The Ideas Report For Serious Investors

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The Superinvestor Issue of The Manual of Ideas is out!

Inside you'll find comprehensive coverage of the portfolio moves of more than 50 top investment managers, including idea rankings based on our proprietary Signal Rank methodology. The latter reveals the current top ideas of the world's best investors, as determined by an acclaimed proprietary scoring process of The Manual of Ideas.

The following is our superinvestor coverage list:

Here is a complete table of contents:

Access the full 167-page report -- subscribe today!

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Good article by Atlantic Monthly on how Soros famously "broke" the Bank of England.

(Thanks to Nadav Manham for the link.)

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By Greenbackd

In The value of Seth Klarman (free registration required), Absolute Return has a rare interview with the president and portfolio manager of the 28-year-old Baupost Group. In the interview, Klarman discusses several of Baupost’s positions over the last twelve months, including the fund’s stake in Facet Biotech, which I fumbled last year:

Around the same time the CIT deal was playing out, Klarman took a sizable stake in Facet Biotech—a small biotech company spun off in December 2008 from PDL BioPharma—for an average cost of $9 even though it had $17 per share in net cash at the time of the spinoff. “We liked the discount and pipeline of products,” Klarman recalls. “We knew that when small caps are spun off, they are frequently ignored and become cheap.”

Biogen Idec tried to acquire Facet in a hostile deal for $14.50 per share, raising the offer later to $17.50. When Facet allowed its largest shareholder, Biotech Value Fund, to buy up to 20% of the company, Baupost asked for identical terms, essentially becoming a poison pill. Baupost then told Facet it did not intend to tender its shares in the $17.50 per share offer. Eventually Biogen backed off, and Facet accepted a $27 per share offer from Abbott Laboratories.

Here Klarman discusses his strategy more broadly:

Value investors are typically thought of as stock investors, but Klarman says most of the time he prefers to buy bonds. Bonds are a senior security, offering more safety, and they have a catalyst built into them. Unlike equity, debt pays current principal and interest. If the issuer doesn’t make that timely payment, an investor can take action. “Catalysts can reduce your dependence on the level of the market or action of the market,” he explains. For example, defaults are specific incidents affecting the company regardless of what is going on in the overall market.

Over the past two years, Klarman’s preference for debt has been even more pronounced. After peaking at just $2 billion in June 2008, Baupost’s total equity assets shrank to around $1.2 billion from the fourth quarter of 2008 to the first half of 2009, before turning up slightly at year-end 2009 to nearly $1.6 billion. That puts equities at just a little more than 7% of total assets under management.

And his view on the market

The value pro is still looking at troubled companies, mortgage securities and select equities. But he is not buying much at the moment. Klarman says there are some opportunities in commercial real estate on the private side, but not as much as would be expected, given the depressed levels of the market. “That’s why we want to be patient,” he stresses.

Baupost is 30% in cash now, its long-time average. Klarman stresses that the cash position is residual—the result of a search for opportunity and not the result of a macro view. He says he can find great opportunities to buy at the same time he has a bearish view on the world. “We’re good at finding bargains, good at doing analysis,” he emphasizes. “We’re not good at calling short-term movements in the markets.”

And when the markets started to crumble in mid-May, he mostly stood pat, asserting that the 5% to 8% drop in prices did not unleash a torrent of bargains, mostly because of the market’s surge from its March 2009 bottom. “The market has gone up so much that, based on valuation, it is overvalued again to a meaningful degree where the expected returns logically from here can be as low as the low single digits or zero for the next several years,” he says.

Click here to see the remainder of the interview (free registration required).

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By Greenbackd

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From C-SPAN: "Responding to questioning, Warren Buffett agreed that there are still risks involved in the derivatives market during today’s Financial Crisis Inquiry Commission hearing. The hearing focuses on the role of ratings firms in the financial crisis and is titled, "Credibility of Credit Ratings, the Investment Decisions Made Based on those Ratings and the Financial Crisis.” Executives from Moody’s, including its current CEO, are also among the witnesses. Mr. Buffett's Berkshire Hathaway is Moody's largest shareholder."

