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Warren Buffett's daughter Susie Buffett provides some interesting insights into Warren's personal life.
Susie Buffett is one of Warren Buffett's three children with his first wife, Susie Thompson Buffett. Like her two brothers, she runs a charitable foundation funded by her father. The Sherwood Foundation is based in the same building in Omaha in which her father has worked for almost fifty years.
Don Graham, son of the late Katherine Graham and current chairman and CEO of The Washington Post, discusses his and his mother's experiences with Warren Buffett in a new BBC interview.
First Manhattan's David 'Sandy' Gottesman, a long-time friend and business associate of Berkshire chairman Warren Buffett, discusses some of the things that make Buffett a truly unique investor.
Microsoft founder Bill Gates discusses his friendship with Warren Buffett in a new BBC interview.
Three years ago, Buffett announced he was giving the bulk of his fortune - currently estimated at $40 billion - to charity, with most of it going to the Bill and Melinda Gates Foundation.
Warren Buffett talked to Evan Davis at the headquarters of his company, Berkshire Hathaway, in Buffett's native Omaha.
Buffett shares his ideas about the current financial crisis, his investment philosophy, and his one indulgence - his private jet.
GMO's Jeremy Grantham provides high market outlook in a recently published quarterly letter. Excerpt:
The idea behind my forecast six months ago was that regardless of the fundamentals, there would be a sharp rally. After a very large decline and a period of somewhat blind panic, it is simply the nature of the beast. [...]
Today there has been so much more varied encouragement for a rally than existed in 1930. The higher prices preceding this crash (that were far above both trend and fair value) had lasted for many years; from 1996 through 2001 and from 2003 through mid-2008. This time, we also saw history’s greatest stimulus program, desperate bailouts, and clear promises of years of low rates. As mentioned six months ago, in the third year of the Presidential Cycle, a tiny fraction of the current level of moral hazard and easy money has done its typically great job of driving equity markets and speculation higher. In total, therefore, it should be no surprise to historians that this rally has handsomely beaten 46%, and would probably have done so whether the actual economic recovery was deemed a pleasant surprise or not. Looking at previous “last hurrahs,” it should also have been expected that any rally this time would be tilted toward risk-taking and, the more stimulus and moral hazard, the bigger the tilt. I must say, though, that I never expected such an extreme tilt to risk-taking: it’s practically a cliff! Never mess with the Fed, I guess. Although, looking at the record, these dramatic short-term resuscitations do seem to breed severe problems down the road. So, probably, we will continue to live in exciting times, which is not all bad in our business.
Miguel Barbosa of Simoleon Sense has posted an interview with Greenbackd, one of our favorite blogs for value-oriented investors. Excerpt:
Q: How did your (academic) background prepare you to invest in activist and liquidation oriented investments?
A: I’m an ex lawyer, so I read filings like a lawyer, which means I’m always trying to find the seemingly innocuous note that reverses the headline position. I also think of the company as a creature separate from its business. Buffett-style investors desire a “wonderful business at a fair price.” To me, that’s only half the story. A company with a broken business model or no business model can be a great investment, for example, if an activist can get on the board or persuade management to take the cash burning business to the woodshed and salvage some of the value on the balance sheet. SOAP and AVGN are good examples of this phenomenon. They were both examples of what I call “activism by defenestration”: management were the ones who threw the business out of a window, but at the pointy end of an activist campaign.
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By Ravi NagarajanSan Jose, California, September 24, 1998. Just another routine day at the office in a suburban office park in the Silicon Valley was interrupted by loud sounds of a celebration coming from the common hallway serving several companies in the building. Was this a birthday party getting out of control, or some other disturbance? Actually, it was the day of eBay’s initial public offering. At the time, I was working as a software engineer for another company operating in the same office park and witnessed some of the festivities. Based on the initial spike in the stock price, it was easy to see why some of the early employees were celebrating.
Due to the close proximity of eBay’s office, online auctions were often discussed around my office. I was very familiar with the concept, the internet, and the company. I would like to say that I failed to participate in the IPO due to application of rigorous value investment standards, but this would be revisionist history. Instead, I was convinced that the idea of online auctions was crazy and could not understand why anyone would want to rummage around for garage sale items on the internet. I simply dismissed the business as a fad. My co-workers and I made fun of the crazy auction guys down the hall. I never even read eBay’s financial statements, which I now regret even though it would not have changed my decision not to participate in the IPO.
Speculation, Investing, and Circles of Competence
I have been asked on many occasions why value investors tend to steer clear of technology companies even in cases where the investor has a significant understanding of technology. In my case, several years of experience in software at the time surely provided the circle of competence required to evaluate eBay’s business model and to understand the technology involved. The trouble was that my circle of competence did not extend to being capable of anticipating the emergence of entirely new industries that had no proven economic track record. Even if I had spent the time to read eBay’s proxy filings, it is unlikely that I would have been able to confidently predict cash flows or to quantify downside risks.
Would it have been possible to develop a circle of competence that included the ability to forecast eBay’s cash flows? It would be arrogant to assume that no one could perform such an analysis and perhaps there were some observers who even managed to predict eBay’s future growth with some precision. However, it is safe to say that most buyers of eBay stock at the time were engaged in speculation rather than investing as defined by Benjamin Graham in Security Analysis:
An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.
Thorough analysis and an understanding of the business would not be enough without also being able to confidently demonstrate the safety of the investment and prospects for returns going forward. Significant wealth has been lost by individuals who mistake a technical circle of competence with an investing circle of competence. It is possible to understand a business extremely well and not be in a position to intelligently value a company.
Example: The Software Industry
Economic Characteristics
Let’s take a closer look at one industry that is very exposed to changing technology. The software industry has economic characteristics that often provide successful companies with outstanding margins and returns on equity. Successful companies typically have strong moats that provide protection against entrants, at least in the short run. This is because switching costs in software tend to be very high. Particularly in the case of commercial software targeting business users, companies do not wish to change vendors frequently due to the cost of implementing a new system and training staff members. Buyers of commercial software are also very risk averse. Usually, decision makers seek to minimize “career risk” by selecting vendors with proven track records that are recommended by consultants.
Sources of Revenue
Most software companies have three primary sources of revenue: Software licensing fees, maintenance fees, and service fees. License fees are normally very high margin due to the low marginal costs of providing an additional copy of software to a new customer. Once the research and development costs have been incurred to produce a software product, the marginal cost of production for additional copies is extremely low. Maintenance fees are normally charged for technical support and upgrades and typically have solid margins, albeit not as high as licensing revenues. Many software companies also provide services associated with their products. Service revenues have much lower margins due to staffing costs, but such revenues can still be worthwhile. The revenue mix of a software company is important when it comes to valuation.
Forecasting Cash Flows
The economic characteristics of an established software firm allow for building models to forecast future cash flows with some precision given that revenue mix and margins tend to change slowly over time, except during periods of disruptive change. It is all too easy to build spreadsheets with revenue and earnings projections far into the future. Such forecasts can incorporate various assumptions regarding overall revenue growth, revenue mix, and margins and can be aggressive or conservative when it comes to growth projections. The cash flow can then be discounted at the analyst’s chosen discount rate to arrive at a present value. If the stock can be purchased at less than the indicated present value, would this qualify as an investment operation as defined by Benjamin Graham?
Technological Change: The Wildcard
The fatal flaw behind this type of valuation model is that disruptive changes can occur in technology and software can be heavily impacted by such changes. The nature of the change is not always incremental. Change can sometimes appear suddenly and can invalidate business models that worked well for many years. While the barriers to new entrants in software can be high within a “steady state” environment where technology is relatively static, the same is not true when technology changes rapidly. In such a scenario, new entrants can leapfrog established players in a very short timeframe.
We have seen several examples of such change in recent decades, but perhaps no change was as profound as widespread adoption of the internet during the mid to late 1990s. Incumbent firms that failed to adapt did not lose their revenue sources overnight, but they experienced steady erosion in short order. In the case of business buyers, “career risk” drives decision making for most managers and will lead to business for incumbent players, but there are always trend setters who will give new entrants with superior technology an opportunity. Such new entrants can quickly displace incumbents and become the new “standard”. This cycle happens again and again in the process Joseph Schumpeter called “creative destruction”.
Many new entrants that appeared in the 1990s are now the established incumbents. Some incumbent firms in the 1990s successfully remained incumbents by adapting and embracing the internet and other advances. Which incumbent firms today with substantial brands and economic moats will adapt successfully over the next decade? Will “cloud computing” displace traditional applications or is it a passing fad?
