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A new issue of the acclaimed monthly investing newsletter, Downside Protection Report, is now available.
Each month, John Mihaljevic, CFA, managing editor of The Manual of Ideas, presents two stock picks that are judged to have strong downside protection and above-average appreciation potential.
View this month's selections now.
We estimate that Tobin’s Q increased from a March low of 0.33 to 0.72 as of June 26, roughly in line with an adjusted average of 0.71 for the period from 1900-2009. Our data shows that while Q declined sharply in 2008, it has increased from 0.55 at yearend 2008 and from 0.61 at the end of 1Q09. The numerator (market value) and denominator (replacement cost) of the Q ratio were up 11% and down 1%, respectively, in the first quarter.
Today’s Q ratio sends a neutral near-term and medium-term market signal, and a modestly bearish long-term market signal. Of the five other instances since 1900 when Q increased to 0.72 or below, it was higher one year later in three instances. Four out of five times, it was higher three years after the initial increase. Five years and ten years after the increase, it was higher in only one of five instances and unchanged in another instance.
Replacement cost declined 0.7% sequentially in 1Q09, a reversal from a sequential increase of 0.3% in 4Q08, reflecting deflationary forces at play in the U.S. economy, including rising unemployment, home price erosion, and financial deleveraging. We note that replacement cost has not recorded a full-year decline in any year since at least 1900. Further declines in replacement cost would therefore be very significant in a historical context. We will watch the recent deflationary trend closely, but we do not anticipate that replacement cost will in fact decrease for the full year 2009.
Print version:
Equities and Tobin's Q, by John Mihaljevic, CFA, June 28, 2009
Learn more John Mihaljevic's Equities and Tobin's Q quarterly report and update service.
Magic Formula Stock Screen, Based on Next FY EPS Estimates
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Signal Value Ranking: Warren Buffett's Berkshire Hathaway
Every three months upon release of 13F-HR filings, Portfolio Manager's Review updates and reviews the best ideas of more than 20 top investment managers:
• William Ackman, Pershing Square
• Zeke Ashton, Centaur
• Bruce Berkowitz, Fairholme
• Warren Buffett, Berkshire Hathaway
• Ian Cumming & Joe Steinberg, Leucadia
• David Einhorn, Greenlight
• Glenn Greenberg, Chieftain
• Brian Gaines, Springhouse
• Tom Gayner, Markel Gayner
• Mason Hawkins, Southeastern
• Chris Hohn, Children’s Investment Fund
• Carl Icahn, Icahn
• Seth Klarman, Baupost
• Eddie Lampert, RBS (ESL)
• Dan Loeb, Third Point
• Steve Mandel, Lone Pine
• Mohnish Pabrai, Pabrai Funds
• Rich Pzena, Pzena Investment
• Kenneth Shubin Stein, Spencer
• Prem Watsa, Fairfax
• Marty Whitman, Third Avenue
Respected value investor Aaron Edelheit of Sabre Value Management posted the following comment on investing in Russia on his blog recently:
"Ikea said Tuesday that it was suspending further investment in Russia, apparently because of pervasive corruption and demands for bribes."
"The announcement came after a rare statement by Ikea's 83-year-old founder in a radio interview that Ikea had decided not to solve problems by slipping money under the table."
"Kudos to Ikea for standing up and going public with how corrupt Russia is, but they should not be surprised, and they should have known better than invest money and time in Russia. Russia is run mafia style and people on the inside and who live there can easily tell you that there is little difference between the Russian mafia and the Russian government. I refuse to invest one penny in that country and this article is yet another reason to stay far away from its corrupt ways."
By Ravi Nagarajan
In a CNBC interview today, Berkshire Hathaway Chairman and CEO Warren Buffett stated that the economy is not “moving yet” and that “green shoots” were not yet visible. Mr. Buffett joked that he was hoping the cataract operation on his left eye last month would help him see “green shoots” but he has not seen many hopeful indicators of economic growth.
Mr. Buffett’s comments on the economy are well worth considering carefully and not only because of his investment track record. Through Berkshire’s ownership of a diverse portfolio of operating companies, Mr. Buffett receives a broad array of reports that shed light on numerous important industries. This is particularly true for areas such as homebuilding given Berkshire’s exposure to building materials. In addition, reports from HomeServices of America, the second largest full service real estate brokerage in the United States, certainly provide a great deal of insight into the troubled real estate sector.