FCIC Hearing: Session 1   

FCIC Hearing: Session 2 (incl. Buffett testimony)

FCIC Hearing: Session 3

AP: Congress grills Moody's officials

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It is said that those who fail to study history are doomed to repeat it.  The benefits of a careful study of general history is self evident and the same applies to investors who wish to learn from past events as well as the mistakes of others.  There is no reason to learn painful lessons firsthand when we can learn vicariously through our predecessors.  At the same time, it is important to guard against the tendency to judge those making decisions in the past solely based on events that occur subsequently.  However, it is reasonable to expect that an individual making a decision in the past should have acted logically based on knowledge available at the time.

With this in mind, it is interesting to review Michael Burry’s letter to his investors written in November 2006.  ‘A Primer on Scion Capital’s Subprime Mortgage Short’ is Dr. Burry’s attempt to explain his decision to take a bearish position in credit default swap contracts.  Based on accounts in The Big Short, which we reviewed last week, Dr. Burry’s investors were highly skeptical of his short position and many were threatening to withdraw funds.

Viewed from our perspective in May 2010, Dr. Burry’s investment thesis was obviously correct and the letter makes perfect logical sense.  We have the benefit of hindsight and are fully aware of the wreckage in the mortgage market that took place after mid 2007.  However, the real question is whether the argument was persuasive from the vantage point of late 2006.  It certainly appears persuasive even if one does not base that judgment on what we know today.  Dr. Burry clearly outlines the structure of the securitizations in question, documents the very thin nature of the lower tranches, and shows how a modest level of default could easily hit the higher “investment grade” tranches.

The following excerpt is from the conclusion of Dr. Burry’s letter and nicely illustrates the risk/reward characteristics of the trade.  If the thesis was proven to be incorrect, the annual cost of carrying the position would amount to about six percent of fund assets each year.  The benefits of the thesis being proven correct was massively larger than the actual risk assumed:

The Funds currently carry credit default swaps on subprime mortgage-backed securities amounting to $1.687 billion in notional value. As I selected these, I was not looking to set up a diversified portfolio of shorts. Our shorts will have common characteristics that I deemed to be predictive of foreclosure, and therefore they should be highly correlated with each other in terms of both the timing and the degree of ultimate performance. Again, ultimate performance matters much more than the valuation marks accorded us by our counterparties in the interim. In the worst case, I expect our mortgage short will fully amortize to nil value over the next three years, corresponding to an average annual cost of carry over that time of roughly six percent of current assets under management. Calibrating the more positive outcomes will become easier as 2007 progresses.

It is always risky to retroactively pass judgment on decisions that were made in the past with imperfect information.  It is true that the consensus viewpoint at the time was that nationwide home prices “never” decline, and if this is accepted at face value, the annual six percent cost of carry could seem like a simple speculation.  Dr. Burry’s investors included sophisticated and well respected value investors who today would probably concede that his short thesis was accurate but disagreed strongly at the time. Alan Greenspan still thinks that those who predicted the housing bubble were merely lucky “statistical illusions”.

The author of this post 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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Warren Buffett was highly critical of Kraft’s acquisition of Cadbury throughout the takeover process.  It is therefore not entirely surprising to learn that Berkshire Hathaway cut its stake in Kraft by nearly 23 percent during the first quarter. It is not common for Mr. Buffett to openly criticize managers so it was all the more notable to hear him say that the deal made him feel poorer, particularly due to the “dumb transaction” involving the sale of Kraft’s pizza business to fund part of the acquisition.