These are all questions that can radically alter the economics of the industry in the coming years and the fortunes of existing players, even those with powerful moats in today’s environment.
Adapting to Change
When examining incumbent firms with current economic moats, it is particularly important to determine whether they have a track record of investing in R&D and successfully navigating major shifts in technology in the past. Has the company cut R&D spending in the economic downturn to limit damage to earnings or have investments been maintained? Does the company have a culture where change is embraced rather than feared? Do employees “live and breathe” technology? Some of these questions are unquantifiable but are still critically important.
What About Start Ups?
If it is so important to evaluate track records, then how can anyone invest in a start up? This is a very important question, but one that may be outside the scope of investing as defined by Graham. There is certainly an important role for venture capital firms and others who invest in early stage companies that have technologies which could be game changers and end up disrupting incumbent firms. The economy would suffer significantly without venture funding. Perhaps a widely diversified group of such companies can be selected with the idea that most will fail but the few that succeed will make the overall endeavor worthwhile? While this may be true, I would still argue that such operations are not within the category of “investing” as defined by Graham because they fail the test of providing adequate safety of principal and satisfactory returns through quantitative analysis.
It is certain that closely adhering to the principles of value investing will result in missing most if not all early stage opportunities. Value investors who choose to invest in technology firms are best served by focusing on established incumbent firms with attractive valuations and a history of adapting to change rather than speculating on unproven ventures. If the investor does choose to participate in unproven ventures, it should be done with full awareness that the operation does not meet Graham’s standard as an “investment”. This does not mean that the endeavor is unwise or doomed to failure, only that the tools of value investing are not suitable for providing guidance on the decision.
The author of this post, 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.
Elizabeth Ody of Kiplinger.com shares the following advice and insights in a recent article:
Warren Buffett, chairman of Berkshire Hathaway: I have no idea what the stock market's going to do tomorrow, or next week, or next month or next year. But over a 10-year period you will do considerably better owning a group of equities than you will owning Treasuries. In fighting the economic war, we've taken action that sows the seeds of substantial inflation down the road. Not in the next six months or year, but 10 years from now the dollar will buy a lot less than it buys today.
Robert L. Rodriguez, chief executive of First Pacific Advisors: Don't run with the herd. Being surrounded by people who are doing the same thing as you offers a false sense of protection. Today, being a loner means owning short-maturity, high-quality debt on the bond side. And if the U.S. government continues to blow up the nation's balance sheet through massive deficits, you should probably move at least 20 to 40 percent of your assets out of the United States.
Jeremy Grantham, chief investment strategist at Grantham, Mayo, Van Otterloo: The recent rally has been very speculative, favoring risky assets over the past few months. I'm sorry if you missed investing at the market's March lows, but don't compound the damage to your portfolio by chasing gains in risky assets. We're at the beginning of a seven-year period of lean returns. You should only be buying the highest-quality blue-chip companies, where valuations are most attractive.
Bill Gross, co-chief investment officer at Pacific Investment Management: The biggest danger right now is that you'll earn zero percent on mattress money, or virtually zero percent in a money-market account or at the bank. Yes, that money is safe, but the economy and inflation may come roaring past you at higher levels. You also have to consider diversifying outside of the United States. The dollar is a weak currency, and as it devalues against other currencies, our standard of living will suffer. Higher returns relative to risk lie in Asia and Brazil.
Martin J. Whitman, co-chief investment officer at Third Avenue Management: Do what we do -- find extremely well-financed companies that do not rely on continuous access to the bond or stock markets for refinancing, that are run by competent management teams and that have favorable prospects for growth. Buy these companies' stocks when they are available at a meaningful discount. All other systems of investing are concerned with predicting stocks' near-term price movements.
Jim Rogers, chairman of Rogers Holdings: Diversification is garbage -- it's something brokers invented to avoid getting sued. You only need four or five good ideas in your life to get really rich if you avoid mistakes. And the one way to avoid mistakes is to stick with what you know. Then, when you see a major development in your area of expertise, you'll know better than Wall Street when to buy or sell.
Pensions & Investments has an interview with Daniel Och, founder and head of Och-Ziff Capital Management (OZM). Here is an excerpt:
Where do you see interesting investment opportunities?
Several of our businesses are secularly more attractive than they were three years ago. For example, convertible arbitrage, where many participants were using large amounts of leverage, we believe is a much more attractive business than it had been. Long/short equity also continues to be appealing to us.
We're constantly thinking about where we can expand into new opportunities. Structured credit is a good example of that, consisting of residential mortgage-backed securities, commercial mortgage-backed securities and structured products with corporate assets as the underlying collateral. These are areas we were not involved in three years ago given the significant leverage and embedded leverage and the fact that virtually all of the risk management was based on what the rating was.
We built very deep and strong capabilities in structured credit. Now that the sector has dislocated, (we are able to) take advantage of opportunities. Number one, we think that banks and financial institutions will begin to be more aggressive in selling assets off their balance sheets. Number two, on the commercial side, we think that deteriorating fundamentals will impact the structured side, creating literally hundreds of billions of dollars' worth of distressed product.
Our expectation is that the opportunities are beginning now and will continue into 2010, although having said that ... it may take longer to emerge. I think another of the mantras of our firm applies here: Have capabilities everywhere and obligations nowhere.
Read full interview with Daniel Och.
(Thanks to Simoleon Sense for the link.)
India-based Professor Sanjay Bakshi recently presented to India's Ministry of Finance on the subject of persuasion.
In his latest commentary, Legg Mason's Bill Miller challenges the view that the U.S. economy will revert to a "new normal" once the current crisis has ebbed. Writes Miller,
In my colleague Michael Mauboussin’s terrific new
book, Think Twice, the opening chapter tells the story of Big Brown, the super looking colt who’d won such impressive victories in the Kentucky Derby and the Preakness, the first two legs of racing’s Triple Crown. This is a story with a lesson that directly relates to investing, and to understanding the kind of recovery that appears to be getting underway in the U.S. economy.After winning all 5 of his starts by a combined total of almost 40 lengths, Big Brown was a 3-10 favorite to win the Belmont Stakes and become the first horse in 30 years to win the Triple Crown. Those odds indicated the “wisdom of crowds” putting a 77% probability on Big Brown’s winning the race and making horse racing history. Part of that was right: he did make horse racing history —
by being the only horse to win the first two legs of the Triple Crown and finish last in the Belmont.
That so many were so sure of Big Brown’s success was due to a common analytical error that manifests itself in investing as well as horse racing. That error is the neglect of base rates. Psychologists call it the “inside” view, in contrast to the “outside” view. As Michael explains in his book:
The inside view considers a problem by focusing on the specific task and by using information that is close at hand. The outside view…asks if there are similar situations that can provide a statistical basis for making a decision. The outside view wants to know if others have faced comparable problems, and if so, what happened. It’s an unnatural way to think because it forces people to set aside the information they have gathered.
In the case of Big Brown, taking the outside view would be to see how many horses in the past had won the first two legs of the Triple Crown and then went on to win the third. The inside view focused on Big Brown, his history, the competition he faced, the tracks he ran on and their condition, his time between races, and so on.
The outside view revealed that 29 horses had won the first two races of the Triple Crown in the 130 years it had been run, with 11 of those horses going on to win the third race. Parsing the data a little more finely showed a remarkable divergence in winning percentages. Before 1950, 8 of the 9 horses that had a shot at the Triple Crown won it. After 1950, only 3 of 20 were successful. Moreover, when Big Brown’s speed ratings were compared to the most recent 6 Triple Crown contenders (and not just to his competition in the race), he was the slowest by a wide margin. If those who were betting on the Belmont had used the outside view instead of the inside view, no one would have believed what everyone did believe, that Big Brown had a nearly 80% chance to win the Belmont.
Investors are faced with these sorts of problems constantly: if I put my money in bonds now, what rate of return should I expect over the next 5 or 10 years? What is the outlook for stocks over the next 12 months? What are the chances of a significant rise in inflation over the next few years? What kind of economic recovery will we have? Should I fire my active money manager and replace him with a passive index product? What are the chances we have a “double-dip” recession? And on and on.
Faced with these sorts of questions, most people default to the inside view, and then augment its flaws with the usual assortment of behavioral biases long known to psychologists: they anchor on the most recent experience, they assume instances are representative of deeper patterns, they give more weight to vivid examples or dramatic outcomes, they place twice the weight on a dollar lost as on a dollar gained, etc.
