The Ideas Report For Serious Investors

Have you heard about The Manual of Ideas but are not quite sure what we do? Here is a quick look at the most recently published issues of our key subscription-based publications. Find out for yourself why our research team and our publications have won industry-wide acclaim in less than a year following the publication of our inaugural issue.

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The latest issue of the monthly Downside Protection Report was published today, November 30th. Inside, editor John Mihaljevic presents his top two monthly stock picks, including a Jacksonville, Florida-based provider of ATM management services and a Canadian gold mining company with key assets located in EU member state Bulgaria.

The ATM management company highlighted in the report is experiencing strong profitability and has ample opportunities for organic growth, yet the shares trade at well below ten times earnings. The company has a strong management team, which appears poised to capitalize on opportunities to gain market share while expanding profit margins. This micro-cap company remains undiscovered by Wall Street and institutional investors, but that should not last long given management's strong execution.

The Canadian gold mining company featured in the report still trades for less than tangible book value despite a strong balance sheet with no net debt and a solid asset base. The company already has a large producing gold/copper mine -- the largest mine of its kind in Europe -- and is likely to double or triple annual production over the next several years. With the company trading at a discount to comparables based on current production alone, the shares offer a compelling risk-reward trade-off, in our view.

Start your 30-day FREE trial of Downside Protection Report and read the current issue now.

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The latest issue of the monthly European Value Report was published on November 27th. Inside, the acclaimed Manual of Ideas research team, which includes an on-the-ground presence in Europe, presents the team's top two monthly European investments.

One of the companies highlighted in the latest report is Dutch-based food producer and distributor Wessanen (WES NA). Writes the MOI research team: "Although the revelation of financial reporting “irregularities” at a U.S. subsidiary in June is only one of many problems the company faces, it has certainly led to more investors “throwing in the towel”. Wessanen’s shares are down by about 15% year-to-date and 60% over the last three years. With a new CEO, the announced exit of loss-making North American operations (representing nearly two-thirds of total revenue), and focus on a profitable European branded business, we think shares do not properly reflect the company’s potential for strategic change."

Start your 30-day FREE trial of European Value Report and read the current issue now.

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The latest issue of the bi-weekly 10x45 Bargain Hunter was published on November 28th. As always, the report shows the Top 45 results for 10 essential stock screens for value-oriented investors. The screens include the following:

1. "Magic Formula," based on Trailing Financials — Companies with high returns on capital employed, trading at high trailing EBIT-to-enterprise value yield
   
2. "Magic Formula," based on This Year's EPS Estimates — Companies with high returns on capital employed, trading at high earnings yields (based on this FY EPS estimates)
   
3. "Magic Formula," based on Next Year's EPS Estimates — Companies with high returns on capital employed, trading at high earnings yields (based on next FY EPS estimates)
   
4. Contrarian: Shunned by the market, but not by insiders — Companies close to 52-week lows, with consistent insider buying and no selling
   
5. Contrarian: Biggest Losers (deleveraged & profitable) — Non-financial companies with no net debt, positive analyst estimates for next year's EPS, and large YTD price drop
   
6. Value with Catalyst: Cheap Repurchasers of Stock — Companies that may be creating value by reducing their shares outstanding at relatively cheap prices
   
7. Profitable Dividend Payors with Decent Balance Sheets — Dividend-paying companies with no net debt and EPS estimates in excess of 75% of the indicated annual dividend
   
8. Deep Value: Lots of Revenue, Low Enterprise Value — Companies that trade at low multiples of net revenue
   
9. Deep Value: Neglected Gross Profiteers — Companies that trade at low multiples of gross profit
   
10. Activist Targets: Potential Sales, Liquidations or Recaps — Companies that may unlock value through a corporate event
    

Subscribe to 10x45 Bargain Hunter and read it now.

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The latest issue of the monthly Portfolio Manager's Review was published on November 20th. The "Superinvestor Issue" includes a proprietary review of the top holdings of more than twenty top investors. Also inside is a discussion of five superinvestor companies that offer compelling value, as judged by the Manual of Ideas research team.

The report also includes an interview with micro-cap value investor and Columbia Business School professor Paul Sonkin. In the interview, Sonkin discusses the secrets to success in microcap investing and outlines the thesis behind some of his top investment picks. Sonkin also cites his favorite books for investors: Hermann Simon's Hidden Champions, Ben Graham's The Intelligent Investor, and Paul Strebel's In the Shadows of Wall Street.

Superinvestor portfolios highlighted in the report include:

• William Ackman, Pershing Square
• Zeke Ashton, Centaur
• Brian Bares, Bares Capital
• 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 Capital
• Prem Watsa, Fairfax Financial
• Wally Weitz, Weitz Funds
• Marty Whitman, Third Avenue

Companies mentioned in the report include Abbott Labs, Aetna, Alcatel-Lucent, Alleghany, Allegheny Energy, Alliance One, Allstate, AmeriCredit, ATP Oil & Gas, Baldwin & Lyons, Becton Dickinson, Boeing, BreitBurn Energy, Brookfield Asset Management, Brookfield Properties, CA, Campbell Soup, Capital Southwest, CapitalSource, Cardinal Health, CarMax, Chesapeake Energy, Citigroup, Columbia Banking, Contango Oil & Gas, Crosstex Energy, dELiA*s, Dell, DENTSPLY, Diageo, Dillard's, DineEquity, DIRECTV, Domtar, DreamWorks Animation, Enzon Pharma, Fair Isaac, Fairfax Financial, Forest City Enterprises, Forest Labs, Gastar Exploration, General Electric, Hartford Financial, Heritage-Crystal, Hertz, Humana, Huntsman, International Assets, International Coal, Investors Title, ITC Holdings, J.C. Penney, Jefferies Group, John Bean Tech, Johnson & Johnson, Kraft Foods, Leucadia National, Level 3 Comms, Lockheed Martin, Markel, McDonald's, MI Developments, Microsoft, MTS Systems, Multimedia Games, News Corp., Northrop Grumman, Omnicom, Orange 21, Overstock.com, Paychex, Pfizer, Pioneer Natural, Pool Corp., Resource America, RSC Holdings, Sears Holdings, Spirit AeroSystems, St. Joe, Syneron Medical, Theravance, Thomas Properties Group, TravelCenters, tw telecom, Tyco Electronics, United America Indemnity, United Parcel Svc, USG, Viad, ViaSat, Wal-Mart, Walt Disney, WellCare, Wells Fargo, Wendy's Arby's, Yum! Brands, Zenith National, Zoran, and more.

Subscribe to Portfolio Manager's Review and read it now.

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The latest issue of the quarterly Equities and Tobin's Q report was published on September 21st. The full issue is available for FREE download.

Learn more about Equities and Tobin's Q and don't miss the next quarterly issue, expected to be published in mid-December.

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Do you want to get started with The Manual of Ideas but are not sure which publication is right for you? We recommend starting with a FREE trial of Downside Protection Report, our most popular publication. DPR will give you a great sense of our approach to generating winning investment ideas. Start now.

Posted by manualofideas at 01:41 PM | Permalink | Comments (0)

Famed value investor Robert Rodriguez of First Pacific Advisors is taking a one-year sabbatical. In his final fund commentary, Rodriguez pulls no punches on the government's deficit spending:

One final thought that brings me to the intensifying issue that we have written about several times before — the explosion in Treasury debt outstanding. Since September 30, 2008, Treasury debt has risen from $10 trillion to $11.9 trillion, a rate of $5 billion per day. There is no end in sight for this out of control debt growth, as reflected by federal government deficit forecasts, which we consider optimistic, that total between $7 and $9 trillion for the period 2010 to 2019. In our March 2009 Letter to Shareholders, we estimated that US Treasury debt would swell to between $14.6 trillion and $16.6 trillion by the end of 2011. If we stay on this present trend, we should reach this range which, in our opinion, is outrageous and fiscally irresponsible. This insanity is not a Democratic Party or a Republican Party "thing." Both parties are responsible, but who is ultimately more responsible than these two parties? It is we, the citizens, who keep re-electing these power-centered financially inept politicians and it will be our children and grandchildren who will have to "pay the piper." It is not right and is morally reprehensible that one generation would do this to another.

Our country is currently in this financial mess because consumers, corporations and government succumbed to the temptations of excessive spending, debt growth and risk taking. Just as any family or company can get into trouble with too much debt, so can a state or country. California is a perfect example of a state government that has been devoid of economic reality and totally irresponsible in its finances, with spending far exceeding revenue growth for years. Our federal government also exemplifies this unsound and unwise trend. Before new expenditure programs are created and laid upon preexisting ones, we should be demanding that federal, state and local governments get spending under control first. We cannot trust most politicians because they practice "bait and switch" tactics in proposing new programs. The true long-term program costs are always understated because new benefits are added subsequently that were not included in the original optimistic cost estimates — Social Security, Medicare and Medicaid are perfect examples of this process, and the proposed new health care spending program, if passed, will likely follow this same course.

As a beginning, no new programs should be created until others have been eliminated to offset these costs in the year of origination. We should have government prove to us first that this new budgetary balance can be achieved and maintained. Once at approximate equilibrium, we can begin to focus on debt reduction through the process of expenditures growing at less than the rate of revenue growth. Most families know that before they can regain control of their finances, they first have to control their spending. If our elected officials cannot agree to meet this principle of fiscal discipline and be held accountable to it immediately, they should be ousted from office. Most of our current elected representatives would fail this test. As is the case with any company or family that does not deal with its pre-existing debt first, and then proceeds to take on additional debt beyond its means to pay, foreclosure or possibly bankruptcy will likely result. The same goes for a country, unless it can continue issuing debt denominated in its own currency. In this case, it can expunge its debt through the process of printing money and, thus, it can create a monetary inflation that destroys the purchasing power of previously issued debt. Our lenders will not stand for this and current trends show that foreign central banks are beginning to shift their holdings from Treasury notes and bonds to much shorter term Treasury bills. This is an ominous trend. At FPA, we began this process several years ago in our fixed income management accounts.

Read the full letter to shareholders of the FPA Capital Fund.

Posted by manualofideas at 12:32 PM | Permalink | Comments (0)

The Financial Times recently featured an interview with investor Jim Rogers. Here are some of the highlights:

What is the secret of your success?

As I was not smarter than most people, I was willing to work harder than most. I was prepared to examine conventional wisdom. If everyone thinks one way, it is likely to be wrong. If you can figure out that it is wrong, you are likely to make a lot of money.

What is your basic investment strategy?

Buy low and sell high. I try to find something that is very cheap, where a positive change is taking place. Then I do enough homework to make sure I am right. It has got to be cheap so that, if I am wrong, I don’t lose much money. Every time I make a mistake, it is usually because I did not do enough homework.

Do not underestimate the value of due diligence. In the 1960s, General Motors was the world’s most successful company. One day, a GM analyst went to the board of directors with the message: “The Japanese are coming.” They ignored him. Investors who did their homework sold their GM stock – and bought Toyota instead.

I’m not buying any stocks at the moment. If anything is undervalued now it is commodities and some currencies.

Where should people put their money in the recession?

Invest only in things you know something about. The mistake most people make is that they listen to hot tips, or act on something they read in magazines.

Most people know a lot about something, so they should just stick to what they know and buy an investment in that area. That is how you get rich.

You don’t get rich investing in things you know nothing about.

Read the full interview.

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

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Watch the Bloomberg interview with Marc Faber.

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

Interesting analysis from the Pew Center On The States:

California’s financial problems are in a league of their own. But the same pressures that drove the Golden State toward fiscal disaster are wreaking havoc in a number of states, with potentially damaging consequences for the entire country.

This examination by the Pew Center on the States looks closely at nine states, in addition to California, that are particularly affected by the recession. All of California’s neighbors–Arizona, Nevada and Oregon–and fellow Sun Belt state Florida were severely hit by the bursting housing bubble, landing them on Pew’s list of states facing fiscal difficulties similar to California’s. A Midwestern cluster of states comprising Illinois, Michigan and Wisconsin emerged, too, as did the Northeastern states of New Jersey and Rhode Island.

 

"Beyond California: States in Fiscal Peril" makes clear that the recession severely impacted states from different geographic regions with different types of economies, tax structures and political leanings. 

Updated 11/19/09—The Pew Center on the States hosted a briefing on November 13  with officials from California and Michigan following the release of "Beyond California: States in Fiscal Peril." 
View video clips and listen to the full audio from the event.

• Download the report. (Adobe PDF)
• Download the executive summary. (Adobe PDF)
• Read more about the states profiled. 
• Read how the states were assessed. 