In a 13F Filing with the Securities and Exchange Commission this afternoon, Berkshire reported holding 106.7 million shares of Kraft as of March 31, 2010 compared to nearly 138.3 million shares on December 31, 2009.  In addition to the sale of Kraft shares, Berkshire liquidated shares in several other companies and added to positions in three companies.  No new positions were initiated during the quarter.  Let’s take a brief look at the Kraft sale and other transactions revealed in today’s report.

Why Sell if Kraft is Still Undervalued?

The reason we stated that the sale of Kraft shares was not “entirely surprising” is due to Warren Buffett’s longstanding preference for dealing only with managers who can be trusted to exercise good business judgment.  With wholly owned subsidiaries, Mr. Buffett is looking for good operational managers who can run their businesses well but he handles all capital allocation personally.  This is not the case with minority stakes in public companies.  Mr. Buffett quite clearly believes that Kraft CEO Irene Rosenfeld is incompetent in capital allocation, although he has said that she is a capable operational manager.

What makes the size of the reduction somewhat surprising is that Mr. Buffett still believes that Kraft is undervalued on a component part basis.  According to several accounts of notes taken at the Berkshire Hathaway annual meeting (for example, click on this link for The Inoculated Investor’s notes), Mr. Buffett quite clearly stated that Kraft is undervalued.  The implications of a large sale is that the degree of undervaluation may not represent enough of a margin of safety to protect against future incompetence in capital allocation.  Of course, Berkshire continues to own a large stake in Kraft even after the sales during the first quarter.

Other First Quarter Portfolio Changes

During the first quarter, Berkshire eliminated positions in Wellpoint, United Health Group, Travelers, and SunTrust Bank.  Both individually and in aggregate, these were relatively small positions for Berkshire and from the prior 13F report, it appears that the Wellpoint and United Health stakes were most likely positions controlled by GEICO’s Lou Simpson.

In addition to Kraft, positions that were reduced but not entirely eliminated include CarMax (3.4% reduction), Costco (17.5% reduction), Gannett (21% reduction), Johnson & Johnson (11.9% reduction), M&T Bank (17.2% reduction), Moody’s (3.2% reduction), Conoco Philips (9.4% reduction), and Proctor & Gamble (9.6% reduction).

Berkshire added to its position in three companies:  Republic Services (30.6% addition), Iron Mountain (11.4% addition), and Becton Dickinson (16.3% addition).

In addition to the changes noted above, the latest report shows the effect of Berkshire’s acquisition of Burlington Northern Santa Fe.  The 76.8 million shares that were held as of December 31, 2009 no longer appear on the report due to the completion of the acquisition on February 12.

Due to the widespread availability of free high quality resources for viewing Berkshire’s portfolio in real time, we are no longer providing the spreadsheet that was previously posted following the 13F release.  Instead, we suggest using Dataroma’s Berkshire portfolio tracker for basic information or GuruFocus.com for more in depth coverage.

The author of this post 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.

Posted by manualofideas at 04:51 AM | Permalink | Comments (0)

In recent weeks, there has been some speculation that Li Lu may be a potential candidate for Chief Investment Officer at Berkshire Hathaway once Warren Buffett retires.  Berkshire Hathaway’s succession plans call for Warren Buffett’s job to be split into two roles.  The new CEO will have ultimate responsibility for Berkshire Hathaway and one or more investment officers will have oversight responsibility for investment operations and will report to the CEO.

Who is Li Lu?  According to his Wikipedia entry, Li Lu was an organizer of the student protest movement in China and took part in the Tiananmen Square protests of 1989.  After the post-Tiananmen crackdown, Mr. Lu had to flee mainland China and moved to the United States where he became one of the first students in the history of Columbia University to complete three degrees simultaneously:  a B.A. in Economics, a J.D. from Columbia Law School, and a M.B.A. from Columbia Business School.  Mr. Lu founded Himalaya Capital in 1997 and ran the fund until 2004.  In 2004, he founded a long only investment vehicle named LL Investment Partners.