The financial crisis that is now abating has created a near perfect environment for the admixture of all of the above, and that is perhaps why what Nobel winning economist Ken Arrow called the “clouds of vagueness” seem particularly thick and forbidding just now. Taking the outside view on some of the issues facing investors won’t make an inherently unknowable future predictable, but it can improve the odds of getting things right, or getting fewer things wrong.
The difference between the inside and the outside view is well on display in the different and in some cases strongly held views about what kind of recovery is now unfolding in the U.S. PIMCO’s Mohamed El-Erian is the most prominent advocate of the “new normal”, a term he coined to describe a recovery with real growth of 1-2%, persistently high unemployment, and much greater government involvement in the economy. He has recently warned of a big letdown from the “sugar high” we are now experiencing in the market and the economy as the effects of the abatement of the credit crisis and massive government stimuli, both fiscal and monetary, begin to wear off.
He may be the most prominent, but he is not alone. In fact, it looks like he is the leader of a not so silent majority. The current consensus growth rate for the U.S. economy in 2010 is 2.4%. This is way below “normal” for the first year of a recovery, yet even it is well above what most thought only 6 months ago. In April the IMF projected negative growth in world output of 1.3% this year, and only 1.9% growth in 2010. That included a projection of zero growth in 2010 for developed
countries.Projections such as these follow the classic inside view pattern: they look at current conditions, current trends, anchor on the most recent data, and adjust from there. Since the economy bottomed in March, almost all time series forecasts of economic improvement have been adjusted higher as the year wore on. They are still well below “normal.”
Continue reading Bill Miller's commentary.
Read Bloomberg's coverage of the debate on the "new normal".
Jonathan Heller of the highly recommended Cheap Stocks blog has posted notes from the Value Investing Congress in New York. You will not want to miss these notes, as they include some of the most important takeaways from the Congress in an easy-to-read format.
Here is an excerpt from Vivek Kaul's recent interview with value investor Mohnish Pabrai:
How much of Warren Buffett's success can be attributed to his investment prowess and how much to the fact that he is Warren Bufett?
Well the thing is you could have invested even after Buffett had invested and you could have made six times the money out of it.
In fact there are a couple of professors in Ohio, who studied any stock that Warren Buffett bought, if you bought on the last day of the month, when it was public that he owned that stock, and you sold it after it was public that he had started selling it, you would have generated north of 20% annual rate of return.
I would say that we will never see another Warren Buffett. Just like we will never see any Albert Einstein or another Mahatma Gandhi. Buffett is a very unique individual. His skillsets outside of investment are phenomenal but they get dwarfed by his investing skills. The main thing that makes Warren Buffett Warren Buffett is that he is a learning machine who has worked really hard for, let's us say seventy years, and is continuously learning every day.
So the thing is if you want to be like Buffett, there is no short cut. First of all, you have to be deeply interested in investing and you have to be very willing spending tens of hours, hundreds of hours, reading the minutiae. There is a very famous value investor called Seth Klarman. He is into horse racing. And his famous horse is called Read the Footnotes.
Read Vivek Kaul's interview with Mohnish Pabrai.
(Thanks to Value Investing World for this link.)
US News has a fascinating, short interview on Jamie Dimon of JP Morgan. Rick Newman talks to Duff McDonald, author of a new Dimon biography entitled Last Man Standing. Here are excerpts:
Over the course of the financial crisis, JPMorgan Chase remained profitable, a pillar of relative stability in the midst of an earthquake. The bank absorbed the failed Bear Stearns and Washington Mutual, while accepting $25 billion in bailout money that it paid back with interest once the government allowed it to. Through it all, Dimon consulted frequently with officials in Washington, and news reports have even depicted him as President Barack Obama's favorite banker. A new biography of Dimon, Last Man Standing by Duff McDonald, describes Dimon as a diligent and trustworthy executive who has risen above the swill of Wall Street. I spoke recently with McDonald about the man some think will be the next treasury secretary. Excerpts:
Jamie Dimon is clearly a survivor. Is he that smart or just lucky? Of course there's luck in any career, but wasn't it Seneca who said, "Luck is when preparation meets opportunity"? Jamie is the guy who was ready to take advantage of opportunities when they happened. So I don't really think it's luck at all. Jamie has proved that preparation is all there is on Wall Street.
How do you think of Dimon today? He's the most prominent banker in America, and if there is such a thing as a financial philosopher, Jamie's it. His letter to shareholders in the 2008 JPMorgan Chase annual report was a tour de force of explicatory brilliance. He explained what happened.
Was it Dimon talking? Or corporatespeak? It was totally Jamie talking. He explained the risk exposures, which were mostly mortgages. Where we went wrong, ways the system can be improved. He explained: Is JPMorgan caught up in this? Yes. But he's aware of the exposure. This is a guy who wrote the letter while still in the midst of the crisis, since he began writing it at the end of 2008.
How is Dimon different from other Wall Street CEOs? I was talking to Warren Buffett about Jamie, and he said, "Banking's not that difficult. You just need to be a banker, and Jamie's a banker." All these other guys weren't being bankers, they were being gamblers. There's a great line from Andrew Ross Sorkin's new book, Too Big to Fail. At some point during the crisis last year, an executive from Morgan Stanley gets a call from Jamie and goes to talk to John Mack [Morgan Stanley CEO]. He says that he just got a call from Jamie Dimon, who asked if he can do anything to help. The executive says, "Jamie is always hanging around the hoop. You know Jamie's saying, 'Let's make friends with these guys before I eat them.' "His entire career he's played it conservatively so he can pounce on opportunity. All these other guys were gamblers. Bear Stearns. Lehman. That's fine, but Dimon was the guy standing around the hoop waiting for the ball.
How do you see the new Wall Street firmament? Goldman Sachs is clearly still a betting house, and that's fine. I understand the debate over taxpayer dollars going to these firms, and that will go on for a long time. But Goldman is clearly the best at what it does. Morgan Stanley is a betting house, and then you have Citigroup and Bank of America, which are just kind of screwed up. The bank of the moment is JPMorgan Chase. Other than Goldman, JPMorgan Chase and Jamie Dimon are the kings of Wall Street. On investment banking they go toe-to-toe with Goldman.
Was the Bear Stearns takeover in March of 2008 a good deal? The Federal Reserve bore a lot of the risk for that deal. Jamie Dimon will tell you he felt a patriotic imperative in doing what he did. He was asked to take over a $400 billion balance sheet from a firm that everybody knew was the dodgiest on Wall Street. In 48 hours. It turned out to be a big loser. They've already booked substantial losses. The assets they backed, they've lost a ton of money on. They got a decent commodities business and a prime brokerage business, but they lost money. Buying Bear Stearns was not a good deal in and of itself. But it worked out beautifully because it made them the bank of last resort. That helps you get customers. No one's leaving Chase, the retail bank. And JPMorgan's institutional business boomed at the end of 2008.
What's Jamie Dimon like? He's a fun person with a sense of humor. He's a CEO, so he's somewhat unapproachable, but he's a nice guy. I've never met a man who has less doubt about who he is. He has a sense of conviction and no second thoughts. He's also a total family man. He has three daughters who love him and a wonderful wife. They have a house in upstate New York and a nice apartment on Park Avenue. He spends time with his family and doesn't do the really obvious things, like golf. He just works all the time. The wonderful thing about the Dimons is they don't seek publicity.
Is he humble? No. He's proud. He knows what he's accomplished. He's well aware of his own capabilities and his achievements. The difference is, he's not resting on his laurels. He thinks. He's diligent.
Does he have a future in public office? I don't think Jamie Dimon would ever run for office. He wouldn't put his family in that position or deal with the attendant issues. But would he accept an appointment? Don't be surprised if he does. When Obama got elected, there were rumors that Dimon would end up in Washington. I asked him why he didn't shoot down the rumors. He said, "Isn't it kind of presumptuous to turn down a job you haven't been offered?" But if he were offered the position of treasury secretary, it's almost a slam-dunk he would take it. It's the only thing he has left to do--public service. He told me that his one regret is never having done any public service, and he'd like to.
He's a Democrat? He's a Democrat.
Why? Because he comes from a free-thinking family. His father played violin in their living room during social events when he was growing up. The family talked about a lot of things beyond just the day-to-day. He was exposed to different ideas.
What have been the toughest moments in his career? Being fired in 1998 by Sandy Weill [Dimon's former mentor and CEO of Citigroup at the time]. He's still hurt.
What did he learn from that? He learned how not to be Sandy. How not to fire your most valuable person in a fit of pique.
