.
Could SDRs Threaten Dollar?
At the recent G20 summit in London, political leaders agreed to create $250 billion of special drawing rights (SDRs), which will be exchangeable into a basket of currencies rather than just the U.S. dollar.
With the dollar continuing to enjoy the position of world's de facto reserve currency, any major issuance of paper money that can be used globally and redeemed into multiple currencies represents at least partly a challenge to the U.S. dollar. However, the prevailing view still seems to be that SDRs cannot threaten the dollar's leadership position, at least not when "only" $250 billion of SDRs are issued. A ten-fold increase in the value of SDRs would probably threaten the monetary supremacy of the U.S. globally, but this is unlikely to occur any time soon.
There are rising signs that China is growing worried over its dollar reserves. According to Reuters,
Some experts think China wants to redenominate some of its huge dollar holdings into SDRs without selling dollars on the open market – which would risk a crash in the US currency and a fall in the value of its reserves. But they say the US and the other countries whose currencies make up the SDR are unlikely to agree.
First Eagle's McLennan Likes Shimano, Nestle, Gold
Matthew McLennan, manager of the First Eagle Global Fund, comments on his fund's approach and his favorite stock investments.
First Eagle funds have benefited from a solid long-term investment approach, which has been ingrained into the funds' culture thanks to the leadership of founder and famed value investor Jean-Marie Eveillard.
When the Hunter Becomes the Hunted
One of Europe's most feared activist investors finds himself in the hot seat as shareholders in his vehicle Principle Capital Investment Trust plc ('PCIT') reassert themselves. Click here for the latest in the battle of Brian Myerson against his former backers QVT, Invesco Perpetual and EIM. For the latest annual report including a list of PCIT portfolio investments follow this link.
Frank Martin's Fireside Chat
Noted value investor Frank Martin of Martin Capital Management held another of his "fireside chats" on April 2nd. Read the transcript or download the audio file in MP3 format.
Notes from Warren Buffett Meeting on March 13th
Every year, Wharton Business School students visit Warren Buffett in Omaha. Here are this year's notes, compiled by Anix Vyas.
During the visit, Buffett was asked how he values gold:
Buffett commented: “Absent the total destruction of paper money, gold is a terrible investment.” He mentioned that people think that gold is a good way to hedge, but he challenged that belief and said that the best protection in an environment like today is to retain enhancing purchasing power. Gold is an instrument that fails to really do this, has “zero utility” and only “mystique.”
April 08, 2009
Berkshire Hathaway Downgraded by Moody's
Moody’s cut the long-term issuer rating of Berkshire Hathaway to Aa2 from Aaa today.According to Moody's, there has been "a meaningful drop in earnings and cash flows, particularly for businesses tied to the US housing market, construction, retailing or consumer finance." Moody's went on to state, "These extraordinary market pressures have reduced the excess cushion available from National Indemnity and the other affected operations to support potential funding needs of the parent company."
While this downgrade is noteworthy because Buffett prided himself on having a Aaa rating, it appears that the judgment of the folks at Moody's is once again impaired.
First, Moody's rated all sorts of mortgage-linked junk as Triple-A. Now, they strip one of the strongest and most conservative companies in the world of the Triple-A rating. Perhaps this is truly the final argument against credit rating agencies, at least of the Moody's and S&P kind.
LTCM's Robert Merton Wants You To Listen
Economics Nobel laureate of Long-Term Capital Management fame, Robert Merton, recently spoke about financial markets. Merton is clearly a genius in some areas but he has also been spectacularly blind-sided in the past. We would much rather listen to people like Warren Buffett and David Swensen. However, when we feel like delving deeper into some of the complex financial issues that got us into the financial mess we're in currently, Merton can clearly provide some insight.
Goldman's Blankfein: Banks Had Unjustifiable "Swagger" and "Overvalued" Their Contributions
Kevin Byun's Q1 Letter to Investors: "...many interesting opportunities presented themselves at the end of the first quarter..."
Up-and-coming value investor H. Kevin Byun is the founder and managing partner of Denali Investors. Investment funds managed by Byun generated a gross return of +28% for the full year and +43% for the fourth quarter of 2008. In the first quarter of 2009, Byun was down 6% while the S&P 500 declined 12%. We will continue to keep Byun on our watchlist, as his investment strategy appears to be sound and well executed.