During the Berkshire Hathaway annual meeting, Charlie Munger made a vague reference to a candidate for the CIO position who returned 200 percent in 2009.  At the Wesco meeting the following week, Mr. Munger mentioned Li Lu in the context of the BYD investment.  While no specific reference has been made to Li Lu, it is obvious why there is some speculation regarding the possibilities.

In the following video, Li Lu speaks to Bruce Greenwald’s value investment class at Columbia University. Please click on this link for the video.  Note that registration is not required to view the video.  Simply click on the play button in the center of the display.  Do not select a video quality.  The site will open up an unrelated window but should begin streaming the main presentation.  The actual lecture starts at about the three minute mark.

The author of this post 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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By Nadav Manham

In his annual letter to Moore Capital investors, Louis Bacon wrote about his fund's new marketing strategy:

Bacon also said it's looking to attract longer-term investors after its performance was restrained by redemptions during the financial crisis.

Moore Capital has a new marketing team, which "has had very good success in attracting what we hope is sticky capital from more institutional investors," he wrote in the letter.

Bacon is a rock star among hedge fund rock stars. His fund has returned over 20% for over two decades. My understanding is that he charges above-market fees and has a long lock-up. If even he needs stickier capital, imagine how difficult it is for everyone else. And how important.

My working hypothesis about attracting sticky capital is that it is a two-part process. The first part involves, as Bacon notes, attracting more institutional investors with a long-term capital base. This is not easy, but it is simple: everyone knows who these investors are. You might think of this as "structural stickiness": that portion of an LP's propensity to redeem capital from your fund that can be explained by the type of investor it is (pension, endowment, fund of funds, high net worth, etc). The way to increase the aggregate structural stickiness of your capital base is to attract LPs in the right categories. Simple but not easy.

The second part of the process is more amorphous and intangible. It is the effort to increase an LP's "non-structural stickiness," which can be defined as that portion of an LP's propensity to redeem capital that cannot be explained by its category. High non-structural stickiness can overcome low structural stickiness. That is, an investor in a category known for being flighty can sometimes be your most loyal investor. Consider Warren Buffett's father-in-law:

"Doc Thompson was the kind of guy, he gave me every penny he had, basically. I was his boy."

That was in 1956, and it worked out well. Non-structural stickiness is a function of persuasion, positioning, and underwriting.

I've created a new category called "The Search for Sticky Capital" in which I plan to explore these issues further, the search for both structural and non-structural sticky capital. I will explain what I mean by "persuasion, positioning, and underwriting." The presence of sticky capital is a significant source of competitive advantage for a hedge fund, so the ability to attract it and create it is crucial.

I confess I am a novice in this area, so I welcome any thoughts you may have.

P.S. On the flip-side, from the perspective of a prospective investor in a hedge fund, sticky capital is also very important. You want to spend time learning about how a fund goes about increasing the stickiness of its capital, both structural and non-structural.

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.

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In a warning that was largely ignored at the time but proven correct in subsequent years, Warren Buffett referred to derivatives as “financial weapons of mass destruction” in his 2002 letter to Berkshire Hathaway shareholders.  Critics of Berkshire’s recent involvement in derivatives often like to point out the superficial inconsistency between Mr. Buffett’s earlier warnings and his willingness to enter into derivatives contracts in recent years.  Today’s Wall Street Journal article regarding Berkshire Hathaway’s lobbying efforts related to the financial regulatory reform bill are already raising charges of hypocrisy. Let’s take a brief look at the facts and how the legislation may impact Berkshire Hathaway.

Background

While Warren Buffett has emphasized the dangers of derivatives on many occasions, he entered into a number of derivatives contracts in recent years to take advantage of what he believed were mispriced terms at the inception of each contract.  The derivatives generally fall into two categories:  Equity puts and credit default swaps on individual companies.  The equity puts are long term contracts that require minimal collateral and are not exercisable until contract expiration.  In a previous article, we provided more details regarding the nature of these contracts in an attempt to clear up persistent misunderstandings regarding the issue.  Mr. Buffett’s latest letter to shareholders provides updated information based on developments in 2009

In addition to the derivatives portfolio managed personally by Mr. Buffett, certain Berkshire subsidiaries such as MidAmerican enter into derivatives contracts for hedging purposes.