Could Jamie Dimon be more than a CEO? Could he be a transformative figure? He could be. There's a deep sense of integrity that guides his decision making. The guy is motivated. He absolutely wanted to be rich, and he is rich. Paired with that is a deep sense of doing the right thing. Despite what populist anger seems to be suggesting these days, these are not inconsistent beliefs in America.
Read the entire article. Read Dimon's 2008 letter to shareholders.
Writes value investor Aaron Edelheit on his blog:
Very good interview with the CEO of Morgan Stanley, but be sure to watch the very end in which he confirms to CNBC that he told then NY Fed Chairman, and now Treasury Secretary Tim Geithner to go “$@%@% himself.”
Not everyday you get to see that.
Larry Summers, Director of the White House National Economic Council, was invited to deliver a lecture at the Economist’s Buttonwood Gathering which took place last week. Mr. Summers has received high praise from Berkshire Hathaway Vice Chairman Charlie Munger who is a self-described “right-wing Republican”.
Combined with Mr. Summers’ high position in government, no further endorsements are needed for intelligent investors to pay close attention to the views expressed in the video shown below.
Manual of Ideas contributor Nadav Manham of Elera Advisors writes on his blog:
From the FT. An excerpt from one due diligence report:
"Crudely, there are three ways to make money as a hedge fund manager," said one large multi-billion dollar asset manager.
"You can take advantage of trading technology, but few do.
You can be more intelligent than others, but few are.
"Or you can have some specialised source of sustainable information. Unless that information is from fundamental analysis – and in Galleon’s case it did not all seem to be – then that’s a red flag for us."
Joel Greenblatt, founder of Gotham Capital, shared his thoughts on a number of investing topics in a rare interview on CNBC this morning. The focus of much of the discussion was related to Mr. Greenblatt’s “magic formula” strategy that he outlined in The Little Book That Beats the Market.
This strategy is also discussed in more detail on the Magic Formula Investing website. Additionally, The Manual of Ideas 10×45 Bargain Hunter newsletter includes screens using the “magic formula” based on trailing earnings, current earnings, and next year’s projected earnings. Click on this link to read a review of Mr. Greenblatt’s earlier book: You Can Be a Stock Market Genius.
The new monthly investment idea-oriented publication European Value Report launched earlier this month. The report is researched and edited by the acclaimed research team of The Manual of Ideas, with an on-the-ground presence in London and analysts fluent in several European languages.
Read the inaugural issue of European Value Report.
The introductory subscription offer for European Value Report expires at midnight today. Learn how you can take advantage of this special offer now.
A new issue of the bi-weekly 10x45 Bargain Hunter stock screening report is now available. The report features 10 essential stock screens for value-oriented investors, with each screen containing up to 45 companies.
New companies joining the various screen results this week include Air Transport (ATSG), AT&T (T), Bristol Myers Squibb (BMY), Buckle (BKE), Burger King (BKC), Cass Information (CASS), Cubist Pharma (CBST), Digital River (DRIV), Dell (DELL), DPL (DPL), KONAMI (KNM), Lenovo (LNVGY), Lihua International (LIWA), Nokia (NOK), RadioShack (RSH), SinoHub (SIHI), Synaptics (SYNA), Tyson Foods (TSN), and Verizon (VZ).
Click here to view the latest issue of 10x45 Bargain Hunter.
By Ravi NagarajanMost value investors tend to avoid the use of leverage in their portfolios due to the old saying: “The market can stay irrational longer than you can stay solvent.” An investor can be entirely correct about his or her investment choices but the market may fail to recognize this before ruinous margin calls result in forced asset sales at depressed values. While there are many successful hedge fund managers who skillfully employ leverage and engage in short selling, most individual investors should stay far away from such strategies.
In light of this general conservatism on the part of value investors, an article suggesting the use of mortgage debt to improve investment results may seem a bit odd. In most circumstances, my view is that investors should not only avoid leverage through margin accounts but should also attempt to be free of all forms of personal debt. Excessive debt obviously played a large part in the real estate meltdown and has ruined the finances of many families. Nevertheless, opportunities now exist for intelligent use of mortgage debt for certain individuals.
When Uncle Sam Offers Subsidies … Take It
Mortgage debt has long been heavily subsidized by the Federal Government through income tax deductions for mortgage interest. However, that is only the beginning of the story when it comes to government interventions in the mortgage market today. The government now controls Fannie Mae and Freddie Mac and over the past year has implemented numerous programs to directly and indirectly subsidize mortgages. Most notably, the Federal Reserve has accumulated over $800 billion of mortgage related securities, an action that many believe prevented the mortgage market from grinding to a halt entirely.
The combined result of government actions in the mortgage market has resulted in very low interest rates on fixed rate mortgages for those who have sufficient equity in their homes. In many cases, borrowers have been able to secure fifteen year fixed rate mortgages in the low 4% range and thirty year fixed rate mortgages below 5%. The effective cost of these mortgage loans are further reduced by the interest deduction/subsidy.
Safe Leverage and Inflation Protection
Obviously, mortgage debt should only be used to the extent that it can be safely serviced without any risk of financial distress. Also, mortgage debt should not be used on properties that may have to be sold over the next five to ten years. Once these conditions are satisfied, two major advantages emerge. First, the investor has access to cheap financing for funds that can be deployed to long term value investments. At an after-tax cost of funds below 4% in many cases, it does not require heroic returns to adequately cover the expense. Furthermore, there are no margin calls associated with this form of leverage. As long as debt service payments are made, no default will occur. The investor will not be forced to liquidate holdings that are temporarily depressed to meet any margin calls. Additionally, the long term nature of the debt (fifteen to thirty years) matches the long term investment horizon that most value investors have.
The additional advantage in today’s environment is that mortgage debt provides an excellent hedge against inflation. While there is debate today regarding whether inflation will emerge, the market for commodities and foreign currencies is painting a negative picture for prospects of the US Dollar going forward. Foreigners are growing increasingly uncomfortable with holding dollar denominated assets. The Federal Government is piling up debt at unprecedented rates and the risk that politicians will attempt to monetize this debt in the future cannot be ignored.
To hedge against these concerns, many investors choose risky approaches such as speculating in commodities, shorting treasuries or participating in exchange traded funds employing an array of strategies. However, the presence of low fixed rate mortgage debt on an investor’s personal balance sheet is a natural inflation hedge. The pre-payment features of most mortgage loans also provides protection if inflation does not emerge. The borrower can always pay off the loan at any time, usually without penalty.
Value investors tend to focus on individual companies when making investment decisions and do not spend significant time on macroeconomic forecasts. While this is generally a wise approach, when a simple and low risk hedge against a growing macroeconomic risk is available, it seems intelligent to take advantage of it. While leveraging mortgage debt as an inflation hedge will not provide complete protection for most investors, it can be part of an overall strategy to mitigate the impact of potential inflation in the future.
The author of this post, 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.
Miguel Barbosa of Simoleon Sense, one of our favorite blogs on investing, recently interviewed up-and-coming value investor Sham Gad, author of The Business of Value Investing.
Want to get live news alerts from UK companies in your email inbox? Looking for latest financials on German stocks? Confused about the share ownership of an Italian firm? No problem! After reading this article you should be equipped with some basic tools to help you navigate through various European countries in your quest for good investments. And the best part about it: Most of the resources we present here are absolutely FREE.
To start off, a user-friendly stock screening tool is available at Digital Look. Although sign-up is required, the screens are free to use. The site allows screening for stocks in eleven European countries, including the major markets of the U.K., Germany and France. Once a few companies are identified from the screen as potential targets, which country each company is domiciled in largely determines what resources are available for further research.
Unlike in the U.S. where investors can turn to the SEC’s website for company filings, there is no central filing database for all European companies. Filings are typically made with each country’s stock market regulator via publication on the relevant stock exchange.
Of course, individual company websites provide comprehensive information and are a good way to find out about latest announcements and download financial reports and presentations. Sometimes, however, share ownership information will not be displayed on the website and may be easier to find elsewhere. In the case of Italy, for example, ownership information is available at the central depository of the Italian securities market regulator CONSOB.
In terms of filings, European companies typically report on a semi-annual basis rather the quarterly basis that is commonplace in the U.S. There are exceptions, however, especially at the big-cap companies that also have listings in the U.S. Such companies may report on a quarterly basis. Also, many U.K.-based companies have started publishing so called "Interim Management Statements," which are a fancy word for earnings updates released between the semi-annual reports.