Read Kevin Byun's Q1 2009 letter to investors.
April 07, 2009
Eyepopping: U.K. & U.S. Government CDS Spreads
Nick Gogerty of Designing Better Futures makes some interesting points on credit default swap (CDS) spreads on government debt.
We understand why all sorts of CDS spreads would have blown out in the current financial crisis, but the U.S. government is one entity we're not worried about. With Uncle Ben able to print as much paper as it takes to satisfy the nominal claims on the U.S. Treasury, we don't see how an actual default is in the cards. If there were CDSs that referenced the U.S. government's ability to pay off its obligations in real dollars, however, we would be all over those instruments.
AIG Payments to Goldman Sachs Probed
Bloomberg reports on an investigation into taxpayer money that recently flowed through AIG to Goldman Sachs and other banks:
The Treasury’s chief watchdog for the U.S. financial rescue program is probing whether American International Group Inc. paid more than necessary to banks including Goldman Sachs Group Inc. after the insurer’s bailout.
Neil Barofsky, special inspector general for the Troubled Asset Relief Program, opened an audit last week into whether there were attempts made by New York-based AIG or the government to reduce the payments, according to an April 3 letter to Representative Elijah Cummings. The Maryland Democrat had requested the probe last month along with 26 other members of Congress.
Interview with Jean-Marie Eveillard
Robert Huebscher of Advisor Perspectives published an interview with Jean-Marie Eveillard and Abhay Deshpande of First Eagle today. Writes Huebscher,
Jean-Marie Eveillard was the Portfolio Manager for the First Eagle Global, Overseas, Gold, U.S. Value and Overseas Variable Funds, where he built one of the most successful long-term performance records in the investment business. On March 31, Mr. Eveillard transitioned to a Senior Advisory role at First Eagle Funds. In addition, we spoke with Abhay Deshpande, a Portfolio Manager for the First Eagle Global, Overseas, Gold and U.S. Value Funds.
We with Deshpande and Eveillard on March 31, thus earning the distinction of having the final interview with Eveillard prior to his transition.
Which worries you more – a decline in the dollar, rapid inflation, or deflation?
How are you positioning your portfolio to defend against these scenarios?"We have many worries, but we are not positioned against any particular outcome. Our top-down analysis is focused on those trends that will affect the intrinsic values of the companies we own. We believe the most effective defense against these scenarios is to spread risks through diversification."
You have called your billion-dollar purchase of gold “calamity insurance.” What
potential events do you perceive possible that makes such a large position
advisable? How do you go about determining your allocation to gold?"Our gold position is based on our belief that gold is a universal store of value. We believe a gold position of less than 5% of our assets is irrelevant and a position of more than 15% would be too painful if we are wrong. For most of 2008, our position was between 7-8%, but it eventually grew to almost 15%. This was not because we bought more gold, but because the value of gold rose relative to the value of the rest of our holdings."
"After World War I, during the great inflation of the Weimar Republic, the German government acted very shrewdly. They forbade German citizens from buying gold and from holding foreign currencies, and they taxed real estate very heavily. As a result, some rich farmers bought grand pianos. They did not want the paper currency being issued, because they knew it would be worthless the next day. Instead, they chose pianos as a hard asset that would hold its value. Today, we see gold as having these same characteristics."
"The current actions of the US and UK governments, through “quantitative easing” – which is really just a code word for printing more money – will be rather good for common stocks. Initially, at least, these actions will be bad for cash and Treasury bonds. At some point, they will be good for real estate and fine art. However, these actions are very good for gold."
"The path of increased money supply leads to real assets, and gold is our asset of choice. Common stocks will also benefit, as they are representative of real assets."
"Remember, the opportunity cost of holding gold is near zero, because interest rates are so low. Gold investors should keep in mind the two extremes. The government has a strong incentive to keep long-term Treasury rates low, because it allows them buy Treasury bonds to increase the money supply. At the other extreme, the government dislikes high gold prices, because it reflects poorly on their policies. This is partly why FDR, during the Great Depression, made it illegal to own gold. So, to some degree, gold investors are betting against the government."