Derivatives “Float” and Collateral Requirements

At the end of 2009, Berkshire Hathaway held approximately $6.3 billion of “derivatives float” which represents funds received from counterparties that Berkshire can use for investment purposes.  Berkshire’s counterparties are required to make payments at the inception of contracts. According to Note 12 in Berkshire’s 2009 annual report, very minimal collateral requirements exist and even additional credit downgrades would only require a relatively modest increase in collateral:

With limited exceptions, our equity index put option and credit default contracts contain no collateral posting requirements with respect to changes in either the fair value or intrinsic value of the contracts and/or a downgrade of Berkshire’s credit ratings. Under certain conditions, a few contracts require that we post collateral. As of December 31, 2009, our collateral posting requirement under such contracts was $35 million compared to about $550 million at December 31, 2008. As of December 31, 2009, had Berkshire’s credit ratings (currently AA+ from Standard & Poor’s and Aa2 from Moody’s) been downgraded below either A- by Standard & Poor’s or A3 by Moody’s an additional $1.1 billion would have been required to be posted as collateral.

One additional point that is often missed is that Berkshire continues to own the securities posted as collateral and benefits from any returns earned by the collateral.

It is obvious that Berkshire was able to secure very favorable terms from counterparties regarding collateral requirements precisely because the financial strength of Berkshire has never been seriously questioned.

Berkshire Objects to Retroactive Changes to Collateral Requirements

According to the Wall Street Journal article, Berkshire Hathaway is only objecting to efforts in Congress to retroactively apply new collateral requirements to existing contracts:

The provision, sought by Berkshire and pushed by Nebraska Sen. Ben Nelson in the Senate Agriculture Committee, would largely exempt existing derivatives contracts from the proposed rules. Previously, the legislation could have allowed regulators to require that companies such as Nebraska-based Berkshire put aside large sums to cover potential losses. The change thus would aid Berkshire, which has a $63 billion derivatives portfolio, according to Barclays Capital.

Mr. Buffett’s push is especially notable because he has warned of the potential dangers of derivatives, famously branding them “financial weapons of mass destruction.”

The White House has been trying to kill the Berkshire provision on the grounds that it would weaken the government’s ability to regulate the enormous market for derivatives. Berkshire Hathaway argued that it shouldn’t be made to redo existing contracts and that it is already healthy enough to cover its obligations. The battle over the provision shows how lobbying by businesses and lawmakers to insert just a few words into a complex bill can have a major impact on the country’s biggest companies.

The proposed changes to collateral requirements would have widespread impacts and are not targeted specifically to Berkshire.  The current reports regarding Berkshire’s lobbying indicate that the company is seeking a broad based “fix” to prevent the government from forcing retroactive changes to existing contracts rather than a special exemption only for Berkshire.

Bottom Line Impact

While it is impossible to know exactly what the bottom line impact of the proposed legislation would be for Berkshire Hathaway, it is important to note that any additional collateral that Berkshire is forced to post would continue to be owned by Berkshire and would earn income for the company while it is held.  The ultimate gain or loss from the derivatives position would be unchanged with the main difference being that additional collateral would have to be posted for the duration of the contracts, most of which will remain outstanding for many years.

The more significant impact going forward may be to discourage Berkshire from entering into new derivatives contracts if collateral requirements for new contracts become even more onerous.  A reduction in this type of activity may be inevitable in any case because many Berkshire shareholders may only trust Warren Buffett to personally manage these types of risks.  Whether shareholders would be comfortable with a proprietary derivatives strategy run by Mr. Buffett’s successor is far from clear.