Scoring the States

The Pew Center on the States compiled its list by scoring all 50 states according to six measurable factors that contributed to California’s ongoing fiscal woes, using the best available data as of July 31, 2009. The state profiles in this report go beyond the data to give a fuller picture of the recession’s deep and pervasive effects on states’ financial and economic well-being.

Download the 50-state scorecard

View Full Report:

November 11, 2009 -
Beyond California full report (Adobe PDF)

Associated Press Release

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

One of the challenges for value investors who are instinctively concerned about the Fed's money printing policies is justifying the purchase of gold. After all, Warren Buffett has said the following:

Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.

Buffett is no fan of the shiny metal. So why are other top-notch value investors, including John Paulson and David Einhorn, embracing gold?

Dylan Grice of Societe Generale may have an answer. He recently published a research report entitled "Popular Delusions: A Minskian roadmap to the next gold mania." Here is an excerpt:

Central bank hoarding of gold in 1970 ushered in the famous gold bull market. With central banks likely to be net gold purchasers in H2 2009 for the first time since 1988 the same starting gun is ringing out today. The price at which the USD would be fully backed by gold (as it was during the peak of the 70s mania) is $6,300. So there is a case for gold being “cheap.” Moreover, the 70s bull market was facilitated by tight energy markets, overly accommodative central banks and nervousness that policymakers had lost their way. Sound familiar?

• In 1965, concerned at the inflationary policies of the US and the attendant threat to their dollar reserves, the French central bank started converting their dollars into gold. This set in motion events which saw the central banks of Belgium, the Netherlands, Germany, and eventually Britain doing the same in 1970. By 1971, the Bretton-Woods system, by which all currencies were pegged to the dollar and the dollar effectively pegged to gold, had broken. The French had fired the starting gun for the great 1970s bull market in gold and silver.
  
• It's worth pointing this out because central banks aren't known for their investment acumen. Some commentators have mockingly suggested that the Reserve Bank of India's recent decision to buy 200m tonnes of IMF gold signals the top of the market in the way that heavy selling by the UK signalled the bottom in 1999.
  
• This is cute. But I think it's wrong. Like today, central banks weren't buying gold in the late 1960s to prop it up, they were abandoning attempts to prop up the dollar. Gold feels frothy today, but the Indian purchase of IMF gold eerily parallels the French purchases of the late 1960s. And ill policy winds are blowing in its favour. With the precious metals consultancy GFMS estimating that central banks will be net buyers of gold for the first time since 1988, have the Indians just sounded the same starting gun the French did in 1965?

The Financial Times has more on this subject.

Posted by manualofideas at 12:34 PM | Permalink | Comments (0)

Welcome to this Northern Chinese city, but where are the people?

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Posted by manualofideas at 09:56 AM | Permalink | Comments (0)

Bill Stewart and W.P. Stewart have followed a GARP-oriented investment approach ("growth at a reasonable price") for a long time and have put together an above-average track record. While the firm hit upon hard times last year and lost both assets and its NYSE listing, it continues to manage roughly $1.5 billion in assets. On November 6, W.P. Stewart held an annual investment seminar, the proceedings of which may be followed online. You may find some of the presentations worthwhile.

Click here to access the W.P. Stewart annual investment seminar.

(Thanks to David Lau for the link.)

Posted by manualofideas at 09:04 PM | Permalink | Comments (0)

"The father-and-son duo talk about what it was like growing up Gates as they reflect on the advice that has influenced their careers and their relationship." Excerpt:

Bill, I'd like to ask you about the best advice that you've ever gotten from your dad.

Bill Gates: Well, my dad and my mom were great at encouraging me as a kid to do things that I wasn't good at, to go out for a lot of different sports like swimming, football, soccer, and I didn't know why. At the time I thought it was kind of pointless, but it ended up really exposing me to leadership opportunities and showing me that I wasn't good at a lot of things, instead of sticking to things that I was comfortable with. It was fantastic, and now some of those activities I cherish. They had to stick to it because I pushed back a lot, but it was fantastic advice.

Read the full article.

Posted by manualofideas at 05:37 PM | Permalink | Comments (0)

By Nadav Manham

Anyone who co-wrote Barbarians at the Gate belongs in the Business Writers Hall of Fame.  Anyone who wrote Vendetta about Edmond Safra also belongs in the Hall of Fame.  Anyone who wrote The Big Rich about the great Texas wildcatters belongs there too.  Bryan Burrough did all three, which puts him on Mt. Rushmore. 

Now that I've regained my composure:  The November 2009 Vanity Fair features Burrough's extended profile of Marc Dreier, which Dreier cooperated with.  It's a shame Bernard Madoff came along and ruined everything because Marc Dreier's scheme was even more audacious and difficult to imagine.  It's one thing to go after and defraud the naive and the gullible, rich widows and orphans and status-seekers who don't know much about investing, and to do it via a Ponzi scheme, which has an internal logic to it that makes it easier to prolong.  Dreier just "went full con artist", which everyone knows you should never do (start watching at 0:25 and stop at 1:10), and he went after and defrauded the best, stealing from a who's who of hedge funds.  

The obvious question is how someone like Dreier could have stolen so much from people who are so good.  And he stole the most from the best--you're just going to have to trust me when I say this.  Without knowing the details of the scheme in full, all I can say is that if Dreier had had to deal one-on-one with the managers of these hedge funds, rather than with people who reported to them, he would not have had a prayer of success.  It's one of the buried risks of investing in large funds--the founding genius can't oversee everything.

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. 

Posted by manualofideas at 05:30 PM | Permalink | Comments (0)

Historians writing about events that have faded into a distant memory are challenged by the need to accurately portray these events and to provide analysis and commentary that sheds light on what happened and why.  In contrast, writers covering current events where the end of a story is not yet known face a much more difficult task.  Their interpretation of events may prove to be inaccurate or embarrassing in the not-so-distant future particularly when dealing with a subject related to technology.

Ken Auletta is apparently a brave author given his willingness to write about a story where the ending is still very much unfinished in Googled:  The End of the World as We Know It. Mr. Auletta provides a great deal of insight regarding Larry Page and Sergey Brin, Google’s founders, along with a good description of Google’s meteoric rise over the past decade.  However, the more interesting aspect of the narrative involves the forward looking insights provided by Mr. Auletta and many technology leaders who are quoted extensively throughout the book.

While the book is of particular interest to those seeking more color regarding the entrepreneurial story behind Google and its rapid rise, I found myself drawn to the clear implications for the newspaper industry as well as lessons that investors should learn based on Google’s story. For a review covering other details of the book, The Wall Street Journal published an interesting article earlier this month.

The Decline of Newspapers

Of all the issues facing society today, few come close to the importance of the decline of newspapers and journalism.  This may seem like an outrageous claim given the state of the economy, high rates of unemployment, and the range of other problems facing the country.  However, without top notch journalism, how will citizens be informed about these issues or hold government accountable?

One statistic from the book jumped off the page:

A regular reader of the New York Times spends thirty-five minutes each day with the print version, according to Nielsen, while those who read the Times online spend only thirty-seven minutes a month reading it.  These figures can be misleading, because they average in the occasional visitors who may spend a minute or less online with those who are online devotees.  Nevertheless, there is a wide disparity between online and print newspaper readers.  Pages 165-166

Thirty-five minutes per day versus thirty-seven minutes per month!  What could account for this disparity?  The online reader may be treating journalism as a “buffet” and browsing multiple sites for information rather than spending time exclusively with one paper.  However, the typical online reader may simply be missing a great deal of information compared to the print reader.  The online reader’s knowledge may end up being a mile wide and an inch deep as a result.

One factor that is seldom discussed is the fact that a physical newspaper, by virtue of its format and physical qualities, encourages readers to take in a broader variety of content than the typical online reader who searches for a topic (usually via Google) and is taken directly to the relevant article.  Often when reading a physical paper, one notices nearby articles that seem compelling enough to read but are not subjects that the reader would directly search for.  Some online sites are better than others in terms of suggesting related content, but none that I have seen come close to the physical properties of the printed newspaper.

From an economic standpoint, the book goes into quite a bit of detail regarding the loss of advertising that many papers have suffered and the fact that few papers have been able to charge for content.  While Google has played a role in this trend, it is by no means a situation that was caused by Google.  Readers have simply been conditioned to expect free information online and will hesitate to pay for access.  The drama associated with this dilemma escalated today when Rupert Murdoch’s News Corp. was reported to be in talks with Microsoft regarding a partnership that could result in News Corp’s newspaper content being removed from Google sites.

Creative Destruction and The Intelligent Investor

In the 1980s, who would have thought that the typical city newspaper was anything other than a wonderful monopoly-like business with a powerful economic moat?  As a teenager delivering and selling papers in the 1980s in the Silicon Valley, the question I faced was not whether a household subscribed, but whether they took the morning or evening edition, or if they favored the San Francisco Chronicle or the San Jose Mercury News.  Nearly every house had some type of newsprint on their driveway each day.

The newspaper industry is just one of many that have been impacted by the Internet in general and Google in particular.  Ad agencies, traditional broadcasters, and many other media companies have seen their economic models damaged severely.  Furthermore, few of these businesses twenty years ago could have forecast the economic earthquake to come. Many if not most of these businesses would have appeared to have strong economic moats in place.

Ignoring Google’s rise over the past decade would have been a recipe for creating blind spots when it comes to evaluating the strength of existing moats.  Investors need to constantly monitor their holdings and always consider whether it is possible for their business interests to be “Googled”.  Anyone who believes that it is possible to simply say “I don’t deal with technology” may avoid losing money in technology investments but get blindsided by the impact of technology in unexpected ways.

Avoid being “Googled” by learning the lessons of this book and applying the insights when evaluating the moats of businesses in your own portfolio.

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. 

Posted by manualofideas at 10:19 AM | Permalink | Comments (0)

Zeke Ashton of the top-performing Tilson Dividend Fund (TILDX) recently spoke with Ticker Magazine, outlining his fund's investment strategy, discussing why some investors get tripped by "value traps," and more. Here is a highlight:

Q:  What kind of value are you seeking and how do you judge that?

A: Value can come in many forms, but we are generally most comfortable with those ideas that offer one of two highly visible forms of value. The first form of value is cash flow. We focus on high quality, well-capitalized companies that are already achieving high cash flow levels, and we try to buy those cash flows at reasonably low multiples. Given our emphasis on dividends, it is important to us to buy securities of companies that produce reliable cash flow, because cash flow is what ultimately funds the dividends. The second form of value is asset value, whether it be in the value of hard assets, such as land, natural resources, or investments. Either way, we do our best to make sure that our valuation efforts on each security in the portfolio are underpinned by demonstrated cash flow generation ability and/or asset value. This provides the margin of safety against significant losses that every value investor tries to achieve.

Our belief is that it is more judicious to pay up a little bit more for a company that does have good growth potential versus a comparable business that is not growing as much but which might appear to be cheaper on a conventional price-to-earnings or price-to-book value basis.

When we looked at eBay‘s business, we felt the auction and fixed price merchandise listing businesses is still growing but at a very slow pace. But the PayPal business is growing at a faster pace and is quite profitable. So, we did not see a business that was going to fall off a cliff. Clearly, we saw a business that might have the possibility of future growth, but we certainly weren’t paying for any future growth.

We highlight eBay only because it’s a good example of a high-quality business that was cheap because it was suffering from near-term issues that made it unpopular and therefore available at a very reasonable price. We are still holding some of it in the portfolio though it’s now a very modest size position. Also, eBay doesn’t pay dividends because they prefer to buy back shares instead. So in order to generate some income on it, we sold call options on some of our position at prices that we believed represented a reasonable fair value for eBay stock. Had it taken longer for our eBay idea to work out, we would have continued to sell call options on the position and thus would have earned a nice income on the position over time.

Read the full interview with Zeke Ashton.

Read the full interview with Zeke Ashton.

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

Read an excerpt of the latest issue of Portfolio Manager's Review, entitled "The Superinvestor Issue." The report, published on November 20th, includes a proprietary review of the top holdings of more than twenty top investors. Also inside is a discussion of five superinvestor companies that offer compelling value, as judged by the Manual of Ideas research team.

The report also includes an interview with micro-cap value investor and Columbia Business School professor Paul Sonkin. In the interview, Sonkin discusses the secrets to success in microcap investing and outlines the thesis behind some of his top investment picks. Sonkin also cites his favorite books for investors: Hermann Simon's Hidden Champions, Ben Graham's The Intelligent Investor, and Paul Strebel's In the Shadows of Wall Street.