A $37.50 Latte, Courtesy of Your Local Bank
Here is an eye-opening article on an apparently common practice among banks regarding overdraft fees on your account. Who would have thought that the banks actually try to boost overdraft fees by booking incoming and outgoing cash in the most disadvantageous way for you, their customer. We can already imagine the salesperson for a bank software package going to a bank and putting on the sales pitch: "With our software, you can maximize the harvesting of ancillary account fees, thereby dramatically boosting your bottom line. And the customer will never know!"
April 06, 2009
OID's Interview with Bruce Berkowitz
Read OID's recent interview with Bruce Berkowitz of The Fairholme Fund.
Soros: Housing May Have Hit Bottom
George Soros comments on housing and the banks in a Bloomberg video interview.
Exclusive Interview with Thomas S. Gayner, Chief Investment Officer of Markel Corporation (NYSE: MKL)
The Manual of Ideas is pleased to bring you an exclusive interview with Tom Gayner of Markel Corporation, a Richmond, Virginia-based international property and casualty insurance holding company. Tom has been President of Markel Gayner Asset Management since 1990 and Executive Vice President and Chief Investment Officer of Markel since 2004.
Tom is a true class act. He has been a disciplined steward of capital on behalf of Markel shareholders, and his long-term investment track record is one of the best in the business (see Markel’s 2008 letter to shareholders for specific figures). And, as you’ll undoubtedly learn in this interview, his other qualities are matched by an uncharacteristic sense of humility. In all of these respects, Tom Gayner has lived up to the example set by every value investor’s role model—Warren Buffett.
The following are excerpts of our interview with Tom:
MOI: You have stated that the businesses you seek should have (1) a demonstrated record of profitability and good returns on total capital, (2) high measures of talent and integrity in management, (3) favorable reinvestment dynamics over time, and (4) a purchase price that is fair or better. Perfection, however, is rarely attainable in the stock market. Have you had to compromise on these criteria, and if so, could you illuminate for us how you decide on acceptable versus unacceptable trade-offs?
Tom Gayner: While you say that perfection is rarely obtainable in the stock market, I would go so far as to say that it is never obtainable in the stock market. Perfection doesn’t exist in this world. All of my choices involve various degrees of compromise and tradeoffs. As an accountant, I can tell you that my wife and children are sick of hearing me use the phrase “opportunity cost”. Every decision is also another decision (at least) and every non-decision is also a series of other decisions.
The challenge is to get the balance roughly right between the choices that actually exist. All of the four points I lay out are north stars that guide me. I admit though, that I have never personally been to the North Pole.
The one area where I will not compromise is in the area of integrity. I may not make every judgment correctly when I’m trying to make sure I’m dealing with people of integrity but I will never knowingly entrust money to people when I am concerned about their integrity. Even if you get everything else right, the integrity factor can kill you. My father used to tell me that, “you can’t do a good deal with a bad person.” And he was right.
The other factors can be thought of as shades of gray and nuances. We look for as much of the good as we can find and weigh that against what we have to pay for it, our expectation of how durable the business will be, and what our other alternatives are. I don’t have a formula or algorithm to get that precisely right, I just spend all my time thinking, reading, and adapting as best as I can.
MOI: You emphasize the impact of the passage of time on your investments. With the trend toward compression of time horizons and a focus on short-term performance in the investment industry, we are seeing many investors—even those who consider themselves value investors—emphasizing near-term stock price catalysts. Do you see a growing inefficiency in the pricing of “boring” investments that will deliver returns over time versus investments that are expected to pay off at a foreseeable point in time?
Tom Gayner: Yes.
To expand on that one word answer, I think there is a real time arbitrage opening up right now. An old saying is that in a bull market, your time horizons grow longer and longer. In a bear market, they grow shorter and shorter. The bear market experience of the last few years compresses time horizons for a lot of people. Even if they want to remain focused on the long term, there are inevitable career risks in not putting results on the books today when people are so anxious about every aspect of their lives.
I think that means the playing field for longer term investing is getting less crowded. Fewer people are able to think about the long term and I believe that creates an opportunity to buy wonderful, long duration investments, at better prices than has been the case in the last decade or so.