From a valuation perspective, it seems most conservative to consider the $6.2 billion proprietary derivatives float to be in “run off” rather than a permanent source of value.  The derivatives positions will likely produce significant profits for Berkshire over the next several years but renewal of such opportunities seems too uncertain to rely on the proprietary derivatives strategy as a source of ongoing value.  In contrast, Berkshire’s much larger $62 billion of insurance float remains a long standing and enduring source of intrinsic value for the company.

The author of this post 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 and is the author of The Rational Walk’s Berkshire Hathaway 2010 Briefing Book which provides more information regarding the company including a brief section regarding the derivatives portfolio.

Posted by manualofideas at 01:16 PM | Permalink | Comments (0)

Warren Buffett started his investment partnership in 1956 with $105,100 of capital made up of his own funds and investments from family and close friends.  According to the BLS inflation calculator, initial capital was $840,920 measured in 2010 dollars which would be a very small sum to start a modern day hedge fund.  What is even more remarkable was the fee structure of the Buffett Partnerships.  Mr. Buffett, as the general partner, took 25 percent of all profits in excess of 6 percent.  There was no “2 and 20″ structure in which the general partner received any guaranteed payment.  With nearly all of his net worth invested in the fund and a young family to support, it obviously took a very self confident 25 year old to start this venture.

Mr. Buffett’s early letters to partners have become investment classics and required reading for value investors.   By reading the letters in chronological sequence, one can see how Mr. Buffett’s investment philosophy evolved over the years.  It is particularly interesting to note that many of the same themes that continue to appear in recent Berkshire Hathaway annual letters were regularly appearing in partnership letters during the 1960s.

On an annual compounded basis, the Buffett Partnership returned 23.8 percent/year to limited partners over its history compared to 7.4 percent/year for the Dow Jones Industrial Average.  The limited partners only had one year (1958) in which their results failed to match the Dow Industrials.  (See The Superinvestors of Graham-and-Doddsville for more details)

In his letter to partners in 1969 announcing his “retirement”, Mr. Buffett had the following to say:

“As long as I am “on stage”, publishing a regular record and assuming responsibility for management of what amounts to virtually 100% of the net worth of many partners, I will never be able to put sustained effort into any non-BPL [partnership] activity.  If I am going to participate publicly, I can’t help being competitive.  I know I don’t want to be totally occupied with out-pacing an investment rabbit all my life.  The only way to slow down is to stop.”

Partners who elected to take part of their final partnership distribution in Berkshire Hathaway stock probably did not notice much of a “slow down” in subsequent years.

I was recently contacted by Frank Gifford, a Berkshire Hathaway shareholder who has studied the partnership letters and agreed to share his notes with readers of The Rational Walk.  Mr. Gifford provides a great 20 page introduction to the letters which is very useful for someone looking for a concise summary.

Click on this link to download the partnership letter notes

Disclosure:  The author owns shares of Berkshire Hathaway.

Posted by manualofideas at 12:46 PM | Permalink | Comments (0)

Joel Greenblatt outlined his “magic formula” for stock market investing in The Little Book That Beats the Market. The formula ranks stocks based on two simple and easily calculated figures:  earnings yield and return on capital.  Rather than merely looking for the cheapest companies, the goal is to also find good businesses that achieve high returns on capital.  In the interview shown below, Mr. Greenblatt discusses a new fund that he is introducing which will apply the magic formula to global markets.

Forbes has also published a new interview with Joel Greenblatt with some good background information on the magic formula.

Mr. Greenblatt is also the author of You Can Be a Stock Market Genius which we reviewed last year.  Both books are well worth reading.