Other notable comments included statements of general support for the actions of the Treasury and Federal Reserve. In particular, Mr. Buffett appeared to endorse the reappointment of Federal Reserve Chairman Ben Bernanke. Mr. Bernanke’s term expires early next year.
Also, in a comment that I completely agree with, Mr. Buffett was critical of Apple’s decision to not disclose the extent of Steve Jobs’ health problems and recent surgery:
“If I have any serious illness, or something coming up of an important nature, an operation or anything like that, I think the thing to do is just tell the American, the Berkshire shareholders about it. I work for ‘em. Some people might think I’m important to the company. Certainly Steve Jobs is important to Apple. So it’s a material fact. Whether he is facing serious surgery or not is a material fact. Whether I’m facing serious surgery is a material fact. Whether (General Electric CEO) Jeff Immelt is, I mean, so I think that’s important.”
Here is the CNBC Video of the interview:
Ravi Nagarajan is a private investor and writer focused on applying value investing techniques to find securities trading well below intrinsic business value. He is a Manual of Ideas contributor and editor of The Rational Walk.
Warren Buffet: invest emotion-free
Charlie Munger: Coping with change is key
Jim Rogers: Read everything
"The best advice I ever got was on an airplane. It was in my early days on Wall Street. I was flying to Chicago, and I sat next to an older guy. Anyway, I remember him as being an old guy, which means he may have been 40. He told me to read everything. If you get interested in a company and you read the annual report, he said, you will have done more than 98% of the people on Wall Street. And if you read the footnotes in the annual report you will have done more than 100% of the people on Wall Street. I realized right away that if I just literally read a company's annual report and the notes -- or better yet, two or three years of reports -- that I would know much more than others. Professional investors used to sort of be dazzled. Everyone seemed to think I was smart. I later realized that I had to do more than just that. I learned that I had to read the annual reports of those I am investing in and their competitors' annual reports, the trade journals, and everything that I could get my hands on. But I realized that most people don't bother even doing the basic homework. And if I did even more, I'd be so far ahead that I'd probably be able to find successful investments."
Tiger Woods: Keep it simple
"When I was young, maybe 6 or 7 years old, I'd play on the Navy golf course with my pop. My dad would say, "Okay, where do you want to hit the ball?" I'd pick a spot and say I want to hit it there. He'd shrug and say, "Fine, then figure out how to do it." He didn't position my arm, adjust my feet, or change my thinking. He just said go ahead and hit the darn ball. My dad's advice to me was to simplify. He knew that at my age I couldn't digest all of golf's intricacies. He kept it simple: If you want to hit the ball to a particular spot, figure out a way to do it. Even today, when I'm struggling with my game, I can still hear him say, "Pick a spot and just hit it." When I'm making adjustments during a round, I know some of the television commentators theorize that I'm changing this or moving that, but really what I'm doing is listening to Pop."
Mohamed El-Erian: Push beyond your comfort zone
"We were living in Paris, back when my father was Egypt's ambassador to France. Each day we used to get at least four daily newspapers, from Le Figaro on the right side of the political spectrum to L'Humanité, which was the newspaper of the Communist Party. I remember asking my father, Why do we need four newspapers? He said to me, "Unless you read different points of view, your mind will eventually close, and you'll become a prisoner to a certain point of view that you'll never question."
Reading widely is particularly important right now. Most of the market research these days asks the same question: Is this the market bottom? To answer that question, they look at historical valuations and try to extrapolate from them. And most of the time that is the correct approach. However, right now we are going through major and unpredictable changes in the financial landscape. As a result, "Is this the bottom?" is the wrong question. But you have to read other people like [New York University economics professor Nouriel] Roubini, like [The Black Swan author] Nassim Taleb, and some of the behavioral-finance guys to understand why the question is wrong. The question we should be asking is, In this new world how do the historical variables morph, and what are the unintended consequences of government policy? There's a tendency for everyone to operate in a comfort zone and to want to read what is familiar to them. But if you are just used to following one person or one newspaper, you will miss these big shifts."
For more advice, see the Fortune article.
Not only of interest to Molson Coors Brewing Company (NYSE: TAP) investors...
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Source: WallStats.com.
Any applications for investors in this speech? (After all, much of investing is about the passage of time...)
Ken Lewis, the CEO of Bank of America, is in trouble -- a stock collapse; a rocky merger; the worst fourth-quarter losses in at least 17 years; a stockholder revolt; an urgent need to raise more capital despite a $45 billion infusion from the federal government; and on top of that, he effectively has a new boss, President Barack Obama.