Subscribers, please log in to read our entire interview with Tom Gayner, including his responses to the following and other questions. If you're not yet a subscriber, start your 30-day FREE trial of our acclaimed monthly newsletter, Downside Protection Report. Upon starting your trial, you'll receive an email with a password-protected link to the interview.
Don't miss Tom Gayner's insights on the following topics:
- How does your approach to international investing differ from that to investing in U.S. equities?
- What is the single biggest mistake that keeps investors from reaching their goals?
- You have observed a “strong connection between managing companies and investing in them.” Unlike most investors, you have had an opportunity at Markel to be intimately involved in both managing and investing. How should investors go about building this critical skill set if they don’t have an opportunity to manage a business?
- You define a “fair” purchase price as one that allows you to earn long-term returns in line with the returns on equity of the business in which you invest. When paying a “fair” price, the expected return therefore comes entirely from the business rather than from multiple expansion. Based on this definition, the recent market carnage has created an opportunity to pay less than a “fair” price for many great businesses. In Wall Street parlance, does this make you a bull?
- And other topics of interest to equity investors.
Subscribers, please log in to read the entire interview now. If you're not yet a subscriber, start your 30-day FREE trial of our acclaimed monthly newsletter, Downside Protection Report. Upon starting your trial, you'll receive an email with a password-protected link to the interview.
Tom Gayner's Book Recommendations
In our April 2009 interview with Tom Gayner, Chief Investment Officer of Markel Corporation (NYSE: MKL), we asked Tom the following question, among many others:
The Manual of Ideas: What books have you read in recent years that have stood out as valuable additions to your "latticework of mental models"?
Tom Gayner: There are a number of books that help you to think and teach you things you didn’t know. We all know Security Analysis and The Intelligent Investor and they have stood the test of time.
I think Mark Twain is a great writer and his insights and observations about human nature and money are invaluable. He was broke and rich several times in his life and his writing carries an undertone of his struggles with money. You get a twofer from Twain. You can laugh and learn at the same time.
I read endlessly. John Wooden, the basketball coach at UCLA during their dynasty is a hero to me. General Grant is a hero. Warren Buffett is a hero. Pick some good heroes and read everything you can about them.
I also like reading about history, psychology, and human nature, technological progress and scientific thought. The world is a fascinating place and you will never run out of rich material if you want to keep understanding more and more.
I think I saw a recent interview with Seth Klarman where he said something like, “value investing is the marriage of a contrarian and a calculator.” Some books, like Twain’s, the histories and biographies help you with the human nature and contrarian side of that equation. Some books, like the ones about science and technological developments, along with the accounting homework I did a long time ago, help you with the calculator side. Both elements are essential. Each is severely limited without appropriate balance and understanding from the other side.
Subscribers, please log in to read the entire interview now. If you're not yet a subscriber, start your 30-day FREE trial of our acclaimed monthly newsletter, Downside Protection Report. Upon starting your trial, you'll receive an email with a password-protected link to the interview.
April 05, 2009
Fed's Kohn: "the trick will be unwinding this balance sheet in a timely way to avoid inflation"
According to Bloomberg, "Bernanke, Kohn Pledge Fed to Withdraw Credit When Crisis Ends." This is undoubtedly easier said than done. Given the expediency of recent Fed and Congressional action, we doubt there will be sufficient political will to endanger any future recovery by withdrawing credit early enough to prevent inflation.
April 04, 2009
George Soros on G20 (video)
April 03, 2009
SEC Has Good News For Activist Investors
Corporate law firm Schulte Roth & Zabel LLP writes in a client update:
"In response to no-action requests by Eastbourne Capital Management LLC (“ECM”) and certain entities affiliated with Carl Icahn (the “Icahn Funds”) (collectively, the “Dissident Shareholders”), the staff in the Division of Corporate Finance of the SEC (the “Commission Staff”) granted no-action relief under the “short slate rule”1 permitting the Dissident Shareholders to not only solicit votes for their own nominees, but also to seek authority to vote for nominees of an unrelated dissident. The Commission Staff strictly conditioned this relief on the Dissident Shareholder’s representations that they have not, and would not, agree to act or act as a “group” as determined under Section 13(d)(3) and in Regulation 13D-G. The Commission Staff’s response also indicates that, to exercise this right, the dissident may not actively recommend the election of each other’s nominees, but may only state their intention to vote for each other’s nominees, except to the extent otherwise stated in the Dissident Shareholder’s respective proxy cards."