The author of this post 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 02:17 PM | Permalink | Comments (0)

Mohnish Pabrai provides some great insights on investing in an interview with Steve Forbes this week. Mr. Pabrai comments on a number of topics including the influence Warren Buffett has had on his investment style and the fee structure of his hedge fund.  One quote has particular resonance for someone who has been involved in technology but has chosen to generally avoid tech investments:

I spent a lot of time in the tech industry. And I like to say that I don’t invest in tech because I spent time in it. And I saw firsthand that the durability of technology moats is many times an oxymoron.

Mr. Pabrai also comments on index funds, the benefits of viewing investing as a “gentleman of leisure activity”, the virtues of an afternoon nap, and the main source of misery for investment managers:

Forbes: So what’s that saying of Pascal that you like about just sitting in a room?

Pabrai: Yeah. “All man’s miseries stem from his inability to sit in a room alone and do nothing.” And all I’d like to do to adapt Pascal is, “All investment managers’ miseries stem from the inability to sit alone in a room and do nothing.”

One suspects that “doing nothing” actually refers to moving funds around by frequent trading.  A prepared mind is required to take action quickly and in size when opportunities arise.  For most investors this requires a tremendous amount of reading and hard work.  To view the entire interview, please click on the image below:

For a list of Mr. Pabrai’s investment holdings as reported in his latest 13-F filing showing positions on December 31, 2009, please click on this link.

The author of this post 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 06:00 PM | Permalink | Comments (0)

We'll be updating the following list throughout this year's public company annual meeting season:

• Berkshire Hathaway (BRK.A, BRK.B), by Warren Buffett
• Biglari Holdings (BH), by Sardar Biglari
• Coca-Cola (KO), by Muhtar Kent
• Fairfax Financial (FRFHF), by Prem Watsa
• Goldman Sachs (GS), by Lloyd Blankfein
  
• JP Morgan (JPM), by Jamie Dimon
• Leucadia (LUK), by Ian Cumming
• Sears Holdings (SHLD), by Eddie Lampert
  
• Winthrop Realty Trust (FUR), by Michael Ashner

Posted by manualofideas at 09:44 AM | Permalink | Comments (1)

The Rational Walk is pleased to have this opportunity to present an exclusive interview with Prem C. Jain, the author of the recently released book Buffett Beyond Value which we reviewed last week.  Prem Jain is the McDonough Professor of Accounting and Finance at Georgetown University.  He has previously taught at the Wharton School of the University of Pennsylvania and the Freeman School of Business at Tulane University.  His research has been published in many prestigious finance and accounting journals including the Journal of Finance and the Journal of Accounting Research.

Professor Jain generously took the time to provide extensive answers to several questions regarding Warren Buffett, the evolution of behavioral finance in academia, defining an investing circle of competence, approaches for investors who wish to expand their competence over time, and much more.

Please click on this link to read the interview in a formatted pdf file.

Q:  There are many books covering Warren Buffett’s career, particularly over the past few years. What made you decide to write a book about Warren Buffett and how is your book differentiated from Buffett biographies such as Snowball?

Most authors of books on Warren Buffett spend a significant part of their books on narratives about Warren Buffett as a person. They do not analyze his investing philosophy in enough detail to develop a good sense of Buffett-style investing. I have tried to fill that gap. Having taught Buffett’s principles for over twenty years and having personally benefitted from his principles, I have written a book that is primarily about Buffett’s investing principles. My book is even more valuable to those who already have some background on Buffett from reading biographical books such as Snowball.

Q:  Much of your book focuses on how investors can learn from Warren Buffett’s techniques and generate market beating returns. Yet, the usual caveat is that investors must not stray from their circle of competence. Many investors have trouble precisely identifying the boundaries of this circle. How would you suggest that investors go about defining their circle of competence?

An investor should start with analyzing one industry that the investor knows the most about. The investor is in his circle of competence if he is not often surprised by the developments in that industry. Else, he needs to study it more. As a professor, I have benefited from investing in education stocks as I understood the business models of several of those companies. Furthermore, to precisely identify the boundaries of one’s circle of competence, one must also test one’s knowledge in several additional stocks in the same industry.