Lastly, it's worth pointing out that most companies publish annual reports in English as well as in their local language. Based on our research team's history of interaction with the investor relations departments of European companies, we have observed that European companies no longer regard the IR function as purely administrative. European IR representatives are in most cases knowledgeable about their companies' businesses, they are accessible to private investors and speak fluent English. As a result, you should not hesitate to use IR as a point of contact when doing fundamental research on a European company. If you do so, come equipped with some probing questions so that you are not simply listening to a company's "pitch."
The following list includes websites you may find helpful when researching European investment opportunities.
UK/Ireland
Investegate: Live provider of all announcements from UK quoted companies. Includes a free sign-up service to receive email alerts when new announcements are published.
London Stock Exchange: Provides downloadable reports with basic information on listed companies.
Hemscott: Provides basic information on 2,350 UK and Irish listed companies. Also has premium services available on a subscription basis.
Trustnet: Provides information on closed–end and open-end funds.
Takeover Panel: Official information on UK takeover bids and related regulations.
Companies House: Provides information on private UK companies. (nominal fees apply)
Germany
Frankfurt Stock Exchange: Provides basic information on listed companies.
Onvista: Provides basic information on German companies and related premium services. (in German)
Insiderdaten: Provides information on insider transactions for Germany companies. (in German)
Switzerland
Swiss Stock Exchange: Provides basic information on listed companies.
France/Holland/Belgium/Portugal
NYSE Euronext: Provides basic information on listed companies. Participating exchanges include Paris, Amsterdam, Brussels and Lisbon.
Sweden/Finland/Norway/Denmark/Iceland
Nasdaq OMX Nordic: Provides basic information on listed companies. Participating exchanges include Stockholm, Helsinki, Copenhagen and Iceland. Information on Norwegian companies listed on OMX is also available.
Italy
Italian Stock Exchange: Provides basic information on listed companies.
Consob: Provides information on share capital and major shareholders of Italian companies.
Spain
Madrid Stock Exchange: Provides basic information on listed companies.
CNMV: Provides information on Spanish companies including major shareholders.
Eastern Europe and Other Markets
Site-by-site: Provides links to official stock exchange and national bank websites in individual countries.
Nasdaq OMX Baltic: Provides basic information on listed companies in Estonia, Latvia and Lithuania including financial reports.
Other
Digital Look: Provides a stock screening tool for selected European countries. (free sign-up required)
Renaissance Capital: Provides information on foreign IPOs listed on U.S. markets. Service allows search by foreign country.
European Value Report: Idea-oriented research publication of The Manual of Ideas, featuring two European stock picks per month
We recently interviewed one of Canada's most well-respected value investors, Tim McElvaine of McElvaine Investment Management. As always, he is insightful and to the point.
There is no better way of learning a new language than by going to the country where it's spoken. Similarly, if you are looking to expand your horizons and learn about European investment opportunities, there is no better way than by tackling as many European company annual reports as you can muster.
You will not only learn about individual companies, some of which may be global competitors to U.S. companies in which you may already have an investment, but you will also start learning the accounting language "spoken" by European companies. Rather than read a dry textbook on the differences between U.S. and European accounting standards, you can ease into those differences by reading annual reports.
The following links will take you to a FREE service that provides annual reports, in electronic and print format, for many companies trading on stock exchanges in Europe. Grouping your company reading list by stock exchange may be useful, as you'll be able to navigate the European investment landscape by major region or country.
AIM (London; smaller companies) | Bovespa | Dublin | Euronext Amsterdam | Euronext Brussels | Euronext Lisbon | Euronext Paris | Frankfurt | ISEQ (Irish) | Italy | Lisbon | London | Milan | NASDAQ EUROPE | OMX Copenhagen | OMX Helsinki | OMX Iceland | OMX Stockholm | Oslo | Oslo Bors | PLUS (London; small and mid cap companies) | Prague | Vienna | Warsaw | Zurich
An even better way to structure your tour of the European investment landscape may be by industry:
Aerospace & Defence | Agriculture, Paper & Packaging | Automotive | Banks, Financial Services & Insurance | Biotechnology | Building & Construction | Business & Support Services | Chemicals | Closed End Funds & Investment Companies | Computers, Technology & Internet | Consumer & Retail Products | Electronics & Engineering | Food Manufacturing & Products | Healthcare & Pharmaceutical | Industrial & Manufacturing | Leisure & Entertainment | Metals & Mining | Oil, Gas & Energy | Publishing & Media | Real Estate | Telecommunications | Transportation | Utilities
Or you can simply go through one list of all European companies for which free annual reports are available. Several companies on the list are well-known corporations that are worth reading about regardless of your interest in Europe in particular. These companies include: Agfa-Gevaert | AstraZeneca | British American Tobacco | Christian Dior | Deutsche Bank | Euro Disney | J Sainsbury | London Stock Exchange | Old Mutual | Park Plaza Hotels | Raiffeisen International Bank | Royal Dutch Shell | WPP Group
Join European Value Report as the acclaimed research team of The Manual of Ideas uncovers the best European investments each month.
In a Q2 letter to investors, dated July 13th, respected value investor David Einhorn of Greenlight Capital states that at the end of the second quarter, "the five largest disclosed long positions in the [Greenlight] Partnerships are Arkema, Criteria Caixa, Ford Motor Company debt, gold, and Pfizer."
Einhorn has owned French chemicals company Arkema (Paris: AKE) and Spanish investment group Criteria Caixa (Madrid: CRI) for some time. Greenlight has also owned other Europe-domiciled companies in the past, including French auto maker Renault and Austrian Post, which was named a top monthly stock pick in the recent issue of European Value Report.
While it is impossible to divine Einhorn's strong interest in European equities, we note the following attractive investment attributes offered by many European markets:
Here is a quick overview of the top two European holdings of Greenlight:
Criteria Caixa is an investment group with holdings in financial and industrial companies. The company’s core shareholder is “la Caixa”; it has been listed on the continuous market of the Spanish stock exchange since October 2007. Criteria has a firm commitment to international growth, active management of its portfolio within a framework of controlled risk, and boosting the growth, development and returns of the companies it invests in. Criteria CaixaCorp holds the largest corporate investment portfolio in Spain by net asset volume with a value of €14,823 million at June 30, 2009. [view investor presentation] [read annual report]
(click to enlarge)
Arkema is a global chemical company and France’s leading chemicals producer that operates in three businesses: Vinyl Products, Industrial Chemicals, and Performance Products. Arkema reported revenue of 5.6 billion euros in its most recent fiscal year. The company has 15,000 employees in over 40 countries and six research centers located in France, the United States and Japan. With internationally recognized brands, Arkema holds leadership positions in its principal markets. [view investor presentation] [annual report]
Disclosure: No positions.
Bruce Berkowitz of The Fairholme Fund held a call with investors on September 30th [listen to call; read transcript]. As always, we found Berkowitz's commentary lucid and helpful in understanding his approach to investing. Here are a few highlights from the call:
On The History of The Fairholme Fund
"In our first letter to shareholders, in May of 2000, we stated our goal of providing shareholders with superior investment performance, without risking permanent loss of capital. We accomplish our goal when we purchase securities at a significant discount to our estimate of their true worth; that is the cash generated over the life of the investment. In the case of common stocks, we estimate the cash a business will generate for owners over the life of the business. In 2000, the Fairholme Fund had over half its net assets in companies primarily involved in property and casualty insurance. At the time, these companies earned about 20 percent returns on book value, and we paid near book value for them. They were the ugly ducklings of their day that the crowd ignored."
"Since then, we have concentrated in areas such as telecommunications, with the junk bonds of WilTel, eventually acquired by Leucadia, and then Level Three Communications; and WorldCom, which became MCI, and then acquired by Verizon. Today, the fund has about 30 percent of its assets in pharma and managed healthcare. Despite the loud noise of the crowd and the administration's rhetoric, we believe our health-related companies are for essential services and products to an aging population, have few substitutes, and have strong free cash flows relative to market prices."
"While the securities in the portfolio have changed over the years, our adherence to a strategy of counting cash has only become more resolute. By focusing on free cash flows, we steered clear or the dotcom era debacles, as well as the recent financial services meltdown, which brought many once unassailable banks and financial companies to their knees. None of those failed companies could ever show us the money. While we can not predict the future with any high degree of success, we're confident that we can properly respond to whatever the future may bring, by adhering to our basic principles of vigilance, focus, commitment, and value. And by having the necessary cash to quickly act, in size, when the opportunities exist. Cash proves especially useful whenever the cashless are forced to sell without regard to price."