The client brief concludes:
"The Commission Staff’s grant of relief to ECM and the Icahn Funds will further enable soliciting stockholders who are seeking to elect a short slate to “round out” their slate with candidates from the full selection of nominees, even those proposed by another dissident. This new interpretation will allow activists to pursue their goal of achieving better shareholder representation, will allow shareholders to vote for the directors of their choice, and will keep management slates from gaining an advantage when there are multiple dissident slates nominated by unrelated shareholders. Going forward, this scenario may become more common in the activist community. However, activist investors must be careful not to run afoul of the Commission Staff’s response by acting as a group or otherwise engaging in any activities that would be deemed to cause the formation of a “group” as determined under Section 13(d)(3) and in Regulation 13D-G."
Bottom line: Shareholders may have an easier time circumventing companies' poison pill provisions when it comes to forcing change at the Board level, as long as there is more than one activist investor involved in a particular situation.
Tweedy Browne Updates "What Has Worked In Investing"
Tweedy, Browne has compiled a complimentary booklet entitled What Has Worked In Investing. It describes over 50 academic studies of certain investment criteria that have produced high rates of return. In the studies included in What Has Worked In Investing, exceptional returns were found for stocks with one or more of the following investment characteristics: low stock price in relation to book value; net current assets; earnings; cash flow; dividends or previous share price; small market capitalization and a significant pattern of stock purchases by one or more insiders (officers and directors), or by the company itself.
Paul Singer's Inconvenient Truth
Paul Singer, founder and CEO of hedge fund firm Elliott Management Corp., writes in an opinion piece in today's Wall Street Journal that there is "an urgent need for a new global regulatory initiative that addresses the primary cause of the financial collapse: highly leveraged and concentrated positions."
You heard it right, the conservative Singer appears to have had a conversion, endorsing regulation instead of market fundamentalism. Singer's new-found embrace of "some regulation" is noteworthy because he is widely known and respected in Republican Party circles. Some may remember him as a financial backer of the infamous 527 group Swift Boat Veterans for Truth. Whether Singer's opinion piece represents a true change of heart or opportunism in the face of political reality, we do not know.
April 02, 2009
FPA's Rodriguez In His Own Words
Value investor Bob Rodriguez recently spoke with IBD. Read the interview.
About Bob Rodriguez
As of April 2009, Mr. Rodriguez, who joined First Pacific Advisors in 1983, managed the FPA Capital Fund and separate accounts in the Small/Mid-Cap Value equity style. Rodriguez was also the portfolio manager of FPA New Income, a bond fund, and separate fixed-income accounts. He was expected to commence a one-year sabbatical in 2009 and then return to FPA. His prior experience includes serving as a Senior Portfolio Manager, Chairman's Department of Kaufman & Broad, Inc.; and portfolio manager at Transamerica Investment Services, Inc. Mr. Rodriguez received a BS in Business Administration (Magna Cum Laude) and an MBA, both from the University of Southern California.
An updated bio may be posted at the FPA website.
Chou Associates 2008 Annual Report
Noted Canadian value investor Francis Chou writes in his 2008 letter to investors in the Chou Associates funds:
INVESTING TOO EARLY: One of the hazards of being a value investor is that every now and then you are bound to buy stocks too early. Over the last few years, we have communicated through our letters, our deep concern about the easy credit, irresponsible lending, housing bubble and the potential dangers of derivatives like CDOs (collateralized debt obligations) impacting financial companies. As pessimistic as we were over the years, we did not anticipate how severely these factors would paralyze and cripple the financial system when the bubble did burst. There was no place to hide.