Consider this headline from today's AP news item on Madoff: "SEC reaches settlement with Bernard Madoff, bars him from securities industry."
It's nice to know that the SEC needs to reach settlement with a guy who has pleaded guilty to one of the biggest frauds in history in order to bar him from the securities industry. Thank you, Bernie Madoff, for allowing the SEC to bar you from the industry. It appears the SEC might not have accomplished this without you.
June 2009 — Empirical Finance Research Newsletter on The Asset Growth Effect in Stock Returns, a paper by Michael J. Cooper, Huseyin Gulen and Michael SchillAbstract: We document a strong negative relationship between the growth of total firm assets and subsequent firm stock returns using a broad sample of U.S. stocks. Over the past 40 years, low asset growth stocks have maintained a return premium of 20% per year over high asset growth stocks. The asset growth return premium begins in January following the measurement year and persists for up to five years. The firm asset growth rate maintains an economically and statistically important ability to forecast returns in both large capitalization and small capitalization stocks. In the cross-section of stock returns, the asset growth rate maintains large explanatory power with respect to other previously documented determinants of the cross-section of returns (i.e., size, prior returns, book-to-market ratios). We conclude that risk-based explanations have some difficulty in explaining such a large and consistent return premium.
Conclusions: This is a remarkably simple investment strategy, yet sometimes in investing it is the simplest strategies that make the most sense. Although the results in this paper are outstanding, they are not all that surprising. An analysis of the tables suggests that the returns here are likely driven by exposure to small stocks and value stocks, which we already know outperform over long periods. However these results appear to go above and beyond those which might be explained by size and value factors. Nevertheless, the simplicity and remarkable consistency in annual outperformance for this strategy suggest it should be part of any quantitative investor's toolbox.
Subscribe to 10x45 Bargain Hunter for $99 per year (26 issues).
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Imagine that you have invested $10 million in the bonds of Company XYZ, a cyclical business that has just breached a covenant specified in their indenture. The company needs your agreement to waive the covenanttemporarily so as to avoid a damaging bankruptcy filing.
Most bond holders in this situation would waive the covenant, perhaps in exchange for an increase in the interest rate payable on the bonds or, if the company is in more serious distress, in exchange for free warrants to buy the common stock.
You would not really have an incentive to put the company into bankruptcy -- unless you sneakily also purchased so-called credit default swaps (CDS), which are essentially low-cost insurance contracts that pay off in the case of a specified event such as a bankruptcy filing.
You might have bought CDS on Company XYZ even after you knew of the covenant breach. The price of the CDS had gone up somewhat after the covenant breach, but this does not bother you because you can still make 10x on your CDS "investment" if the company files for bankruptcy.
What's neat about this hypethetical situation is that you have the power to put Company XYZ into bankruptcy by refusing to waive their covenant breach. Even if you lose $10 million on your bond investment, your comparable investment in CDS might pay you $100 million when the company files for bankruptcy protection.
Not a bad position to be in -- and it's apparently perfectly legal. Forget about the fact that you have "insider information" about what you will do with regard to the covenant breach -- the SEC doesn't care. Forget about the fact that you will screw other bondholders and shareholders -- you're out for yourself. Forget about the fact that the company's business will be harmed by a bankruptcy filing and employees will be fired -- who cares. You stand to make a cool $100 million on your CDS, just by using your $10 million bond investment as the vehicle to getting there.
It's clear that the legality of this kind of scheme threatens the corporate bond market and invites market manipulation. This is precisely what may have happenedrecently in the bankruptcy filing cases of AbitibiBowater (ABWTQ.PK) and General Motors (GM). To be clear, these companies might have gone bankrupt anyway, especially in the case of GM. But that's not the point. The point is that there might have been bond holders of AbitibiBowater and General Motors who wanted the companies bankrupt because they had side deals with payoffs that were far sweeter than any potential return on their bond investment. Those folks might have put the companies into bankruptcy even if the remaining bondholders had wanted to find a compromise solution.
Listen carefully to the recent comments of George Soros in this Bloomberg video.
Joe Koster has put together a compilation of Warren Buffett's statements on inflation. This is a timely issue, and we thank Joe for making this available. Read Joe's post at Value Investing World.Here is a look back at the inaugural issue of Portfolio Manager's Review, dated November 2008. An equal-weighted basket of the Top 10 companies recommended in this issue roughly six months ago is up 64.80% as of the market close on June 10, 2009. Each of the ten stocks we selected from the 100 companies we analyzed is up since the publication date, with appreciation ranging from 25.32% (Syneron) to 113.79% (Tempur-Pedic).