Superinvestor portfolios highlighted in the report include:

• William Ackman, Pershing Square
• Zeke Ashton, Centaur
• Brian Bares, Bares Capital
• 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 Capital
• Prem Watsa, Fairfax Financial
• Wally Weitz, Weitz Funds
• Marty Whitman, Third Avenue

Companies mentioned in the report include Abbott Labs, Aetna, Alcatel-Lucent, Alleghany, Allegheny Energy, Alliance One, Allstate, AmeriCredit, ATP Oil & Gas, Baldwin & Lyons, Becton Dickinson, Boeing, BreitBurn Energy, Brookfield Asset Management, Brookfield Properties, CA, Campbell Soup, Capital Southwest, CapitalSource, Cardinal Health, CarMax, Chesapeake Energy, Citigroup, Columbia Banking, Contango Oil & Gas, Crosstex Energy, dELiA*s, Dell, DENTSPLY, Diageo, Dillard's, DineEquity, DIRECTV, Domtar, DreamWorks Animation, Enzon Pharma, Fair Isaac, Fairfax Financial, Forest City Enterprises, Forest Labs, Gastar Exploration, General Electric, Hartford Financial, Heritage-Crystal, Hertz, Humana, Huntsman, International Assets, International Coal, Investors Title, ITC Holdings, J.C. Penney, Jefferies Group, John Bean Tech, Johnson & Johnson, Kraft Foods, Leucadia National, Level 3 Comms, Lockheed Martin, Markel, McDonald's, MI Developments, Microsoft, MTS Systems, Multimedia Games, News Corp., Northrop Grumman, Omnicom, Orange 21, Overstock.com, Paychex, Pfizer, Pioneer Natural, Pool Corp., Resource America, RSC Holdings, Sears Holdings, Spirit AeroSystems, St. Joe, Syneron Medical, Theravance, Thomas Properties Group, TravelCenters, tw telecom, Tyco Electronics, United America Indemnity, United Parcel Svc, USG, Viad, ViaSat, Wal-Mart, Walt Disney, WellCare, Wells Fargo, Wendy's Arby's, Yum! Brands, Zenith National, Zoran, and more.

Learn more about Portfolio Manager's Review.

Subscribers, log in to download the full report.

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

Robert Huebscher has posted part two of his interview with Columbia Business School professor Bruce Greenwald, author of Value Investing and Globalization.

Read part one and part two of the interview with Bruce Greenwald.

Posted by manualofideas at 09:16 AM | Permalink | Comments (0)

Berkshire Hathaway has released a new 13-F filing today which reveals the composition of the company’s equity portfolio as of September 30, 2009.  In addition, the company released an amended 13-F filing for Q2 which shows a position in Exxon Mobil as of June 30, 2009.  This was previously not disclosed due to Berkshire’s request for confidential treatment for the position.

Highlights

During the third quarter, Berkshire made further purchases of Exxon Mobil and also initiated positions in Nestle, Republic Services, and The Travelers Companies.  Berkshire closed out positions in the Eaton Corporation and Wabco Holdings while reducing its stake in Conoco Phillips, Moody’s, NRG Energy, Sun Trust Bank, and WellPoint.

Please note that the 13F report only covers holdings that trade in the United States. The report includes shares of foreign issuers only if those shares are held as ADRs that trade on a United States stock exchange. Shares that trade on foreign exchanges are not reported on this form. Therefore positions such as POSCO, Swiss Re, Tesco plc, and BYD are not covered in this analysis.

Let’s take a closer look at Berkshire Hathaway’s portfolio changes during the third quarter as well as examine the likely performance of the portfolio during the first half of the fourth quarter.

New Positions

As noted above, Berkshire amended its 13-F filing for Q2 and revealed a stake in Exxon Mobil.  The company held 854,490 shares on June 30 and increased the stake to 1,276,290 shares worth $87.6 million as of September 30.  Based on the size of the purchase, it is possible that GEICO’s Lou Simpson initiated this position rather than Warren Buffett.

The Nestle position acquired during the third quarter was worth $144.7 million on September 30 and, assuming that the same number of shares are held as of today, the value of the investment is now $161.5 million.  This is an interesting purchase given Berkshire’s large existing investment in Kraft and the ongoing drama associated with Kraft’s hostile bid for Cadbury.

Berkshire also added a position in Republic Services worth $96.3 million on September 30.  Republic Services is a provider of services in the solid waste industry operating in 40 states.  In addition, a small position in The Travelers Companies was added to the portfolio.

Increased Positions in Wal-Mart and Wells Fargo

Berkshire nearly doubled the size of its position in Wal-Mart during the third quarter.  As of September 30, Berkshire owned 37,836,642 shares of Wal-Mart worth $1.86 billion.  The Wal-Mart position is valued at slightly over $2 billion today assuming the same number of shares are held.

Berkshire added 10.7 million shares to the already massive position in Wells Fargo.  As of September 30, the Wells Fargo position was worth $8.8 billion, and has been nearly unchanged so far this quarter.

Reduced Positions in Conoco Phillips and Moody’s

Berkshire reduced its position in Conoco Phillips by 7.1 million shares.  This is a continuation of the gradual liquidation of the position following a large impairment charge that was taken in the first quarter.  Please refer to the review of Q1 results for a more detailed discussion of the Conoco impairment.

The position in Moody’s continues to be slowly liquidated with 8.8 million shares sold during the third quarter.  So far, Berkshire has sold an additional 1.15 million shares in the fourth quarter.  Berkshire still holds over 38 million shares of Moody’s based on a recent Form 4 SEC filing.  It appears that Warren Buffett is trying to slowly liquidate this position after making some lukewarm statements about the economic moat of the credit rating firms during Berkshire’s 2009 annual meeting.  For coverage of Mr. Buffett’s comments on Moody’s at the annual meeting, please click on this link.

Strong Results in Q4

Berkshire’s portfolio appears to be posting strong results close to the mid-point of the fourth quarter.  We  know that Berkshire has sold shares of Moody’s during the quarter based on the Form 4 filing referred to above.  In addition, based on Warren Buffett’s recent interview with Charlie Rose, we know that Berkshire’s shares in Union Pacific and Norfolk Southern have already been sold.

Adjusting for the proceeds of the Moody’s sale and estimating the proceeds of the Union Pacific and Norfolk Southern sales, we can estimate that Berkshire’s equity portfolio is up 8.6% for the quarter so far assuming no other changes were made to the positions reported on September 30.  The increase in the value of the portfolio plus value of the liquidated shares of Moody’s, Union Pacific, and Norfolk Southern should account for approximately $4.8 billion.  Adjusting for deferred taxes owed on the gains, this would account for approximately a $2,000 increase in book value per A share since the figures reported on November 6 in Berkshire’s Q3 report.

For a more detailed look at Berkshire’s portfolio holdings, we have prepared an Excel workbook.  The first worksheet shows Berkshire’s portfolio changes for the third quarter.  The second worksheet attempts to estimate Berkshire’s portfolio value as of November 16. The Excel file is available under the resources listing shown below.

Resources:

Excel workbook with Q3 13-F Analysis and Q4 Estimates (Source: The Rational Walk)
PDF File with Q3 13-F Analysis and Q4 Estimates – Same Data as Excel File above
Berkshire Hathaway’s Q3 13-F Filing (Source: SEC)
Berkshire Hathaway’s Q2 13-F Amended Filing (Source: SEC)
Berkshire Hathaway’s Q2 13-F Original Filing (Source: SEC)
Berkshire Hathaway Form 4 Filing – 10/28-29 Moody’s Sale (Source: SEC)

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.

Disclosure:  The author owns shares of Berkshire Hathaway.

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Here is a CNBC video of the complete event with Bill Gates and Warren Buffett at Columbia University on November 12, 2009. Read the transcript.

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One of the most successful investors of the past several decades, Paul Tudor Jones, was the subject of a PBS documentary shot in the 1980s. The video provides a fascinating view into Jones in the early years of his investment firm. Jones's competitive drive and evident love for trading may have been some of the most important qualities behind his huge success.

Watch the 1987 PBS documentary on Paul Tudor Jones.

Read Paul Tudor Jones's latest letter to investors, in which he makes a bullish case for gold.

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Charlie Rose spoke with Berkshire Hathaway chairman Warren Buffett in New York last Friday. Buffett was in town with his friend Bill Gates for a meeting with Columbia Business School the previous day.

Watch an excerpt of the televised interview (don't miss another clip labeled "Web Exclusive").

Watch past Charlie Rose interviews with Warren Buffett.

Michael Corkery of The Wall Street Journal provides the following takeaways from Buffett's latest conversation with Rose:

“I am not for shooting them….but…I want to make it painful for them.”

That is Warren Buffet speaking about how he would like to punish Wall Street executives for their missteps that led to the financial crisis. Buffet told interviewer Charlie Rose that not just executives, but the banks’ directors should be subject to severe curbs on compensation, such as clawbacks and limits on payouts for up to five years after they leave a firm. [...]

On the economic stimulus:

“There should have been more infrastructure in there, and they hung a Christmas tree on it — as I said, it’s sort of like mixing a tablet of Viagra with candy. I mean, it would have been better to leave out the candy and have the full Viagra.”

On leverage and greed:

“….Being greedy can be fun for awhile, you know. Leverage can be fun when it works. Leverage is one of those things that works 99 times out of 100, and when it doesn’t, you know, it’s all over.”

On being “wired” to make money:

“A prosperous country should not just be prosperous for the people like me who are wired a particular way at birth — no credit to me — but I happen to know something about capital allocation and that wasn’t — you know, instead I could have been wired, you know, so I was — I don’t know; a great ukulele player. But there’s no money in that.

On redistributing wealth:

…The market system is not perfect in any kind of distribution of wealth, and taxation is a way you get to the excesses of what the market system produces and where you take care of the people that get the short straws. In a country as prosperous as we are, nobody should get a really short straw.

On breaking up the big banks:

“In 1998, though, it was a firm Long Term Capital Management that actually threatened the system and they had 200 employees in Sanford, Connecticut, and nobody had ever heard of them. So it isn’t just sheer size. It’s creation of huge leverage positions.…If you’ve got a $2 trillion bank, you know, you’ve got to do a lot of things, and I’ll let you do a lot of things, but — I don’t want them at the racetrack; let’s put it that way.”

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Up-and-coming value investor Kevin Byun of Denali Investors spoke to students at Columbia Business School last Thursday. Kevin discussed his brand of special situation investing, revealing a unique and highly successful investment approach.

View Kevin Byun's presentation on special situation investing.

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Warren Buffett and Bill Gates appeared at Columbia Business School yesterday and answered questions from students for over an hour.  The full video is provided below and a transcript has been posted documenting the full session.  I found Mr. Buffett’s response to one question to be particularly important for individuals who are interested in being an active investor:

QUESTION: Hi, I’m Brian Seedabalker. I’m a second-year student. Mr. Buffett, it’s great to see you again. I was on the trip to Omaha last month. Thank you for hosting us. My question is, how would you recommend an individual investor who follows the Graham and Dodd philosophy to allocate their capital today?

BUFFETT: Well, it depends whether they are going to be an active investor. Graham distinguished between the defensive and the enterprising and that. So if you are going to spend a lot of time on investment, you know I just advise looking at as many things as possible and you will find some bargains. And when you find them, you have to act. It doesn’t — it hasn’t changed at all since I was here in 1950, 1951. And it won’t change the rest of my life. You start turning pages. When I got out of school, I turned every page in Moody’s 10,000-some pages twice, looking for companies. And you have to find them yourself. The world isn’t going to tell you about great deals. You have to find them yourself. And that takes a fair amount of time. So if you are not going to do that, if you are just going to be a passive investor, then I just advise an index fund more consistently over a long period of time.

The worst investment mistakes tend be those made by individuals who buy stocks on hot tips or cursory research such as reading a one page Value Line report or a newspaper article.  Intelligent investing takes a great deal of time, and if you think about it, why would this be a surprise?  Mr. Buffett’s advice to buy an index fund if you do not intend to invest the time in research is exactly correct.

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.

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Kenneth Rogoff of Harvard University and author of This Time is Different: Eight Centuries of Financial Folly speaks with Charlie Rose about the current financial crisis, putting it in historical context.

Go to CharlieRose.com to watch the interview (search for Rogoff).

Read the transcript.

Says Rogoff: "I basically favor having what we call some version of narrow banks, where our deposits go into things like Treasury
bills and things which are very, very sound instead of more speculative activities, and to separate that out in some way."

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Respected investment manager Aaron Edelheit of Sabre Value writes the following on his blog:

The Treasury Department and the Federal Reserve with help from Congress and the White House is making something very, very clear. They are going to devalue the American dollar through the printing of money, maintaining excessively low interest rates and out of control government spending.