On The Investment Process
"In order to protect your capital, we will continually challenge ourselves by asking how might our investments fail. To help answer this question, we retain outside experts ... devil's advocates, if you will ... who have decades of hands-on operational experience in their respective fields, because knowing what you don't know and tapping those who do is one of the critical skills of investing."
"We're not asking our consultants to sell anything for us. We just really need to pick their brains and make sure we understand what we're getting into. And, by the way, this isn't new. Okay? This is not new. Other companies we've studied, with very long, successful records, have used the same process. So, again, we hire experts to corroborate our ideas, our assumptions; and, more importantly, try and disprove what we think is correct."
"When we commit your capital to an idea, it's because we've exercised vigilance in researching both the upside and especially the downsides of a given investment."
"When researching companies, we start with past SEC reports, conference calls, and investor presentations. We then focus on every business element that requires management to exercise judgment, and every element of accounting that may not reflect reality. For example, we check reserves for insurance claims, bad debts, lawsuits, healthcare liabilities, pension obligations, and Uncle Sam. We assume every estimate is too liberal, too light. We look for kitchen-sinking of real expenses, hidden for periods of time, which, in the aggregate, can reverse years of so-called profits.
Management is considered guilty until proven innocent.""Then it's time to consider which way the winds are blowing. Is the underlying company facing economic, demographic, technological, political competitive headwinds? Is the business growing? Which way are interest rates heading? We then consider where our security lies within the capital structure of the company, and then assess the entire capital structure of the underlying entity. We look at leverage, return on assets versus the return on equity, tangible equity; we want to weigh the heft of the balance sheet, and review and search for all off-balance-sheet items. Can the business work without leverage? To what extent is the business dependent on the kindness of strangers? And by that I mean the capital providers. We also examine good will, which may or may not be a gift that can keep giving. Then it's on to reviewing customers, suppliers, competitors, substitutes, and think of the industry's concentrations of power. Then it's to review, consider, and think about all the different stakeholders in the company. Who are the owners? The regulators? Taxing authorities? Creditors? Retirees? Unions? How powerful are the employees?"
"And, of course, management must be carefully studied. How much does management take in total compensation? Do they under-promise and overdeliver? Do they respect owners? Are they true owners and not just option-holders? Do they allow a level playing field with owners? How good is the paper trail of key executives? Do they play in the center of the court? Do they have a deep understanding of the business? How have they allocated capital over time? It's awfully hard to make a good investment with bad people."
"We then consider illogical extremes. For example, we considered the U.S. Government's past desire for every family to own a home, and evaluated the effect on relevant financial institutions. We consider the worst case. Are there too many variables to monitor or estimate? What are the correlations with other investments? We try and understand the unknowns. Of course, we want to know how can we die with this investment. For example, we did not know how to quantify monumental derivatives risk."
"Then we return back to the price that we're willing to pay for the security. And while easy to say, it's near impossible to be exact with common stocks. And so we use a price range. Does the range reflect an average past environment and normal risk-free rates? Does it allow bad luck? Stress? And a margin of safety? Can we achieve a double-digit, growing, free cash yield, without risking principal? Are we playing Russian roulette? Are we picking up pennies in front of a steamroller? If we haven't killed the investment idea yet, we then compare it to our other investments. How does the investment compare to an investment in other securities of the underlying entities? How does it compare to our current portfolio investments?"
On The Importance of Cash Flow
"At the end of the day, the only thing that we can spend is cash. We can't spend a click, or an eyeball, or a metric. I mean, we can spend cash to benefit our families. So we count cash. And the best way to understand how we try to count cash is to use the analogy of the corner grocery store ... 7-11, or before the time of credits cards, when there was one cash register, and purchases were made, and cash went into the register, and supplies came in, cash came out to pay for all the supplies, and for salaries, and insurance, and to keep the place looking good. And that's it. And then, at the end of a period, what was left in that cash register was for the owners. And then the owners had to decide how to allocate that cash, whether to spend it, whether to reinvest it back in the business to grow it, or rather to invest it in another business. So all we're trying to do with ... we say it a whole bunch of different ways, all we're trying to do is just to measure that cash and understand how it's reallocated, and understand how it eventually gets into our pockets, the owners of the company."
On Stocks versus Bonds
"At Fairholme, we treat common stock as the most junior bond in a company's capital structure, where the true earnings, the free cash flow of a company, are akin to a coupon without a maturity date. We get really excited when we can find more senior and secure bonds that yield better than average equity-like returns. We then compare market prices to our estimates of free cash flows, to determine
an expected return on investment. Price matters, and buying right is half the battle. Getting a reasonable estimate of expected free cash flow is the other half."
On Whether Large Fund Size Hurts Performance
"Basically, by having most of my family's money in the fund, I try to create the balance necessary for such decisions. Personally, I don't wish to sacrifice that which I have worked hard for and may need for that which I will not need. For now, size has helped. Having cash, when few do, has helped. Having heft makes a positive difference, and one of the few advantages against the unknown. Size also allows us to keep focused on the fund, while keeping fees relatively low for what we do. With scale, we can meet the ever-increasing costs of doing business. The bottom line, we have smart shareholders and directors, who are not afraid to voice their opinion on how our size is affecting our performance."
On Protecting The Portfolio From Inflation
"The best way we can protect against inflation is by finding companies that generate large amounts of free cash, which then can either be profitably reallocated into the company or paid to shareholders. And to find companies with that free cash flow, that coupon is growing. And studying history, it's my belief that that's the best we could possibly do. But, also, real, tangible assets will become more valuable, as it will take more dollars to buy those assets; hence, our recent focus on companies such as St. Joe [JOE]."
On Investing In Emerging Markets
"It's hard enough when you're the home team, investing in your own backyard. I don't want to play an away game, where I don't know all the rules. So the answer is no. There's plenty to do here."
On Sears Holdings (SHLD) (price was $65 on the date of the call)
"...the value of all the pieces, in death, is worth more than the current market price. And if Eddie Lampert turns around Sears and KMart, then it's going to be worth considerably more. In another area, if the stock price goes down, the company continues to buy back stock, great, we win. If the stock price just goes up, we win. I don't see ... this is a good example of how we invert the investment process. I can't see how we're going to lose."
Listen to Bruce Berkowitz's conference call on September 30, 2009.
Follow Bruce Berkowitz's top ideas—and get acclaimed analysis by the Manual of Ideas research team—in Portfolio Manager's Review.
European Value Report, the newly launched monthly investment publication of The Manual of Ideas, has named Bloomsbury Publishing (London: BMY) as one of the Report's top two stock picks for the month of October. European Value Report seeks to uncover compelling investments across Europe. The Report benefits from an on-the-ground presence in London, and the research team includes analysts fluent in languages spoken in several European countries. Analysts responsible for identifying European investments frequently travel the continent to find new ideas.Read European Value Report's thesis on Bloomsbury Publishing.
Disclosure: No positions.
European Value Report, the newly launched monthly investment publication of The Manual of Ideas, has named Austrian Post (Oesterreichische Post) (Vienna: POST) (Yahoo: POST.VI) as one of the Report's top two stock picks for the month of October.
European Value Report seeks to uncover compelling investments across the European continent. The Report benefits from an on-the-ground presence in London, and the research team includes analysts fluent in languages spoken in several European countries. Analysts responsible for identifying European investment ideas frequently travel the continent to uncover new opportunities.
Read European Value Report's thesis on Austrian Post.
Disclosure: No positions.
Easily the best quantitative investor on Wall Street, James Simons of Renaissance Technologies, looks set to retire in the near future. This will certainly mark the end of an era for quantitative investing, as Simons has long been regarded as the most brilliant of a crop of mathematically-driven investment managers.
An excerpt from the Fall 2009 issue:
Feature Interview: Howard Marks, Co-Founder and Chairman, Oaktree Capital Management
"Do An Excellent Job at a Few Things"
G&D: It seems that most investors focus more on the return side of the equation than on risk, whereas you take the opposite perspective.
Howard Marks: That is important, and that is one of the reasons we are still around. Sun Tzu said if you sit by the river long enough, you’ll see the bodies of your enemies float by. The key is “long enough.” If you live long enough, you have to be the survivor. When I was a kid, we didn’t have the video games you have today, so we used to listen to comedy records. One of the greatest ones was Mel Brooks doing the 2000 year old man. Carl Reiner says to him, “how did you get to be the world’s oldest man?” And he says, “Simple. Don’t die.” How do you get to be the world’s oldest investor? The answer is don’t crap out.