Since launching Portfolio Manager's Review, we have been humbled by the feedback and subscription requests we have received. Some of the world's most famous value investors now rely on Portfolio Manager's Review in their idea generation processes. We are committed to continue delivering a product that is unlike any other.
Learn more about Portfolio Manager's Review.
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By Zain Griffith
In our May issue of the Portfolio Manager's Review - "The Superinvestor Issue," our team highlighted 100 companies owned by well respected investors and profiled 30 of them. One company of particular interest was Facet Biotech (NASDAQ: FACT), currently owned by Seth Klarman of The Baupost Group.
Below you will find the profile for Facet Biotech, which was included in the May issue of the PMR.
Background:
As discussed in the write-up, FACT was spun-off from PDL Biopharma (NASDAQ: PDLI) in December 08. FACT, post-spin, consists of PDLI's former R&D operations, a product development pipeline that includes four drugs (two in Phase II of development and two in Phase I), and a pile of cash. PDLI contributed $405 million in cash or $17 per share to FACT at the time of the spin-off.
Why is Seth Klarman interested in a biotechnology/pharmaceutical company?
Mr. Klarman recently discussed his investment thesis for FACT in this presentation. If you have not seen the video, I highly encourage you to watch it--at least twice. To hear the thesis, fast-forward 26 minutes and 30 seconds into the presentation.
In the video, Klarman stated that FACT "has about $16-$17 per share in cash, so you could clearly liquidate that, stop all discovery activities and mail out $10-$14 per share back to the holders."
FACT is a classic Ben Graham "net net." At the time Klarman mentioned FACT in the video (in March), the stock had traded down to around $6 per share--a very substantial discount to cash.
Klarman always looks for investments with downside protection. In this particular case, the cash provided the downside protection and potential near term upside was present in the form of a catalyst. That catalyst was a group of dissident shareholders led by Dr. Roderick Wong, which wanted the company to pay a cash dividend to shareholders of $15 per share and to sell its assets.
Even though on May 4, 2009, Dr. Wong ended up withdrawing his slate of nominees, FACT's stock price has increased by over 50%, closing on June 5 at $10.73 per share.
Is FACT still a good investment today?
FACT is still trading at a discount to cash, but the margin of safety has clearly diminished. During 1Q09, FACT burned through $20 million of cash--leaving net cash per share of about $14.50. Since the company does not appear to be liquidating any time soon, an investor who purchases shares today must get comfortable with owning a cash burning biotech company. An investor that purchases shares at the current price is essentially receiving at least a years' worth of R&D expenses and the company's current drug development pipeline for free. The pipeline could have some value and could be evaluated based on its optionality.
For additional insight, please see the attached profile.
Disclosure: None
Facet BiotechBy Ravi Nagarajan
When Bruce Berkowitz of The Fairholme Fund has something to say, investors are well served to listen carefully. I was particularly interested in his comments regarding health care given the reform proposals that are currently under discussion. Berkowitz makes a strong case regarding the prospects for continued prosperity among many existing players in the industry.
Berkowitz is also bullish on defense related investments. I found his views particularly interesting as a contrast to a recent article in Barrons regarding the sector.
The video is provided by Morningstar.
Ravi Nagarajan is a private investor and writer focused on applying value investing techniques to find securities trading well below intrinsic business value. He is a Manual of Ideas contributor and editor of The Rational Walk.Zeke Ashton of Centaur Capital Partners spoke eloquently on the topic of value investing and risk management at the Value Investing Congress in Pasadena earlier this month. We found Zeke’s presentation enlightening and asked him to elaborate on some of his key points. A week or so ago, we conducted an exclusive interview with Zeke, and it’s our pleasure to bring it to you here.
Before we proceed to the interview, we should point out that Zeke’s approach to risk management has worked. In 2008, the Centaur Value Fund was down 6.9%, trouncing the 37.1% and 40.0% declines of the S&P 500 and Nasdaq Composite indexes. From inception in August 2002 through the end of 1Q09, the Centaur Value Fund gained 134.6%, net of fees and expenses, versus returns of 15.1% for the Nasdaq Composite and -0.3% for the S&P 500 Index.
Zeke Ashton of Centaur Capital Partners -- Exclusive Interview with The Manual of Ideas, May 2009The above interview appeared in the May issue of Portfolio Manager's Review.