If you are sitting on excess cash and that cash is in US Dollars, I feel like you have been warned. Those dollars will be worth substantially less in the future than they are now.

The Federal Reserve has communicated loud and clear they are going to keep interest rates low for an “extended time.” By keeping interest rates artificially low they are trying to recapitalize the financial system, but in the process are punishing savers who are earning little or no interest returns on their money. By keeping interest rates so low, they are actively trying to re-inflate the economy and prices, as they are worried about deflation. They are also keeping interest rates lower than other countries, thereby causing other countries currencies to increase in value.

More importantly, the Federal Reserve is doing something called “Quantitative Easing.” This made up term, means money printing. The Federal Reserve is quite simply buying the new debt that the Treasury Department is issuing. In fact, in the second quarter of this year, the Federal Reserve bought as much as half of all new Treasury Bonds issued. Think about that for a second. The government is buying half of the debt that the government issues. Does that sound absurd?

Treasury bond issuance is up 200% this year as the government posts close to a $1.5 trillion annual deficit. So, here is a dumb question. If the Federal Reserve is buying half of all new Treasury bonds, what happens when they stop? They claim they are going to stop in the first quarter of next year.

I don’t think the Federal Reserve can stop buying. The moment they stop buying interest rates will soar and bond prices will plunge, which will make our debt problem even worse. Money printing will go on for a while, and it will destroy the dollar. In a cynical way it also makes all of us feel better in the short run. We export more in the short run with a cheaper currency, our debts our lower and stocks, real estate and other real things start going up in price. And what better way to pay for all of the government debt, than to devalue that debt?

But in the long run, this is disastrous and it always ends badly. Even worse is to look at the White House and Congress. Beyond the Fed’s money printing, we have out of control spending by Congress. The projected US deficit for 2009 through 2019 is $9 Trillion. Who in the world is going to finance that debt? Where is that money going to come from?

A recent study by Peter Bernholz showed that the 12 largest hyperinflationary episodes in history all reached a tipping point when government expenditures were more than 40% of GDP. Well, the US government is over 40% this year and is projected at 40% next year.

The evidence of massive money printing is already popping up. Look at the price of precious metals, such as gold, which is soaring. Throughout history gold has been a monetary substitute and it becomes very valuable when governments become reckless with money printing and spending.

Better yet, look at the stock market or other commodities. I think we see the clearest evidence of the money the Fed is printing flowing into the markets. The stock market is quite expensive; the economy has been terrible, yet it continues to rise. I think that is why it is quite dangerous to short right now. The market may keep going up simply because there are more dollars floating around out there.

So what is my firm, Sabre Value, doing about the devaluation of the dollar?

Read more on Aaron Edelheit's blog, Investing in a Life of Value.

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Once again, Oaktree Capital Management's Howard Marks has some lucid commentary on achieving investment success in an imperfect world:

In the two-plus years since the onset of the financial crisis, it’s been a regular theme of mine that we should look back, identify the causes and learn from them. I’ve tackled this assignment in a number of memos and a variety of ways. Now, despite the fact that you’ve heard much of this from me before, I’m going to try to pull it all together, using the quotations, adages and images that I feel best capture the essence of what we’ve been through. When I think back, these are the ones that stand out.

"Greed Is Good"

There’s no debating which line from the film Wall Street is the most memorable. It’s hard to forget the image of slicked-back takeover artist Gordon Gekko urging on his troops, invoking the positive power of self-interest. What he meant by “greed is good,” of course, was that greed – or self-interest, or the profit motive – is what drives people and companies operating in a freemarket setting to strive for more and better, and thus to work hard and optimally allocate resources. It’s the force that motivates Adam  Smith’s “invisible hand” and carries economies to increased output and higher standards of living.

Among the many pendulum-like phenomena we occasionally witness is the swing in people’s willingness to rely on the free market. First they trust the market to come up with solutions. Then the shortcomings of those solutions are laid bare and there’s a call for regulation. Then the folly of government involvement becomes evident and people want the free market back, and so forth. Because neither extreme is perfect, the oscillation between them goes on. Governments can’t run economies or companies. But it’s equally true that in a free market, the rules will occasionally be stretched and participants harmed.

In a free market, things will inevitably go past the optimal to the extreme. When they swing back, the retreat can be painful. Thus, if we’re going to rely on the market to settle things, we have to be willing to accept the consequences.

Read the complete memo by Howard Marks.

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Introduction: "Carl Icahn, a prominent activist investor in corporate America, talks about his career and how he became interested in finance and involved in shareholder activism. He discusses his thoughts about today's economy and American businesses and their inherent threats and opportunities. He believes that the biggest challenge facing corporate America is weak management and that today's CEOs, with exceptions, might not be the most capable of leading global companies. He sees opportunities for current, intelligent college students to succeed in the corporate world if they work hard and can identify valuable business pursuits."

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Here is a preview -- we will bring you more coverage later this evening.

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Click here for notes from the meeting of University of Akron students with Warren Buffett, chairman of Berkshire Hathaway.

Paula Schleis's article in the Akron Beacon Journal offers a glimpse into Buffett The Man:

"He's the nicest guy in the world," [business professor Todd] Finkle said. "Very down to earth. Very humble, and he doesn't put himself above anybody."

Kim Baitz, 26, said when she first learned Finkle was asking students to apply for a chance to go on the trip, she had just lost her job.

"I thought this was the perfect opportunity to meet the most intelligent man in the world in finances, and I thought it would be a good time to seek some guidance," said Baitz, who is pursuing her master's in business administration.

She took copious notes of advice from Buffett, but one thing that resounded with her was his belief in finding a career that brings out your passion.

"He goes to work happy every day, and so many of us go to work looking forward to the weekend," she said. Loving what you do is so much more important than making money, he advised.

Finkle said many comments made a deep impression on him as well, but one he'll never forget was in response to Finkle's own question about the most influential people in Buffett's life.

Among those Buffett named was a friend who was a Polish Jew, taken to a World War II concentration camp after an acquaintance reported the friend's hiding place to the Germans.

Buffett said ever since hearing that story, "when he would begin friendships, he would ask the question: Would this person hide me from the Nazis?"

"He then went on to say that one of the most important things [if not the most important] was unconditional love. If you can find two or three people who love you unconditionally, you are a lucky person."

Read the full article. Read the meeting notes.

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The Motley Fool's Chris Hill recently interviewed Buffett biographer Alice Schroeder, author of The Snowball: Warren Buffett and the Business of Life. Here is a highlight:

Hill: You spent a lot of time with him. What most surprised you about him as you were writing this book?

Schroeder: The big surprise was to see how he turns the women around him into these maternal figures -- that a man who was 26 years older than me would be relating to me like a kid. It was really interesting. And this is true with all the women around him. I had to really resist it as an author because (a) I am not his mother, and (b) I was there to report and to be objective. But he didn't have a great childhood, and he didn't have the kind of mother that you would want, so he is sort of always looking for that. He is quite vulnerable. That was a big surprise.

Hill: Do you think that is the biggest misconception about him? His vulnerability?

Schroeder: I think in the personal side, yes. On the business side, I think the biggest misconception about him is that he is a "buy and hold forever investor." He has never said that, but people take little snippets and slices of things that he said, and they turn them into mantras or slogans. I think that people have made a mistake of pulling a few words or a sentence or two here and there and treating that as an all-weather investing technique. It doesn't really work because Warren himself is quite opportunistic, and he does trade and he does adapt. So anybody who thought that you could buy four or five big-cap growth stocks at a fair price and then you could just sit back and just go to sleep -- that has not worked out very well, and he would be the first to say so.

Read the full interview with Alice Schroeder.

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Robert Huebscher of Advisor Perspectives recently spoke with Columbia Business School professor Bruce Greenwald, author of Value Investing and Globalization.

Read Huebscher's interview with Greenwald.

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Do you receive Portfolio Manager's Review in the mail each month? Then you are eligible for a FREE copy of Jeff Benedict's book on R. C. Willey. Email us to request it.

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From Bloomberg:

Raj Rajaratnam: Galleon co-founder Rajaratnam, 52, was arrested and charged Oct. 16 with making millions of dollars by trading on insider information. Rajaratnam, born in Sri Lanka, earned a degree from the University of Sussex, England, in 1980, and an MBA in Finance from the University of Pennsylvania’s Wharton School in 1983. Rajaratnam lives in New York.

Roomy Khan: A former employee of Intel Corp., Khan, 51, was convicted of wire fraud in 2001 for passing inside sales information to Galleon. She worked for Galleon in the 1990s and tried to rejoin the firm in late 2005. She has agreed to plead guilty to charges of conspiracy and securities fraud. She is cooperating with federal authorities. She lives in Fort Lauderdale, Florida.

Deep Shah: A former analyst at Moody’s Investors Service, Shah, 27, is alleged to have given insider information to Khan, including Hilton Hotels Corp.’s impending takeover by Blackstone Group LP. Federal authorities believe he is now in India.

Rajiv Goel: Goel, 51, a former Intel Capital employee, was arrested and charged Oct. 16 with passing inside tips about Clearwire Corp. and Intel earnings to Rajaratnam. He lives in Los Altos, California. He has an MBA in Finance from Wharton and is a friend of Rajaratnam.

Danielle Chiesi: Chiesi, 43, was a consultant at New Castle Funds LLC, a former Bear Stearns Cos. hedge fund. She was arrested and charged Oct. 16 with insider trading. Prosecutors claim she passed tips along to Rajaratnam, including advance notice of a spinoff by Advanced Micro Devices. Chiesi lives in New York.

Mark Kurland: Kurland, 60, co-founder of New Castle, was Chiesi’s boss. He was arrested and charged in the insider trading case Oct. 16. Kurland lives in Mt. Kisco, New York.

Robert Moffat: A former executive with International Business Machines Corp., Moffat, 53, was arrested and charged Oct. 16. Federal officials claim he passed tips to Chiesi, including information about the Advanced Micro Devices spinoff and IBM earnings. He lives in Ridgefield, Connecticut.

Anil Kumar: A friend of Rajaratnam, Kumar, 51, is a former director at the consulting firm McKinsey & Co. He was charged with insider trading Oct. 16. Investigators claim Kumar gave Rajaratnam inside information on the impending spinoff of Advanced Micro Devices, which was a McKinsey client. He lives in Saratoga, California.

Hector Ruiz: The most prominent executive tied to the Galleon case, Ruiz, 63, is the former chief executive of Advanced Micro Devices. He is the executive prosecutors say provided insider information about the upcoming Advanced Micro Devices spinoff to Chiesi. Ruiz, who has not been charged, said he will resign as chairman of Globalfoundries Inc., the company that resulted from the spinoff, Jan. 4. He is on a leave of absence from the company.

Richard Choo-Beng Lee: Lee, 53, and Rajaratnam were colleagues at the research firm Needham & Co. almost 20 years ago. Lee and Ali Far founded Spherix Capital LLC in 2008. Lee has a degree in electrical engineering from Duke University and an MBA from the University of California, Berkeley. He pleaded guilty and is cooperating with federal authorities. He lives in San Jose, California.

Ali Far: Far, 47, is a former Galleon employee who founded Spherix Capital with Lee. He pleaded guilty and is cooperating with the government. Far lives in Saratoga, California.

Steven Fortuna: Fortuna, a co-founder and principal of the hedge fund S2 Capital in Boston, pleaded guilty and is coopering with prosecutors. Fortuna is alleged to have traded on a tip from Chiesi about Akamai Technologies Inc. earnings. Fortuna, 47, lives in Westwood, Massachusetts.

Ali Hariri: A former vice president at the semiconductor company Atheros Communications Inc., Hariri, 38, allegedly tipped Far and Lee to company earnings. He was arrested Nov. 5 and charged with conspiracy and securities fraud. Hariri lives in San Francisco.

Arthur Cutillo: Cutillo, 33, a former attorney at the law firm Ropes & Gray LLP, was arrested Nov. 5 and charged with passing insider tips on deals the firm was working on involving Hilton, Avaya Inc., 3Com Corp. and Axcan Pharma Inc. Cutillo, who is alleged to have received kickbacks for the tips, lives in New Jersey. Prosecutors say he was a key source of inside information for the ring.

Jason Goldfarb: Prosecutors claim Goldfarb, a 31-year-old New York lawyer, received tips from Cutillo and passed them on to Zvi Goffer.

Zvi Goffer: Prosecutors claim Zvi Goffer, 33, was known within the ring as “the Octopussy,” due to his reputation for having multiple sources of inside information. Goffer, the founder of Incremental Capital LLC, previously worked at Galleon and Schottenfeld Group LLC. Prosecutors say he paid Cutillo and other tipsters and gave them prepaid mobile phones to avoid detection. He was arrested and charged Nov. 5 with fraud and conspiracy. He lives in New York.