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Repricing of Risk
At the time of writing two years ago, preservation of capital was given little consideration. However, in 2008 there was a huge repricing of risk. For example, the greater the probability of permanent loss of capital, the greater the spread should be between a particular debt instrument and risk-free treasuries. Currently the spreads between the higher risk securities and U.S. treasuries are at near historic highs. Other indicators are showing that investors are running scared, and banks and financial institutions are hoarding capital instead of lending. The following are some examples:
1) Two years ago, the spread between U.S. corporate high yield debt and U.S. treasuries was 311 basis points; a year ago it was 800 basis points. Currently, it is over 1,600 basis points, down from its peak of over 1,900 basis points in December 2008. (Source: JP Morgan).
2) Two years ago, the spread between U.S. investment grade bonds and U.S. treasuries was approximately 85 basis points; a year ago it was approximately 274 basis points. It is now over 550 basis points, which is slightly down from its peak of 592 basis points in December 2008. (Source: JP Morgan).
3) In December 2008, an auction of 4 week treasury bills ended with a 0% yield (currently they are yielding 8 basis points or 0.08%). The yield on 10 year treasury is 2.94% (up from 2% in December 2008) but down from 4.75% two years ago. In September 1981, it was 15.3%.
4) Today, investment bankers and anyone working for the financial/investment industry are considered the new pariahs of society. They are the butt of jokes. My favorite one is, 'What is the difference between an investment banker and a pigeon'? 'At least a pigeon can still put a deposit on a house'.
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ZOMBIE COMPANIES: The Fed and the U.S. government have a tough job in tackling the financial crisis and, whatever actions they take, they are scrutinized, criticized and/or second guessed. There is no one perfect approach. Every approach has its pros and cons. However, where zombie companies are concerned, we would prefer to give companies that are insolvent and failing the opportunity to reorganize and restructure their capital structure in an organized way. When they do emerge from reorganization, they will come out leaner and stronger. What we are seeing now is that the U.S. government has pledged $9.7 trillion (and still counting) to counter the financial crisis. Billions of dollars have been given to prop up failing financial institutions and still they are asking for more financial assistance. The requests from the very large financial institutions are not based on business and investment merit but more on the line that if they don't receive more bailout money, they would have to file for bankruptcy and that would precipitate a chain reaction that will totally paralyze not only the U.S. financial system but also the entire Western banking system. The sooner we recapitalize the zombie companies in some form or the other (including nationalization for a short-term period) the quicker we can unfreeze the credit market and get the economy moving again.
MARK-TO-MARKET ACCOUNTING: We have been hearing of late that the current financial mess is caused in part by mark-to-market accounting. Nothing could be further from the truth. The financial mess was caused by misguided policies and actions on the part of some companies and would have occurred regardless of whether this accounting rule was in place or not. As investors, we prefer transparency and clarity and unless these rules exist, companies will not disclose what the assets are currently worth in the market. Obviously, when there are extenuating circumstances like the period we are in now, good and toxic assets may be priced at unduly low prices. In such a case, we would favour a provision that gives companies some grace period before they have to take action to shore up their balance sheets either through asset sales or by raising capital. In the end, transparency should prevail over opaqueness and undisclosed market values in the financial statements.
INFLATION: Almost all governments whose economies have been adversely affected by the financial crisis have been providing all kinds of liquidity including printing money to minimize the impact of the credit freeze on their economies. Historically, that is how nations have tackled their debt burden and this episode is no different. In the short term it may work, as the liquidity will counter some of the deleveraging and credit freeze in today's crisis. But longer term such actions can bring huge unintended consequences including the return of high inflation and the likely debasement of the U.S. currency. We don't know the timing of it but all that excess liquidity will have to go somewhere when normal times return.
MORE REGULATION: Yes, we will have a more regulated environment going forward. You can bet your last dollar on it. There is a need for regulatory reforms to ensure that, in the future, the near collapse of the world financial system does not happen again. And more regulation of financial institutions will most certainly lower their future growth and profitability. We need to also get away from the notion of 'too big to fail'. Failing financial companies have used this excuse to hold us ransom in giving them financial assistance.
PENSION ASSETS: Most corporate pension plans have a majority of their assets invested in equities. With the markets down at least 40% across the world, we can safely assume that pension assets are down significantly. Eventually, companies have to make up the shortfall of their underfunded pension assets and therefore, their cash flow and earnings will take a significant hit in the future.