Founded in 1995,Oaktree manages over $60 billion of investments in a variety of less efficient arenas, including High Yield Debt, Distressed Debt, and Private Equity, among other asset classes. Oaktree’s excellent long-term track record and Mr. Marks’ unique investment philosophy have resulted in a loyal following of investment professionals. Since starting his career in 1969, Mr. Marks has seen a range of ups and downs in the financial markets, from the growth of the high yield bond market to the current leverage meltdown.
We are pleased to present the inaugural issue of European Value Report, a new publication of The Manual of Ideas. Each month, European Value Report will bring subscribers the top two investment ideas in Europe, as selected by our acclaimed research team.
Special offer: Subscribe by October 19th and take $100 OFF the annual rate of $299. If you are an existing Manual of Ideas paid subscriber, take another $100 OFF for total savings of $200 per year.
One of our favorite blogs for value-oriented investors, Greenbackd, comments on a recent 10x45 Bargain Hunter stock screen in a new article. Greenbackd points out that one of the new additions to the screen results, Axcelis Technologies (ACLS), has appreciated materially and may not be a compelling value at this time due to continuing high cash burn. On the other hand, Greenbackd points out that Axcelis was recently upgraded by a Citi research analyst.
An article referencing the latest issue of the quarterly research publication Equities and Tobin's Q has been published by Robert Huebscher of Advisor Perspectives. Writes Huebscher, "The latest data for Tobin’s Q-Ratio, a valuation metric shown by academic studies to be highly predictive of market performance, show that investors should brace themselves for sub-par returns over the next 10 years."
I returned, and saw under the sun, that the race is not to the swift, nor the battle to the strong, neither yet bread to the wise, nor yet riches to men of understanding, nor yet favor to men of skill; but time and chance happeneth to them all. --Ecclestiastes 9:11
Nice guys finish last. --Leo Durocher
The NYT has a long and detailed case study of the Simmons Bedding Company, which was owned by a series of private equity companies in recent years. As a new student of the art and science of private equity manager selection, I read the piece with great relish.
The fundamental message of the article to someone in my position is that anyone evaluating a private equity fund must be able to disaggregate the returns of that fund, to isolate the various components that together form the "35% IRR" or whatever large number a fund uses to advertise its great success.
Not all of these components are created equal, and the private equity manager selector must judge which of these can ultimately be attributed to manager skill, which to luck, and which to simple greed that comes at a social cost. All three seem to have been on display in the Simmons saga.
Starting, like Dante, in private equity hell and moving heavenward, the practice of PE firms paying themselves management fees for running the companies they buy, or success fees for selling them, represents the least "worthy" form of private equity returns, the equivalent of a major stockholder/CEO of a company voting to give himself an enormous raise. I can't morally object to a PE firm, which is after all a fiduciary to its limited partners, engaging in this if it can get away with it, but this component of a PE fund's return should be given the least value when evaluating a PE manager.
(This wouldn't be an Investor's Consigliere post without a Buffett anecdote, so here it is: In 1996 Buffett sat on the board of Gillette when it purchased Duracell, the well-known battery maker. Kohlberg Kravis and Roberts, the buyout firm that owned 34% of Duracell at the time, demanded an "investment banking" fee of $20 million for its work on the deal, even though it was more properly the seller, not the banker (Morgan Stanley was). Now my adoration of Warren Buffett is second to no one's, but I think even he would confess that throughout his long career as a board member, he's been something of a . . . wimp, holding his tongue even when he wanted to object to certain practices. In this case, however, KKR's demand so offended him that even though he favored the merger, he abstained from voting on it as a form of silent protest. End of anecdote.)
The next level up, call it PE Purgatory, are all the practices that come under the general heading of replacing equity with debt, which include the dividend recapitalizations mentioned in the article as well as the initial underwriting of deals. George Orwell, who had a lot to say about capitalism and human nature, pointed out that when the powerful call something X, they're often trying to hide that fact that X is really the X's opposite. Warren Buffett, another student of capitalism and human nature, has written that "private equity" isn't about equity at all, but rather about its opposite: debt.
The common denominator in these types of transactions is that, in exchange for some present benefit for the private equity buyer/owner (either leverage for its equity or, in the case of a dividend recapitalization, cash up front), the burden of the company's future success or failure shifts from owners to debt holders. It's complicated for a manager selector to evaluate the "worthiness" of these transactions, as they can involve manager skill, luck, and pure greed, or some combination of the three. For instance, A PE manager that is able to finance a deal with low-interest PIK bonds at a time when such bonds have willing buyers can be
a) skillful, in the sense of protecting its equity from future cash flow problems in the business,
b) lucky, in the sense of being in the right place at the right time (e.g. NYC during a credit bubble), and/or
c) egregiously greedy, in the sense of having the chutzpah to sell something (as an insider) that it would never itself buy.
From the perspective of the manager selector, skill is always good. Lucky is good too, certainly better than unlucky, except for two problems: a) a PE fund that can only prosper when conditions are completely favorable won't outperform over the long term, and b) lucky people have a tendency to confuse their good luck with skill. Egregious greed is almost always bad, and not for moral reasons, which each investor must work out for itself. My objection to egregious greed is practical: it creates negative karma--not for the next life, but for the next deals. A PE fund that foists crappy debt on gullible bondholders once won't often get a chance to repeat the feat. A fund that borrows too much and must resort to mass layoffs to avoid bankruptcy will find its union pension fund LPs less than willing to invest in its next fund.
There is also a very subtle psychological downside to playing this game of replacing equity with debt, often in ever increasing proportions as in the case of Simmons. John Maynard Keynes famously described modern securities markets as
so to speak, a game of Snap, of Old Maid, of Musical Chairs--a pastime in which he is victor who says Snap neither too soon nor too late, who passes the Old Maid to his neighbour before the game is over, who secures a chair for himself when the music stops. These games can be played with zest and enjoyment, though all the players know that it is the Old Maid which is circulating, or that when the music stops some of the players will find themselves unseated.
Modern private equity can be looked at similarly, although in this case the Old Maid being passed around is the inevitable (and it is inevitable) losses that will afflict bondholders and equity holders when rosy business expectations that prevailed on the days securities were sold don't pan out. Many PE players have had great success at this game, but it occurs to me that those who play it may forget that if you choose to play, no matter how good you are one day it will be you holding the Old Maid at the end of the game, or you without a seat when the music stops. In that sense then, to even play the game is to lose it sometimes.
Finally, we come to Private Equity Paradise, the noblest and most worthy components of PE returns, and the purest measures of manager skill. They are the ability to buy assets at bargain prices, and the ability to effect real and lasting operational improvements in the companies purchased. A manager selector fortunate enough to invest in a fund that derives most of its returns from these components will feel as Dante did when he saw Beatrice, either for the first time (take it away, Ridley Scott) or when they reunited in heaven (take it away, Signore Alighieri). Ultimately, nothing justifies the existence of the PE industry (and the fees it charges), either for its investors or as a social institution, but these two factors.
Having rambled at length on this subject, I must confess that I've never known of any PE fund that has tried to disaggregate the components of its returns like this. If someone reading this works in the industry and has seen it done, please let me know. Nor do I think it would be possible for someone from the outside looking in to attempt such a disaggregation with any precision. Therefore, I suppose, we as manager selectors must console ourselves with the various qualitative efforts we can make to penetrate the essence of a given fund's returns.
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 a Manual of Ideas contributor and editor of The Investor's Consigliere.
We generally agree with those who argue that U.S. currency debasement will lead to depreciation in the U.S. dollar and accelerating inflation, making gold a good investment, at least in nominal terms. However, it is always important to consider opposing views, so here is a bearish perspective on gold, put forth by Sajid Karsan:
Not long ago, major media outlets would post daily articles reporting the price of oil and how demand is far exceeding supply. Not long before that, these same outlets were saying things like "they're not making any more land" as housing prices rose through the roof. A few years before that, the rising stock prices of technology companies were making daily headlines as the stock market had entered what was claimed to be a "new paradigm shift, where traditional methods of valuation no longer apply". Today, it's the price of gold that is the talk of the town.
Why does the topic of gold garner so much interest today from major media outlets and bloggers alike? Because so many readers are interested (thus generating traffic), and the readers are likely interested because they own gold themselves. Indeed, demand for this asset has risen to such an extent that the price of gold now flirts with its all-time high:
Does this represent an asset bubble? To answer that, we must try to determine the intrinsic value of gold. The intrinsic value of any investment is the sum of the discounted future cash flows the investment will generate. Unlike a bond or a stock, however, there is no future cash flow expected from a bar of gold. In effect, the only reason one would purchase it as an investment is because one believes someone else will be willing to pay even more for it in the future.