Emanuel Goffer: The brother of Zvi Goffer, Emanuel, 31, was a trader at Spectrum Trading before joining Zvi at Incremental Capital. He was arrested and charged with securities fraud and conspiracy Nov. 5. Emanuel is alleged to have traded on insider tips from Zvi.

Gautham Shankar: Shankar, 35, was a trader at Schottenfeld. He pleaded guilty to securities fraud for trading on tips from Zvi Goffer and is cooperating with the authorities. He lives in New Canaan, Connecticut.

David Plate: A trader formerly with Schottenfeld, Plate was arrested and charged Nov. 5 with securities fraud and conspiracy for trading on tips from Zvi Goffer. Prosecutors say he now works for Incremental and lives in New York.

Craig Drimal: Drimal, 53, was arrested and charged Nov. 5 with fraud and conspiracy for trading on tips from Zvi Goffer. Prosecutors say he worked in Galleon’s office space without being employed by the firm.

Michael Kimelman: Kimelman, a trader with Lighthouse Financial Group, was arrested and charged Nov. 5 with fraud and conspiracy for trading on tips from Zvi Goffer.

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Bloomberg has an interesting article quoting John Reed, the man who was at the helm of commercial bank Citicorp when it merged with Sandy Weill's Travelers Group in 1998, creating the ill-fated behemoth Citigroup (C).

One of the most striking revelations in the article is Reed's admission that the repeal of Glass-Steagal should never have happened. Reed, of course, advocated for the repeal in 1999. Says Reed now, "When you're running a company, you do what you think is right for the stockholders. Right now I’m looking at this as a citizen."

Should corporate executives always look at big decisions as citizens first and as shareholders second? That might be a nice outcome for society, but it is neither possible nor is it necessary. If senior executives thought about what was right for shareholders, we might not have the kind of crisis we have had recently. The problem is that executives did not think about what was right for shareholders. Instead, they thought about what was right for their own bonus compensation in any given year. If Reed had done the right thing for Citigroup shareholders with respect to Glass-Steagall in 1999, he would have opposed the repeal. The latter has not exactly benefited Citigroup shareholders over the past ten years.

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Note the authoritative-looking set of the Rukeyser show. Everything and everybody on the set seems so polished and proper, yet it's all just a show. It's easy to see the folly of these kinds of programs when we look at them far removed in time. Yet, almost everything we watch on business television these days is no more useful than this Rukeyser show of 1987:

Part 1 of 3:

Part 2 of 3:

Part 3 of 3:

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Transcript:

CATHY BARON TAMRAZ: Greetings from San Diego, where we have just completed the Fortune Most Powerful Women’s Summit. I am Cathy Baron Tamraz, CEO of Business Wire, and I am here with the only male that is allowed into this conference and that is Warren Buffett, Chairman of Berkshire Hathaway, which is also the parent company of Business Wire. Warren has graciously agreed to answer some questions today, and kick off a conference that Business Wire and Market Platform Dynamics are holding in New York City, to launch a new Web site about the payment industry callexd PYMNTS.com. We are really excited about this new portal, which will be a primary source of news for the payments industry. It will havebreaking news and regulatory news in the payment industry, new technology and new products.

Because the payment industry is so vital to the economy, we thought it would be relevant to talk to Warren and hear his views on the state of the economy and what we can do to revitalize it. So thank you, Warren, for speaking with us today and agreeing to be interviewed by me.

WARREN BUFFETT: You are my favorite interviewer!

CBT: Thank you very much. That’s on tape, by the way. So, the first question I have for you is about the near-term future of our economy. The last 12 months feels like a really bad dream. This year has been the year that shook the world. It’s been a year since the bankruptcy of Lehman Brothers and it almost sent the economy over a cliff. We had the Bear Stearns fallout, Merrill Lynch sold to Bank of America, the AIG crisis, Fannie and Freddie falling under government control. It’s been a really difficult year. So, what do you think is going to happen now in the fourth quarter of 2009 and also in 2010?

WB: I am not sure about exact quarters or anything of the sort. Who knows about next week or next month? We made enormous progress since a year ago. We had a real panic. And if you didn’t panic, you didn’t understand what was going on. What happened in September and October of 2008 will particularly be remembered for a long, long time. And while the governmental authorities malign things sometimes, they fortunately did some very right things, very important things. They did them properly, and they kept us from going over the cliff. The fallout from that financial panic hit the regular economy in the fourth quarter like a ton of bricks. We are coming back from that. The patient really went into the emergency room and it won’t come out of the hospital entirely for a while.

There are things that have to be cured in the system, but this system works. If you look at this country, we have gone through the Great Depression, we have gone through world wars, we have gone through civil war, and we have progressed like no country in the world. We have the right system. It doesn’t avoid all the problems, but it overcomes all the problems.

CBT: Do you see consumer-spending increasing in the near term?

WB: No, and not for a while. I think people had an experience a year ago that they are not going to get over quickly. But the factories are there, the human potential is there, the system is there. It works over time. Your kids will live better than you and I live, and our grandchildren will live better than they do. This country moves forward.

If you take the 20th century, we had a Great Depression, world wars, a nuclear bomb, a flu epidemic. We had all these things, and at the end of the 20th century, the average American was living seven times better than at the start of the century. It’s amazing. The Dow Jones Average had gone from 66 to 11,400. So the country works, you don’t have to worry about that.

CBT: This latest debacle has also been called a “crisis of confidence.” Five trillion dollars of American wealth has vanished. If confidence is what’s needed to stimulate the economy, how do we put trust back into the financial system? Does the government need to retain a stronger hand?

WB: Well, people became afraid a year ago, and confidence is not going to exist when fear exists. Fear is very contagious. It spreads very quickly, and that’s what happened in the start of the fourth quarter last year. The confidence doesn’t come back as fast as it’s lost, but it does come back. It’s come back a long way already, but it has a ways to go. As people see and really get re‑affirmed about the fact that this system works. We are still tossing out 14 trillion worth of product a year. It will return. It’s already returned with most people in most ways, but it’s not back 100%. It’ll get there.

CBT: Do you have any comment on the unemployment rate?

WB: Well, the unemployment rate will turn around late. It always lags. People who have gone through a period like this are slow to rehire until they really have to. On the other hand, the time will come when they have to. There will be more people working in housing a year or two from now. We have a brick company. We have companies in the carpet business. We have had to let people go in those businesses in the last year, year and a half. We will be adding people at some point, but we won’t do it until we see the demand come back. It’ll be a little slow because we don’t want to go through what we did before. Although, I will guarantee you that three years from now, our brick companies, our carpet company, and our insulation company will all be employing far more people than now.

CBT: That’s good to hear. The next question is about the government. Congress and the administration have been working on reforming financial regulation. Do you think they are on the right track? And will reforms and new rules to protect consumers help restore confidence?

WB: Well, the new rules won out, so the things they have done during the last year fell pretty short of confidence. Not everything is done perfectly, but nobody can do them perfectly. The important thing is that they got things done and people do believe in them, and they’ll believe in them more and more as it goes along. Government has a real role to play and it will not prevent bubbles forever. Human beings do crazy things from time to time, and the real question is how they recover from it. You and I have done things in our life, and the truth is that we came back from them. That’s the important thing.

You can’t rule out human emotions. When people get greedy as a pack, strange things happen. When they get fearful as a pack, strange things happen. That isn’t the way they exist most of the time, but they do give into that. So rules will help us avoid some of the problems. They’ll help us modify some of the problems, but they won’t eliminate all future problems.

CBT: I was watching a little TV this week and I was listening to William Cohen, who is the author of “The House of Cards.” He said that if you don’t change compensation and how Wall Street is incented, the same thing is going happen all over again. And yet, I recently heard that Wall Street is hiring, and they are also guaranteeing big bonuses and compensation packages, which is a little bit alarming if you ask me. What’s your view is on that?

WB: Well, Wall Street is about trying to make a lot of money. It’s the nature of the system. You get a huge capitalist system, and it raises lots of money and it makes lots of big deals and people – some people get paid very well for it. What you have to change in Wall Street is you have to make sure that in addition to carrots, there are sticks. And it can’t be a one‑way street where they are making ungodly amounts of money when things are good and then they move on to someplace else for a while when things are bad. You have to create a downside. I hope there are some practices put into place – and I’ll have a few thoughts on them myself – but Congress undoubtedly will have a few thoughts too. You have to put in something where there is downside to people who really mess up large institutions and we need some new help in that. Too many people have walked away from the troubles they have created for society, not just for their own institution, and they have walked away rich. They may not be as rich as they were before, but they have walked away better than they should have. There have to be incentives – not only to get rich, but to behave well.

CBT: President Obama said this week that the financial firms “owe a debt to the American people.” And I wasn’t exactly sure how, how they could pay that back to the American people.

WB: It’s interesting. Exactly a year ago when I was at this conference, I had a proposal for the so‑called “toxic assets.” I called three people in the financial world who were going to write Secretary Paulson about it. I wrote them on October 6th. I called three people to help out on this, and it would have required a lot of effort on their part and some commitment of money and time and energy. I asked all three of them if this went forward to do it absolutely pro‑bono. I asked them not to make one dime out of it. And they all said yes to me. So, they are good people. Many are motivated by greed. None of us are perfect, you know? I always say that, “Every saint has a past, every sinner has a future.” We have got some sinners back there, but they are not all bad. They went along with a bubble that they helped create – but the whole American public did. You still have to have the right rewards and penalties for behavior. That’s how you get decent behavior. So, I don’t look at Wall Street as “evil.” I look at Wall Street as given to huge excess sometimes. I don’t want to get rid of it. We need something to allocate capital and distribute securities and all of that throughout the system. We have got a big capitalist system and we have to have a big capital market – but there is plenty of room for improvement.

CBT: Looking into your crystal ball, what will the stock market look like a year from now?

WB: Well, I don’t know about a year from now. Five years from now, it’ll be higher, yeah. Ten years from now, it’ll be higher. One year from now, I don’t know.

CBT: Fair enough. Moving a little bit more closely to the payment and card system. On September 3rd, the The Wall Street Journal had an articled titled “Wal‑Mart to Pay via Check Cards.” Wal‑Mart isn’t going to issue paychecks anymore. So it’s all going to be through a card system, which is actually good for the payment industry and the card industry. And it seems to be a growing movement to use cards to dispense payments. I noticed that on some airlines, if you don’t have a card – a credit card of some kind – you can’t eat or drink anything if you are sitting in economy because they don’t take cash anymore. So that, that’s kind of interesting…

WB: Some restaurant just announced that in New York too, that they weren’t going to take cash.

CBT: That brings us to the next question: Do you think cash is ever going to disappear as a form of payment?

WB: It won’t disappear, but in the end – and that’s the genius of the American system – we do give the consumer what they want. If people want to use the convenience of cards, they will do it. Now there will be enough people that want to use cash, so consumers won’t turn their back on it entirely. They haven’t given up landline phones entirely for cell phones. The American consumer – in the end – is king. You can push them around for a week or a month maybe, but you either figure out what’s in your customers’ mind and decide you are going to serve them; or you are not going to be in business. They are right, and you are wrong. It’s what made this country, to some extent, what it is. Our market system where the customer – 300 million Americans – tell people what to make, where to serve them, and how to do business. Compare that to some totalitarian system, where somebody decides what people are going eat for lunch and we win.

CBT: Well, we are certainly not used to that…

WB: Oh yeah. Mm‑hmm.

CBT: The credit card industry is about 50 years old, and it’s pretty safe to say that it’s going to transform in the next 10 or 15 years. Sometimes I think we’ll have chips in our hands to scan and pay for things. All kinds of things will be transacted electronically.

WB: Cathy, I met Ralph Schneider who was the founder of the Diners Club back in the 1950s. He had just designed an IRA, and they are just using it around New York. They used to charge the merchants 10 percent and the card was very low priced then. American Express went into the business originally defensively. They had the Travelers Check and they were worried about what the credit card would do to it. In 1964, when American Express had what they called the great Salad Oil Scandal, we became this little outfit in Omaha and became the largest shareholders of the American Express Company. I went around to restaurants and service stations, and asked people about whether the Card was losing its appeal because of the scandal that was going around. They said the Card wasn’t losing it but that it was growing in appeal. So, I watched the credit card industry almost from the beginning in that respect. We got in early. I could see it was a powerful tool. First Data was in Omaha, and I have watched them all. Carte Blanche, the Hilton Card – some of those have disappeared over the years. Of course, Visa and MasterCard have been successful. There have been all kinds of developments, but the truth is, the American public likes to be able to go into their pocket and pull out a card.