RECOVERY OF THE STOCK MARKET AND ECONOMY: The economy may get worse before it gets better. However, I have strong faith in the strength and resilience of a free market system. In the 20th century, the standard of living went up seven times in spite of the Great Depression, two World Wars, the oil embargo in the 1970s, interest rates of 15% or more to combat inflation and so on. The current financial crisis is severe, probably not as bad as the Great Depression, but worst of all the recessions in the 20th century. One unitholder said, 'This market feels worse than a divorce. You lose 50% of your assets and you still have your spouse'. The good news is, if one wants to look at the current situation in a contrarian manner, most of the bad news is already reflected in the stock prices. We don't know whether the stock market has hit bottom yet but we suspect that when we look back at the current environment 10 years from now, we will classify this as one of the best periods for buying stock and debt securities.
BANKING SECTOR: Banks that have not been affected by the financial crisis will do quite well in the future. With the governments driving the treasuries to yield nearly 0%, the spread between what the banks are paying for deposits and borrowings in the market (like FDIC insured), and what they can lend at is enormous. For the first time in many years, banks are being paid handsomely for the risks they are taking. See the section under 'Repricing of Risk'.
CREDIT DEFAULT SWAPS (CDS): In general, the CDSs are way overpriced. What a dramatic difference from two years ago. To give you some sense of perspective, in October 2002, the 5 year CDS of General Electric Company was quoted at an annual price of 110 basis points. Two years ago, it was quoted at an annual price of 8 basis points and lately it is priced at over 900 points. Some pricing in the CDS market is absurd. Barrons (March 9, 2009) reported that, 'A Merrill Lynch analyst Friday noted it was more costly to protect oneself from the possibility of a default by Berkshire Hathaway (ticker: BRKA) than one by Vietnam. And General Electric (GE) CDS prices outstripped those of Russia -- a country that a dozen years ago actually did default on its foreign debt'.
Hank Greenberg Testifies on AIG
AIG founder and former chairman Maurice "Hank" Greenberg testified today during a House Oversight Committee hearing.
Coming Monday: Exclusive Interview with Thomas S. Gayner of Markel
We had the pleasure of interviewing Tom Gayner of Markel Corporation this week. Markel is a Richmond, Virginia-based international property and casualty insurance holding company. Tom has been President of Markel Gayner Asset Management since 1990 and Executive Vice President and Chief Investment Officer of Markel since 2004. Tom is revered in the value investment community for his exemplary long-term track record and unquestioned integrity.
In our wide-ranging interview with Tom Gayner, to be published this coming Monday, April 6th, Tom provides insight into his investment approach, the market inefficiencies created by what Warren Buffett calls the "institutional imperative," the biggest mistakes that keep investors from reaching their goals, and whether he is a bull or bear right now.
Don't miss this one-of-a-kind exchange of ideas -- come back right here on Monday morning.
April 01, 2009
New FREE Empirical Finance Research Newsletter (plus Stock Screen Results)
Our partners Wesley R. Gray of the University of Chicago and Andrew E. Kern of the University of Missouri present:
April 2009 (current issue) — Empirical Finance Research Newsletter on Post-Earnings-Announcement Drift: Delayed Price Response or Risk Premium?, a paper by Victor L. Bernard and Jacob K. Thomas
Abstract: The Post-Earnings-Announcement-Drift ("PEAD" for short) is one of the oldest and most persistent anomalies in the accounting literature, and traces its roots to a paper by Ball and Brown from 1968. The paper surveyed here, Bernard and Thomas (1989), is one of the most definitive. As its name suggests, PEAD is the tendency of stocks that beat earnings expectations to continue to drift upwards for about two months after the announcement, or likewise for stocks that miss earnings to continue to drift downwards. The abnormal returns associated with the drift are substantial. Even though the phenomenon has been known for several decades now, it is fair to say that not only has the phenomenon persisted but that its cause is still unresolved as well. This paper contributes to that debate.
Conclusions: The post-earnings-announcement-drift is a good phenomenon to exploit because it has been so persistent over time. Today's researchers remain puzzled as to how something like this can endure in light of tremendous competition among investors. The fact PEAD hasn't changed since it was first discovered in 1968 should serve as reassurance that a strategy based on this strategy will remain profitable into the future.