October 2009 — Empirical Finance Newsletter on The Stock Price Performance of Shell Companies, a paper by Ioannis V. Floros and Travis R. SappAbstract: In each of the last eight years reverse mergers have outnumbered traditional IPOs as a mechanism for going public, and shell companies are providing fuel for much of this growth. We study 287 trading shell companies over the period 2006-2008. The purpose of most of these shell firms is to find a suitor for a reverse merger agreement. These companies have no systematic risk, operations, or assets, and their share price tends to decline over time. When a takeover agreement is consummated, shell company three-month abnormal returns are 48.1%. We argue that this exceptional return is compensation for shell stock illiquidity and the uncertainty of finding a reverse merger suitor.
Conclusions: Shell investing is a specialty in the microcap investing space, and has made many an investor very wealthy. But it is largely off the radar of most professional investors as well as academic researchers. This paper provides fascinating insight in to the nature and profitability of shell investing. In general, investing in shells is lucrative and can be done responsibly with careful risk management.
Vito Racanelli writes an interesting article in Barron's on phrases that may spell trouble for investors:
"ANYONE WHO HAS SLOGGED THROUGH THE legalese of a thick Securities and Exchange Commission filing knows the devil is often in the footnotes or the appendix. A good rule of thumb, particularly for adverse corporate information, is that the further back in the report, the more important the information. The urge to skip sections of a 100-page 10K is a strong one, but you do so at your peril."
"Now that most regulatory filings are easily searchable on the Internet, investors can troll through the documents for key phrases suggesting something could be amiss -- let's call them dirty words."
We are pleased to bring you an exclusive 115-minute audio program on the strategy and tactics behind the business achievements of Henry Earl Singleton (1916-99), founder of Teledyne. The program is presented by John Mihaljevic, CFA, managing editor of The Manual of Ideas. John walks the listener through key passages of Dr. George A. Roberts's biography of Henry Singleton, entitled Distant Force, and opines on the keys to Singleton's success. Author John Train has credited Berkshire Hathaway chairman Warren Buffett as saying that Singleton has "the best operating and capital deployment record in American business."
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The latest issue of 10x45 Bargain Hunter, published on October 4th, presents the results of a proprietary Manual of Ideas stock screen for potential activist targets. The list includes 45 companies, nine of which are new additions to the list. In order for a company to join the list, it must have a strong balance sheet that could be recapitalized or liquidated to achieve activist value creation; and insiders must own less than 20% of the shares, implying an inability to exercise voting control over the company. Here are the newcomers to the screen results:Click here to view the full screen results in PDF format.
Disclosure: No positions.
Paolo Pellegrini, the man who made billions for John Paulson by betting on a decline in the housing market, comments on the outlook for the economy and equities.
Thanks to Yaser Anwar for the above video.
By Ravi NagarajanThere is certainly no shortage of commentary on the unemployment statistics that come out every month and most value investors do not make investment decisions based on macroeconomic factors alone. In general, it is always a good time to invest when securities can be found that provide solid return potential and have a large margin of safety. But does this mean that value investors should just ignore today’s Employment Situation Summary from the Bureau of Labor Statistics (BLS)?
At the risk of looking foolish several months or a year from now, I will go out on a limb and say that “this time it’s different” when it comes to assuming that earnings will bounce back to pre-recession levels very quickly. While investing based on macroeconomic forecasts is generally not recommended, bottom up analysis of a business often requires assumptions to be made regarding earnings power. Many value investors look at five or ten year average earnings to assess long term earnings power, but if the last several years represent an aberration, this could be a recipe for overpaying for stocks.
No Green Shoots in Employment
The speed of the job losses over the past year has been unprecedented in post-war history. This chart provided by the BLS shows the one month net change in employment for the past ten years and can be adjusted to provide even more history. The rate of job losses peaked at 741,000 in January 2009 but has remained at very high levels since then. In fact, the 263,000 jobs lost in September is higher than all but two of the months of the 2001-2002 recession (October and November 2001 in the immediate aftermath of 9/11). If it was not for the extreme severity of the economic downturn that followed the financial system meltdown in late 2008, we would still consider the current environment to be a very deep recession.
If we are indeed at a similar point today to the economic conditions prevailing toward the end of 2001, we should not expect any quick snap back in employment. That period was followed by more than eighteen months of continued job losses, with a few months of positive results, before the employment recovery began in earnest in late 2003.
While it is true that previous post-war recessions had quicker employment recoveries, the current situation is more like the 2001-2002 recession in terms of the overall structure of the economy. In many prior recessions, manufacturing was a much larger percentage of the civilian labor force than it is today and when factories restarted production, employment quickly recovered. Services and other non manufacturing occupations are more common today as a percentage of overall employment and there are many more opportunities for outsourcing than in the past. As even President Obama has stated, many of the lost manufacturing jobs will never come back.
Consumer Spending
The fact that consumer spending accounts for nearly 70 percent of Gross Domestic Product is well known and government policies have attempted to boost such spending. The most notable attempt was the cash-for-clunkers program which now appears to have mainly succeeded in accelerating automobile purchases from September into August. With savings rates still at very low levels and unemployment rates near double digits, consumers are unlikely to trigger a recovery.
From a value investing perspective, what all of this means is that maximum skepticism must be applied to the historical earnings of any business that is exposed to discretionary consumer spending. It will be tempting to spot “bargains” by looking at 2005 to 2008 earnings and thinking that stocks are cheap based on such “normalized” numbers. However, there is simply no reason to believe that 2010 will bring about a return to the spending habits of the boom years which were fueled by ever increasing home equity balances and a bubble mentality.
It does not seem inconsistent with a value investing philosophy to be aware of this reality and to conduct bottom up fundamental analysis with a skeptical eye toward historical earnings.
The author of this post, 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.
Up-and-coming value investors Kevin Byun continued his record of outperformance in the third quarter. In a letter to investors, Byun writes, among other things:
"As we consider our opportunity set, one of the most important factors remains investor psychology/behavior. The investment fishbowl that we inhabit contains limited examples of behavior to emulate but many more of what to avoid. Current market stress has revealed more than investors realize about their true temperament. With many burned quite badly in 2008, they are hoping against hope that a healing process will result in full recovery of assets, despite lingering emotional damage from broken promises and misplaced trust. These once trusting investors are looking for answers, solutions, and peace of mind. Not without irony, they are seeking ever more certainty in an increasingly uncertain world (rather than trying to understand and manage the uncertainty that is inherent in it)."
"So while the market gyrations and machinations have rendered many market participants unable to think and act clearly, we must maintain a stable internal compass, and make full use of our practical sensibilities. It is critical, regardless of our recent performance or legacy positions, that we maintain a steady temperament, consistent research process, and clear thinking about the current opportunity set before us."
"Given the erratic nature of the market, I have become increasingly optimistic about our opportunity set. The uncertainty and dislocation are a blessing to value investors, not because we enjoy uncertainty or dislocation, but because of the opportunities they create. Our strategy has remained consistent throughout and I am selectively employing our flexible and tactical approach congruent with our investment framework."
Joel Greenblatt is the founder and a Managing Partner of Gotham Capital and Adjunct Professor of Finance and Economics at Columbia Business School. He is the author of You Can Be A Stock Market Genius (Simon & Schuster, 1997) and The Little Book That Beats the Market (Wiley, 2005). He is the former Chairman of the Board of Alliant Techsystems, an NYSE aerospace and defense firm. Greenblatt is also Chairman of the Success Charter Network, a network of charter schools in New York City.
Greenblatt is famous in the investment world for his long-term investment track record, which ranks among the best ever and is believed to comprise returns of some 40% per year for more than two decades.
The following are books listed on the syllabus of the value and special situation investing course Greenblatt teaches at Columbia Business School:
In a September 2009 interview with Portfolio Manager's Review, up-and-coming value investor Brian Gaines, founder of Springhouse Capital Management, provides the following book recommendations in response to a question:
Brian Gaines: "I tend to read and re-read more of the business history books as it is always useful to compare and contrast past periods to today’s times. Books like Barbarians at the Gate, The Vulture Investors or Merchants of Debt are consistently great reads. Market Wizards also provides some interesting comparisons to today’s markets. I recently read Lords of Finance about central bankers following World War I and through the Great Depression and it was fascinating."
See also books recommended by...
David Einhorn is one of the most widely respected hedge fund managers. He employs a value-oriented, research-intensive long-short strategy in managing Greenlight Capital.
Download the Fall 2009 Issue