CBT: Well, that was a really great lead into a question I had about American Express. Everyone knows here that Berkshire Hathaway has an investment in American Express, as you just said. So, you obviously know a lot about the payment industry and that company in particular. Can you tell us what attracted you to that company?

WB: Well, what originally attracted me back in 1964 was that Diners Club got the jump. They were way ahead of American Express. American Express came in with a very interesting market and concept. People already were carrying Diners Club, and American Express wanted to enter the field. They charged more than Diners Club did for their product. Diners Club had this card that had a bunch of flashy little symbols and everything on it. American Express brought out that centurion, and originally it was the green card with the guy that looked like Mr. Integrity. If you went into a restaurant, and you were buying dinner for somebody, and you had a choice of pulling out this Diners Club card that looked like you were giving a check from your mother or pulling out this centurion that made it look you were J.P. Morgan or something – you went with Mr. Integrity. They actually took over the field by establishing themselves not as the low‑priced competitor but, but as the class competitor. It was a great marketing arrangement. Then it swept the country. The card I carry in my pocket says, “Member Since 1964.”

CBT: Mine says “Member Since 1983.”

WB: Well, that was the year you were born, I was 40 years old or something when I did this.

CBT: Last question. We would like you to impart a little bit of advice and tell us what is the one lesson that we should take away from this economic Pearl Harbor?

WB: Well, I think that it goes back what I have told my manager to do: Just keep taking care of the customer. We have got a lot of customers in this country. Since 1886, Coca‑Cola has been selling a product that people like, and they just keep taking care of them. It’s what you have done at Business Wire. In the end, nobody that’s ever taken good care of the customer has ever lost; I mean, that, that is the name of the game.

CBT: That is great advice. I want to thank you for your time, Warren, it’s been a pleasure talking to you, and allowing me to interview you.

WB: It's been fun. Thanks, Cathy.

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Warren Buffett's Berkshire Hathaway earned more than $1 billion in gains from derivatives in Q3, according to the company's latest earnings report (more information: 10-Q, Bloomberg).

Full coverage by Ravi Nagarajan:
Berkshire Hathaway Posts Q3 Results; Book Value At Record High4.856

Berkshire Hathaway reported results for the third quarter following the close of trading today.  Operating earnings per share were nearly flat at $1,325 per A share, down slightly from $1,335 in the third quarter of 2008.  Operating earnings per share for the first nine months of 2009 declined 11.8% to $3,572 per A share, down from $4,048 per share for the first nine months of 2008.

Net income per share for the third quarter more was $2,087 per A share, more than triple the net income recorded in the third quarter of 2008.  However, because net income includes the effects of investment and derivative gains and losses, it is more meaningful to focus on operating earnings per share rather than net income per share.

For a number of reasons, the “headline numbers” reported when Berkshire releases quarterly results are often misleading.  For more introductory information regarding the nuances of Berkshire’s quarterly reporting, please refer to coverage of second quarter results.

Book Value Hits Record High

Book value per A share on September 30, 2009 was $81,247, which was up 10.1% for the quarter.  Book value includes the impact of both realized and unrealized investment and derivative gains and losses.  It must be noted that our estimate for Berkshire’s book value was far too conservative.  The estimated range for book value was between $78,500 and $79,200 which is well below the reported results.  It should be noted that Berkshire’s book value was at a record high on September 30.  Whether book value has much meaning for valuation purposes was discussed in a previous article.

Insurance Results

Berkshire Hathaway management evaluates insurance underwriting and investment results separately.  Underwriting results are the responsibility of each subsidiary’s management while investment results are handled by Berkshire’s corporate management under CEO Warren Buffett’s supervision.

Underwriting

Berkshire’s insurance subsidiaries posted after tax underwriting gains of $363 million in the third quarter and $665 million year to date compared to $81 million and $622 million of underwriting gains in the third quarter and first nine months of 2008 respectively.  GEICO, General Re, Berkshire Hathaway Reinsurance Group, and Berkshire Hathaway Primary Group all posted underwriting gains for the third quarter and the first nine months of 2009.

GEICO’s underwriting profits continue to lag the results posted last year despite higher levels of premiums earned and an increase of 662,000 voluntary auto policies-in-force since the start of the year.  This was due to a higher loss ratio for both the third quarter and first nine months of the year compared to prior year periods.  In addition, underwriting expenses increased due to higher policy issuance costs and higher salary and employee benefit expenses.

Underwriting results at General Re improved for both the third quarter and year to date compared to the same periods in 2008 in large part due to a quiet Atlantic hurricane season which reduced catastrophe losses compared to the third quarter of 2008 which covered the period when Hurricanes Ike and Gustav made landfall.

In the section of the report covering Berkshire Hathaway Reinsurance Group, it is interesting to note that the company continues to constrain the volume of business written.  Earlier in the year, this reduction in volume was partially due to Berkshire’s temporary decline in net worth.  However, even though net worth has reached record highs, Berkshire plans to continue to constrain premium volume due to the impending acquisition of Burlington Northern Santa Fe.  In addition, premium rates have not been attractive enough to warrant increasing volume, demonstrating Berkshire’s continued underwriting discipline.  As noted recently, a “hard” insurance market is nowhere in sight.

Investment Income

Net investment income increased by 20.6% to $976 million compared to $809 million for the third quarter of 2008.  The improvements continue to reflect Berkshire’s large investments in Goldman Sachs, General Electric, Wrigley, Swiss Re, and Dow Chemical which were made at various points over the past year.  This improvement has been partially offset by lower earnings on cash equivalents due to very low interest rates as well as lower cash balances.

Utilities and Energy

The Utility and Energy group posted net earnings attributable to Berkshire of $346 million for the third quarter which is 6.8% higher than the results for the prior year period.  For the first nine months of 2009, the group posted net earnings of $802 million, a decline of 5.4% compared to the first nine months of 2008.  The group was impacted by lower revenues due to the decline in average per-unit cost of natural gas sold along with declines in electricity demand at PacifiCorp due to the ongoing recession.

Few people realize that MidAmerican owns the second largest real estate brokerage in the United States.  The real estate group’s revenues have declined in 2009 compared to 2008 levels.  However, earnings have actually increased this year reflecting lower commission costs and other operating expenses.  The real estate group has seen lower sales prices but this has been somewhat offset by higher transaction volume.  Much of this is probably due to government stimulus efforts and particularly due to the $8,000 first time buyer tax credit which has recently been extended and expanded.

Manufacturing, Service, and Retailing

Berkshire Hathaway’s operating companies continue to be heavily impacted by the global economic recession.  The group posted earnings of $336 million for the third quarter, a decline of 49.5% compared to the third quarter of 2008.  For the first nine months of 2009, the group posted earnings of $833 million, a decline of 55.5% compared to the first nine months of 2008.

All business units with the exception of Retailing, which had flat results, posted declines in pre-tax earnings for the third quarter compared to the prior year.  For the first nine months of 2009, all units except for McLane have reported declines in earnings as well.  NetJets continues to depress the results of the “Other Service” group with a 41% decline in revenues for the third quarter compared to the prior year period.  Additionally, NetJets has produced pre-tax losses in the third quarter of $183 million and $531 million for the first nine months of the year.  However, “green shoots” may be emerging.  Management is hoping for a modest profit at NetJets in 2010 barring further deterioration of the economy and an absence of punitive regulations aimed at private aviation.

From a high level perspective, it is encouraging to note that Marmon, Shaw, and the Other Manufacturing units have reported higher revenues and pre-tax earnings in the third quarter compared to the second quarter.  To again use an overused expression, perhaps there are “green shoots” emerging in light of these quarter-to-quarter comparisons.

All Things Considered, A Solid Quarter

Many early articles on third quarter results are loudly stating that Berkshire Hathaway managed to triple earnings compared to the third quarter of 2008.  Such loud proclamations of success are no more enlightening than the proclamations of doom earlier this year when year-over-year net income fell significantly.  Operating earnings are a much better measure to focus on and by this measure, Berkshire Hathaway did indeed produce very solid results for the quarter under the circumstances.  With book value per share at a record high, it appears clear that the company has navigated the worst economy since the Great Depression very well.

To gain insight into Berkshire Hathaway’s performance, it is critical to look behind the headline numbers and the consolidated financial statements.  Examining segment revenues and profitability can reveal facts that aggregate statistics obscure.  In the current environment, it is particularly useful to examine quarter to quarter results of the reporting segments in order to spot turning points in performance.  To facilitate this review, we have prepared an Excel workbook with two spreadsheets.  The first sheet shows Berkshire’s revenues over the past seven quarters and the second does the same for pre-tax earnings.  This file can be found under the resources listed below.

Resources

Berkshire Hathaway Q3 2009 Form 10-Q (Source:  Berkshire Hathaway)
Berkshire Hathaway Q3 2009 Press Release (Source:  Berkshire Hathaway)
Berkshire Quarterly Revenue and Pre-Tax Earnings: 2008-2009 (Rational Walk Analysis)
Closer Look at Burlington Northern Acquisition (Rational Walk Analysis)
Berkshire Hathaway 2008 Report Analysis & IV Estimate (Rational Walk Analysis)

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.

Disclosure:  The author owns shares of Berkshire Hathaway.

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A recent issue of Downside Protection Report featured an investment thesis on Imation (IMN) by the Manual of Ideas research team.  Included below is an edited and updated write-up on Imation, a consumer-focused technology firm with leading market share in removable storage products, such as recordable DVDs. The company has a strong balance sheet and owns the widely recognized Imation and Memorex brand names. Trading well below book value and in line with “net net” working capital, the shares strike us as simply too cheap to ignore.

Company Description and Thesis

If you own a removable storage product, such as a pack of recordable DVDs or an external hard drive, you’ve probably heard of Imation. The company owns the Imation and Memorex brands and has long-term rights to the TDK Life on Record brand. At $8.40 per share, Imation offers an attractive risk-reward, in our view.

Imation — Overview of Major Markets
The company has more than 30% share of the magnetic and optical market segments.

^{Source: Imation.}

Strong Market Share, Global Exposure

Imation is a leader in optical storage and magnetic tape, with additional growth opportunities in new markets such as external hard drives. The company’s products are aimed primarily at consumers and small businesses, with 49% of sales coming through distributors and 43% of sales generated from retailers last year.

Sales of optical products have grown from 35% of revenue in 2005 to 49% in the first half of 2009, as magnetic tape sales have declined from 56% of revenue in 2005 to 28% in H1 2009. Meanwhile, sales of emerging products have grown from 4% in 2005 to 18% in H1 2009.

Imation is a global company, with Americas sales (including North and South America) accounting for only 38% of revenue in H1 2009. Asian sales have grown to nearly one-quarter of revenue, giving shareholders of Imation a relatively conservative way of participating in the growth of emerging markets.

Recent Performance: Unexciting But Not Disastrous

Imation sales have suffered from lower consumer spending in recent quarters, with Q2 revenue down 22% versus the same quarter a year ago (flat sequentially from the first quarter). Excluding a litigation settlement and restructuring charges, Imation reported slightly positive operating income in the second quarter. This was driven by management’s focus on cost containment, which resulted in a decline in SG&A expense from $73 million in Q2 2008 to $60 million in Q2 2009.

Management stated on the most recent earnings call that the “vast majority” of legal expense would go away due to the recent litigation settlement with Philips. Litigation expense amounted to $13 million, or 10% of SG&A expense, in H1 2009. Excluding litigation expense, Imation earned adjusted operating income of nearly $8 million in Q2, hinting at the company’s profit potential.

In Q3, Imation had operating income excluding restructuring charges of $9.2 million, once again showing the earning power of the business. The company generated cash of $22 million in Q3.

Imation — Target Markets of Company’s Major Brands
The three brands are complementary in terms of geographic coverage and user segments.

^{Source: Imation.}

Some Things to Consider When Valuing Imation

Imation paid $332 million for Memorex in 2006, approximating Imation’s enterprise value today. This suggests that the Memorex acquisition likely destroyed value, but also that Imation may be undervalued today. The company has a market value of $362 million, adjusted net cash of $40 million, and tangible book value of $535 million. Imation generates sales of $2 billion and gross profit of $300 million. Earlier this decade, Imation was earning operating income of $100+ million in a “normal” year. The addition of Memorex should have grown this number, but profitability evaporated due to the recession and related execution issues.

Whether Imation can generate more than $100 million of operating income on a normalized basis in the future remains to be seen. If Memorex earns anything close to what might be reasonably expected given the $300+ million acquisition price tag, Imation should at least earn $100 million in total when the economy improves.

We judge Imation shares to have strong downside protection due to (1) a solid balance sheet with no debt; (2) shares trading 30+% below tangible book value and at a single-digit multiple of normalized operating income; (3) the company’s ability to generate positive adjusted operating income in Q3; and (4) leading market share and recognized brands in the growing market for removable storage.

The Variant View

The market seems to be ignoring Imation's earning power, which has been obscured by litigation-related expenses and restructuring charges. The company's Q3 GAAP EBIT was only $1.7 million even as adjusted EBIT was a more meaningful $9.2 million. Once investors start giving Imation credit for the company's underlying earning power as well as the quality of its balance sheet, Imation should be revalued.

Imation Q&A

Q: What is your main concern regarding Imation?

A: Our key concern is that equity value may not be maximized in a timely manner, despite the fact that insiders do not have voting control.
Imation’s strong balance sheet, brand recognition and large installed base could make it an attractive acquisition target, but the staggered Board of Directors and “golden parachute” arrangements with top executives could keep away potential acquirers. With the CEO owning less than 1% of the stock, management may not view shareholder value creation as urgently as might be expected given the current depressed valuation.

Q: What is Imation’s relationship with TDK?

A: TDK, one of Japan’s largest recording media and device companies, owns 21% of Imation. In 2007, Imation bought TDK’s removable recording media business for $41 million, acquiring the exclusive right to use the TDK Life on Record brand through at least 2032. TDK also has a representative on Imation’s Board of Directors.

Q: What is your view of the Philips litigation settlement?

A: Obviously, the settlement will take a chunk out of Imation’s cash balance over the next three years. Note that we have already adjusted for this in our calculation of enterprise value; in fact, our adjustment is conservative because we assume no tax benefit related to the settlement expense.

Ultimately, the settlement should be positive for Imation, as it removes an estimated $4-6 million of quarterly litigation-related expense. This should make the company’s underlying profitability more readily apparent, perhaps providing a catalyst for Imation shares.

Disclosure: No positions.

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We are always interested in listening to the views of Bruce Berkowitz of The Fairholme Funds.  In this interview recorded this evening for the PBS Nightly Business Report, Mr. Berkowitz comments on a number of his holdings, including Berkshire Hathaway.  He appears to be very positive on Berkshire’s acquisition of Burlington Northern Santa Fe.

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In an interview with Consuelo Mack's WealthTrack, James Grant, editor of Grant's Interest Rate Observer, opines on U.S. markets, Fed policies and gold as an investment.

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By Ravi Nagarajan

As reported earlier today, Berkshire Hathaway has entered into a definitive agreement with Burlington Northern Santa Fe (BNSF) to acquire for $100 per share in cash and stock the remaining 77.4 percent of outstanding BNSF shares not currently owned by Berkshire.  In addition, Berkshire Hathaway will split its B shares 50-for-1 in order to accommodate a share exchange for smaller owners of BNSF shares.

This transaction, which will bring Berkshire’s investment in BNSF to $44 billion including shares already owned, is the largest acquisition in Berkshire Hathaway history.  What does this acquisition mean for Berkshire Hathaway shareholders?

Using Stock in Acquisitions

Much of the initial chatter on Twitter and elsewhere related to this transaction centers on Warren Buffett’s decision to use stock for part of the purchase.  Does this mean that Mr. Buffett considers Berkshire Hathaway shares to be overvalued and suitable as currency for acquisitions?  While it is possible that Mr. Buffett considers Berkshire shares to be fully valued or overvalued, this is not necessarily the case.  Let’s look at what Mr. Buffett had to say about using stock in acquisitions over twenty five years ago when Berkshire acquired Blue Chip (from the 1982 Chairman’s letter):

Our share issuances follow a simple basic rule: we will not issue shares unless we receive as much intrinsic business value as we give. Such a policy might seem axiomatic. Why, you might ask, would anyone issue dollar bills in exchange for fifty-cent pieces? Unfortunately, many corporate managers have been willing to do just that.

I highly recommend reading the entire section of the 1982 Chairman’s letter entitled “Issuance of Equity” for more of Mr. Buffett’s thoughts on using stock in acquisitions.  Berkshire’s use of stock, based on these principles, does not indicate that Berkshire shares are overvalued.  Instead, it indicates that management believes that at least as much intrinsic value is being received as being given up through the new share issuance.

Terms of Agreement

The terms of the agreement provides BNSF shareholders with the right to receive either cash payment of $100 or a variable number of Berkshire Class A or Class B common stock.  The mix of cash and stock will be subject to proration if the elections made by shareholders of BNSF do not equal approximately 60 percent in cash and 40 percent in stock.

If Berkshire Hathaway Class A shares trade in the range of $80,000 to $125,000 per share, the value of the share exchange for BNSF shareholders will be fixed at $100 per share.  However, if Berkshire Hathaway Class A shares trade either below $80,000 or above $125,000 at the close of the transaction, BNSF shareholders will receive a fixed number of Class A shares (at either 0.001253489 per share below the “collar” range or 0.000802233 per share above the “collar” range).  BNSF shareholders may elect to receive the economic equivalent in Class B shares as well.

The “collar” terms create a situation where BNSF shareholders who elect stock rather than cash could potentially receive less than $100 per share if the price of Berkshire Hathaway A shares are below $80,000 at the close of the transaction.  BNSF shareholders could receive greater than $100 per share  if the price of Berkshire Hathaway A shares are above $125,000 at the close.  At any share price between $80,000 and $125,000, BNSF shareholders will receive enough Berkshire shares to result in a valuation of approximately $100 per share.

Bet on the United States Economy

There is no doubt that this transaction represents a bullish bet on the United States economy as Mr. Buffett stated in the press release:

“Most important of all, however, it’s an all-in wager on the economic future of the United States,” said Mr. Buffett. “I love these bets.”

We know that Mr. Buffett closely follows railroad statistics and has even said that he would choose railroad data as his only economic indicator if “stranded on a desert island“.  Rail car loadings have been far below levels reached during the peak of the last expansion but have recently shown some signs of improvement.  Mr. Buffett has been appearing on television frequently in recent months and has made bullish comments about prospects for the United States economy in the long run.  The transaction is a massive bet on this bullish sentiment.

Stock Split:  No, It’s Not April Fool’s Day

My initial reaction to the stock split announcement was total shock, but when one considers the terms of the BNSF transaction, it appears that Berkshire had no choice but to either split Class B shares or force small shareholders of BNSF to accept cash instead.  With the post-split Class B shares likely to trade well below $100, it appears that even a small holder of BNSF shares will be able to elect Berkshire stock rather than cash.  This is important for BNSF shareholders who wish to defer payment of capital gains taxes.

What is interesting about this stock split is the fact that it shows great concern for very small holders of BNSF shares.  After all, any BNSF shareholder with more than 35 shares could elect to receive one pre-split Class B share of Berkshire based on current prices.

Make no mistake about it:  The stock split has absolutely no impact on the actual intrinsic business value owned by Berkshire Hathaway shareholders.  However, the split has some interesting implications in terms of potential inclusion in the S&P 500 index in the long run.  It may also result in greater trading liquidity which could theoretically benefit shareholders who wish to enter into transactions.

The verdict is still out on whether this transaction will benefit Berkshire Hathaway shareholders in the long run, and much will depend on the trajectory of the economic recovery in the United States.

Resources:

Berkshire Hathaway/Burlington Northern Santa Fe Press Release
Berkshire Hathaway Press Release on Class B Stock Split
Burlington Northern Santa Fe Investor Presentation Webcast
Burlington Northern Santa Fe Presentation Slides
Burlington Northern Santa Fe Transaction FAQ

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.

Disclosure:  The author owns shares of Berkshire Hathaway.

Berkshire to Acquire Burlington Northern: A Closer Look5.054

As reported earlier today, Berkshire Hathaway has entered into a definitive agreement with Burlington Northern Santa Fe (BNSF) to acquire for $100 per share in cash and stock the remaining 77.4 percent of outstanding BNSF shares not currently owned by Berkshire.  In addition, Berkshire Hathaway will split its B shares 50-for-1 in order to accommodate a share exchange for smaller owners of BNSF shares.

This transaction, which will bring Berkshire’s investment in BNSF to $44 billion including shares already owned, is the largest acquisition in Berkshire Hathaway history.  What does this acquisition mean for Berkshire Hathaway shareholders?

Using Stock in Acquisitions

Much of the initial chatter on Twitter and elsewhere related to this transaction centers on Warren Buffett’s decision to use stock for part of the purchase.  Does this mean that Mr. Buffett considers Berkshire Hathaway shares to be overvalued and suitable as currency for acquisitions?  While it is possible that Mr. Buffett considers Berkshire shares to be fully valued or overvalued, this is not necessarily the case.  Let’s look at what Mr. Buffett had to say about using stock in acquisitions over twenty five years ago when Berkshire acquired Blue Chip (from the 1982 Chairman’s letter):

Our share issuances follow a simple basic rule: we will not issue shares unless we receive as much intrinsic business value as we give. Such a policy might seem axiomatic. Why, you might ask, would anyone issue dollar bills in exchange for fifty-cent pieces? Unfortunately, many corporate managers have been willing to do just that.

I highly recommend reading the entire section of the 1982 Chairman’s letter entitled “Issuance of Equity” for more of Mr. Buffett’s thoughts on using stock in acquisitions.  Berkshire’s use of stock, based on these principles, does not indicate that Berkshire shares are overvalued.  Instead, it indicates that management believes that at least as much intrinsic value is being received as being given up through the new share issuance.

Terms of Agreement

The terms of the agreement provides BNSF shareholders with the right to receive either cash payment of $100 or a variable number of Berkshire Class A or Class B common stock.  The mix of cash and stock will be subject to proration if the elections made by shareholders of BNSF do not equal approximately 60 percent in cash and 40 percent in stock.

If Berkshire Hathaway Class A shares trade in the range of $80,000 to $125,000 per share, the value of the share exchange for BNSF shareholders will be fixed at $100 per share.  However, if Berkshire Hathaway Class A shares trade either below $80,000 or above $125,000 at the close of the transaction, BNSF shareholders will receive a fixed number of Class A shares (at either 0.001253489 per share below the “collar” range or 0.000802233 per share above the “collar” range).  BNSF shareholders may elect to receive the economic equivalent in Class B shares as well.

The “collar” terms create a situation where BNSF shareholders who elect stock rather than cash could potentially receive less than $100 per share if the price of Berkshire Hathaway A shares are below $80,000 at the close of the transaction.  BNSF shareholders could receive greater than $100 per share  if the price of Berkshire Hathaway A shares are above $125,000 at the close.  At any share price between $80,000 and $125,000, BNSF shareholders will receive enough Berkshire shares to result in a valuation of approximately $100 per share.

Bet on the United States Economy

There is no doubt that this transaction represents a bullish bet on the United States economy as Mr. Buffett stated in the press release:

“Most important of all, however, it’s an all-in wager on the economic future of the United States,” said Mr. Buffett. “I love these bets.”

We know that Mr. Buffett closely follows railroad statistics and has even said that he would choose railroad data as his only economic indicator if “stranded on a desert island“.  Rail car loadings have been far below levels reached during the peak of the last expansion but have recently shown some signs of improvement.  Mr. Buffett has been appearing on television frequently in recent months and has made bullish comments about prospects for the United States economy in the long run.  The transaction is a massive bet on this bullish sentiment.

Stock Split:  No, It’s Not April Fool’s Day

My initial reaction to the stock split announcement was total shock, but when one considers the terms of the BNSF transaction, it appears that Berkshire had no choice but to either split Class B shares or force small shareholders of BNSF to accept cash instead.  With the post-split Class B shares likely to trade well below $100, it appears that even a small holder of BNSF shares will be able to elect Berkshire stock rather than cash.  This is important for BNSF shareholders who wish to defer payment of capital gains taxes.

What is interesting about this stock split is the fact that it shows great concern for very small holders of BNSF shares.  After all, any BNSF shareholder with more than 35 shares could elect to receive one pre-split Class B share of Berkshire based on current prices.

Make no mistake about it:  The stock split has absolutely no impact on the actual intrinsic business value owned by Berkshire Hathaway shareholders.  However, the split has some interesting implications in terms of potential inclusion in the S&P 500 index in the long run.  It may also result in greater trading liquidity which could theoretically benefit shareholders who wish to enter into transactions.

The verdict is still out on whether this transaction will benefit Berkshire Hathaway shareholders in the long run, and much will depend on the trajectory of the economic recovery in the United States.

Resources:

Berkshire Hathaway/Burlington Northern Santa Fe Press Release
Berkshire Hathaway Press Release on Class B Stock Split
Burlington Northern Santa Fe Investor Presentation Webcast
Burlington Northern Santa Fe Presentation Slides
Burlington Northern Santa Fe Transaction FAQ

Disclosure:  The author owns shares of Berkshire Hathaway.

Posted by manualofideas at 12:49 PM | Permalink | Comments (0)

This morning, Berkshire Hathaway (BRK.A) announced the acquisition of railroad Burlington Northern Santa Fe (BNI) for a transaction value of $44 billion and an equity value of $100 per share in cash and stock. Read the public announcement and coverage by Bloomberg and Reuters.

Profile of Burlington Northern Santa Fe (BNI)

Burlington Northern provides freight rail transportation of coal and consumer, industrial and agricultural products.

Primary Routes*

^{* Includes trackage rights. Source: Company.}

Business Highlights

• One of North America’s largest rail networks, with 32,000 route miles in 28 states and Canada.
• Balanced revenue base, with four major sources of freight revenue: intermodal, industrial products, coal, and agricultural products.
• Competitive advantage versus trucking. The company’s intermodal transport lags the delivery time of trucking slightly but offers big cost savings.
• Strong intermodal franchise, with one-third of revenue from consumer products transportation, which interfaces with other types of transportation.
• Balanced agri business, with 26% and 8% of segment sales from corn and ethanol, respectively.
• May benefit from higher infrastructure spending under Obama, particularly in industrial products.

• Industrial franchise exposed to housing slump, as 26% and 37% of segment revenue comes from building and construction products, respectively.
• Nearly one-half of consumer products revenue relates to imports, exposing the company to a decline in Americans’ appetite for imports.
• Affected by coal market dynamics. Declines in coal shipments hurt BNI. Coal is expected to remain strategic to U.S. electric power generation. The EIA expects coal supply to increase one-third from 2007 to 2030 to more than 1.5 billion tons.

Major Holders
Insiders 1% │ Berkshire Hathaway 23% │ Cap Re 7% │ Barclays 3% │ State Street 3% │ Vanguard 3%

Key Operating Metrics, 2006-2008

^{1 Calculated as thousand gross ton miles divided by avg number of employees.
2 RTN = revenue ton miles.
3 Net debt to capital, adjusted for long-term operating leases and other items.}

Access Burlington Northern Santa Fe's latest investor presentation here.

Listen to Berkshire Hathaway and Burlington Northern Santa Fe discuss their business combination.

The Manual of Ideas research team profiled Burlington Northern Santa Fe in the May 2009 issue of Portfolio Manager's Review, the monthly subscription-based publication that routinely analyzes the top holdings of more than 20 "superinvestors," including Warren Buffett, Bruce Berkowitz, David Einhorn, Prem Watsa, and Marty Whitman. Learn about subscribing to Portfolio Manager's Review.

Disclosure: No positions.

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

Diane Francis of Canada's Financial Post recently spoke with Prem Watsa, chairman and CEO of Canadian insurer Fairfax Financial (FFH). Watsa is one of the savviest long-term investors in Canada (and beyond); those who know him well compare him to Warren Buffett. Over a period of more than two decades, Watsa has amassed an impressive investment and value creation track record at Fairfax. Here are highlights of his interview with the Financial Post:

Q: One commentator noted that Fairfax’s stock has declined by 3.4% this year, why?

A: “We are long-term investors and our company is a long-term investment. Short term fluctuations are market driven and not value driven. We began in 1985, 24 years ago, with US$30 million in assets and about US$7.5 million of shareholders’ capital. Today, coincidentally, we have US$30 billion in assets and US$7.5 billion in shareholders’ equity. That’s up 1,000 times. Our per share book value has grown from US$1.50 to US$372. Our stock price has gone from C$3.25 to between C$375 and $390 a share. These are all long-term results.”

“We are thankful for our track record. More recently our book value in 2006 was US$150 a share and now, as of end of September, it is US$372 a share, more than double and the stock price has naturally followed suit. Over time the book value and the stock price tend to go together.”

Q: You are in India today, and were born there, how is it doing?

A: “The Indian economy has come back up in spades. This country has recently built the interstate road system which took forever because of their bureaucracies. Now, however,economic development is spreading out of the biggest cities like it did in the United States one hundred years ago. India is looking at growth of 8% - potentially even 10% - next year. Our Indian company, ICICI Lombard, was started from nothing less than ten years agowe have 26% ownership of it, and today it is underwriting almost US$1 billion. It is the largest property and casualty insurer in India and the potential is huge. Only 1% of all homes are insured.”

Q: Bubbles are developing in a lot of asset classes, so what do you continue to bet long-term on?

A: “We like the stocks that we have such as Johnson & Johnson, Wells Fargo. Our thinking is that the stronger get stronger and good management will prevail. Look at the commercial/industrial mortgage problem. There are 100 regional banks in this and say they all go bankrupt. That means there’s opportunities for strong banks like Wells Fargo who can buy regional or smaller banks for cheap.”

Read the full interview with Prem Watsa.

Posted by manualofideas at 02:49 PM | Permalink | Comments (0)

Click here to watch all the Soros lectures.

Introduction

In his recent lecture series at Central European University in Budapest, Hungary, George Soros unveiled his latest thinking on economics and politics in five separate lectures. They are the culmination of a lifetime of practical and philosophical reflection. In his first two lectures he discussed his general theory of reflexivity and its application to financial markets, providing insights into the recent financial crisis. The third and fourth lectures examined the concept of open society, which has guided Soros’s global philanthropy, as well as the potential for conflict between capitalism and open society. The closing lecture focused on the way ahead, closely examining the increasingly important economic and political role that China would play in the future.

Lecture 1: General Theory of Reflexivity -- Link to video here.

George Soros presents the fundamentals of his guiding philosophy, laying the foundation for his four subsequent lectures. This session discusses historical understandings of objective reality, scientific inquiry, and the limits of human perception. It discusses the gap between perceptions and reality, illustrating how actions based on these flawed perceptions then reshape reality in a reflexive system.

Lecture 2: Financial Markets -- Link to video here.

This lecture applies the general theory of reflexivity to financial markets, challenging the prevailing paradigm of the efficient market hypothesis. George Soros discusses bubbles and the recent financial crisis in detail, testing his theory against major financial events.

Lecture 3: Open Society -- Link to video here.

In this session, George Soros discusses the concept of open society, which guides his philanthropy and is central to his political and social thinking. Over the past quarter century, Soros has devoted over seven billion dollars to promoting the underpinnings of this concept—from equal access to justice to freedom of expression—around the world, from South Africa to Poland to the United States. Here, he describes the historical and philosophical roots of open society. George Soros builds on Karl Popper’s thinking while stressing the central importance of fallibility, relating this to reflexivity, and applying these concepts to political and social reality. The lecture concludes by discussing the balance between individual freedom and regulation to protect the common good.

Lecture 4: Capitalism Versus Open Society -- Link to video here.

In this lecture, George Soros explores the conflict between capitalism and open society, market values and social values. Focusing on the principal-agent problem, he will use contemporary economic and political examples to challenge market fundamentalism while presenting ideas for protecting the public good more effectively.

Lecture 5: The Way Ahead -- Link to video here.

Turning his attention to the future, George Soros focuses on the increasingly important role that China is likely to play on the world stage. He will outline key global trends and discuss their major economic and political implications for the years ahead.

Posted by manualofideas at 08:43 PM | Permalink | Comments (0)

We are pleased to make available for FREE the new issue of 10x45 Bargain Hunter, the bi-weekly stock screening report of The Manual of Ideas. 10x45 Bargain Hunter comprises 10 essential stock screens for value-oriented investors, with up to 45 results shown for each screen.

Click here to access the FREE report.

Get 10x45 Bargain Hunter every two weeks for only $99 per year. Or receive it FREE with your subscription to Downside Protection Report. Start 30-day FREE trial of DPR now!

Posted by manualofideas at 08:10 PM | Permalink | Comments (0)

Charlie Munger was interviewed by the BBC and comments on a variety of topics.  As always, Mr. Munger pulls few punches when it comes to providing his candid assessment on investing, economics, politics, and all varieties of “human follies”.

One sure to be classic Munger quote from the interview was in response to a question regarding how concerned shareholders should be when they experience temporary impairments in the market value of their holdings:

You can argue that if you’re not willing to react with equanimity to a market price decline of fifty percent two or three times a century, you’re not fit to be a common shareholder and you deserve the mediocre result that you’re going to get.

And on politics:

Both parties have wings that are full of idiots.  That is the nature of the game.  And the reason it has worked as well as it has is that the people in the middle have sort of over time tuned out the idiots on both sides.  But every once in a while, the idiots get in control.  And, of course, that has terrible consequences.  That’s the nature of the system.

To view the video, please click on the image below.

Posted by manualofideas at 05:11 PM | Permalink | Comments (0)

With the holiday season upon us, now is the perfect time to select meaningful gifts for friends, family, and colleagues.  Rather than buying gifts which are destined to gather dust or end up “re-gifted” to others, consider purchasing a great book matching the interests of the recipient.  In this first annual gift guide for value investors, ten books have been selected which are certain to captivate the attention of anyone interested in the field of investing. Some choices will be familiar while others may be unexpected.  Happy Holidays!

View The Rational Walk’s 2009 Holiday Gift Guide!

Posted by manualofideas at 04:54 PM | Permalink | Comments (0)

An exclusive interview with Professor Max Otte, one of the leading proponents of value investing in Europe's academic finance establishment, was published in a recent issue of Portfolio Manager's Review. The interview with Max Otte, Professor of Corporate Finance at the Fachhochschule Worms in Germany, sheds light on the peculiarities of investing in Europe and provides worthwhile advice for value-oriented investors. Excerpts:

The Manual of Ideas: You teach Bruce Greenwald´s Columbia University seminar on value investing in Europe. Are there examples of value investing theory that have to be “adjusted” in the context of investing in European stock markets? More specifically, are there any accounting or other pitfalls non-European investors should especially look out for?

Professor Max Otte: Europe simply is “more messy and complicated” — if you don’t have a truly global player, you really have to go country by country. That’s ten times the market research you do for a U.S. company. This is a reason why many U.S. investors don’t look here too much, which in my view is a big mistake. The legal system is as reliable as in the U.S. (fewer liability suits), and the business culture is generally one of more trust than in the U.S. The firms are generally more global than U.S. firms, which often tend to be run with a U.S.-centric approach.

As IAS/IFRS are taking hold, accounting is becoming very similar. However, in the German-speaking countries (Germany/Austria/Switzerland), we had the conservative principle of the lower value (cost or market) in financial account. This often understated income and assets and created hidden reserves. Some companies that do not need to fulfill the requirements of the major stock exchanges still cling to the old national standards, which I think were much superior in providing reliable minimum figures and stabilizing the economy. Again, those figures were not always “true and fair,” but much less subject to manipulation than, for example, GAAP.

Warren Buffett doesn’t like the idea that he has to disclose holdings over three percent in a public company in Germany once he starts buying.

MOI: Are there any countries in Europe that you find especially appealing? Perhaps individual sector or company opportunities that have arisen from local macroeconomic dislocation? Are there any European countries you find particularly unappealing?

Professor Otte: First, Europe as a whole is a rather tremendous place and as attractive as many emerging markets. Multiples are down and often lower than in the U.S., and revenue margins in European companies are generally lower than in the U.S. So many European companies have more fat to carry them through the crisis and can work on their margins.

Since I’m an active investor myself and my time is limited, I stick to what I know. I have a rather small universe of stocks. Over 80 percent of my holdings are in Europe right now, just 10 percent in the U.S., and the rest in Asia and gold.

My favorites are still German, Austrian and Swiss family-controlled “hidden champions” — often world market leaders in niche markets, often with very sound balance sheets, excellent growth prospects and long-term oriented management. Currently, you can buy many of these stocks at valuations as if they would never grow again. I presented three [ideas] at the Value Investing Seminar in Molfetta in 2007 – CTS Eventim, United Internet, and AWD – and investors who bought them below my recommended price would have broken even by the summer of 2009 despite the crisis. More of them: Grenke Leasing, Fielmann, Celesio, Takkt. Among large players, Nestlé looks very good, as do the pharmaceuticals.

Read the Portfolio Manager's Review interview with Professor Max Otte.

Subscribe to Portfolio Manager's Review, the acclaimed monthly investment research publication for value-oriented institutional investors.

Start 30-day FREE trial of European Value Report, the research newsletter that features two European investment ideas in each monthly issue.

Posted by manualofideas at 04:03 PM | Permalink | Comments (0)