It is often the case that an investor would invest in one company in an industry (say, Wal-Mart) and would not know much about other companies in the same industry (say, Costco and others). To understand Wal-Mart well, they should study and monitor other similar companies as well. This is how I came across Wal-Mart de Mexico (a Wal-Mart subsidiary in Mexico that trades independently). Only after developing a good understanding of one industry, the investor should start investigating in other industries.

Q:  You identify Warren Buffett as a “renaissance investor” because he was one of the first to blend the “growth” and “value” styles into a model that has produced consistently superior results over many decades. Part of Mr. Buffett’s shift toward “growth + value” was due to the influence of Charlie Munger and others such as Philip Fisher, but part of this was due to size. As Berkshire grew, the small “cigar butt” opportunities were not able to “move the needle” for Berkshire. Portfolio size is not an issue for most small investors. In early 2009, there were many small stocks selling under “net-net current assets” as defined by Graham. Does it make sense for small investors to pursue the “cigar butt” style advocated by Graham or does it make more sense to emulate Buffett’s “growth + value” approach?

Buffett’s investing philosophy has evolved over time. An investor can similarly become a better investor over time. In 1963, Warren Buffett invested in American Express because American Express’s stock price had declined in the wake of the infamous Salad Oil Scandal in which American Express lost money. However, the American Express charge card business was not affected. After a year or two, Buffett sold those shares as the price recovered. In this investing approach which is usually classified as “cigar butt” investing, the focus is on finding stocks when declining stock prices can be attributed more to market psychology than to fundamentals.

The “cigar butt” investing is based on examining numbers such as P/E ratios or other quantitative metrics. However, even as far back as 1967, Buffett wrote in his letter to his partners that really big money tends to be made by investors who are right on qualitative (as opposed to quantitative) decisions. Clearly, Buffett’s investing style was evolving.

An evaluation of Buffett’s writings and decisions over decades suggests that he has maintained the principle of not paying excessively as a value investor (or as a “cigar butt” investor), he is now willing to pay a fair price as a growth investor. If we were to think of him as a pure value investor, it would be difficult to explain him paying about market P/E for several of his stock acquisitions such as BYD and Burlington Northern Santa Fe or even Wal-Mart. He has clearly evolved into a value + growth investor over time and has specifically mentioned that value and growth are two sides of the same coin. An investor should not ignore “cigar butts” but in this day and age when information is ubiquitous, cigar butts are not easily found. However, an investor incorporating the principles of both value investing and growth investing together is more likely to earn large returns.

Q:  Professional familiarity in a field does not necessarily extend to investment competence. For example, many doctors have a reputation as terrible investors because they mistakenly believe that knowledge of technical details of drugs or medical devices makes them qualified to pick investments. The same can be true for many in technology and software fields. But at the same time, it seems natural to invest in areas that professionals know the best. How can a doctor, for example, develop an investment circle of competence that would allow for intelligent investment in companies related to his profession?

This is a good example of an investor not making good returns even when he may have a good understanding of a particular product. The reason is that investment circle of competence requires not only the knowledge of the products but also the ability to understand the financial statements and to project future earnings. Many investors can not translate success of a product into financial success of the company.

I recommend the following to doctors and others who are interested in investing. Investor should think whether the company and not just a product will be successful for a long time. They should forecast sales and earnings in dollar terms and not only evaluate a product’s technical ability. If they are financial-statements-challenged, they should join hands with others who know some accounting and finance. This may prove to be a fruitful partnership.

Q:  Over the past decade, behavioral finance has attracted much more attention than in the past, perhaps due to several events over the past 25 years that could not be easily explained by the Efficient Market Hypothesis. I recall as an undergraduate student majoring in Finance in the early 1990s that there were few mentions of Warren Buffett or other investors who have routinely achieved market beating returns. Most references to Mr. Buffett tended to dismiss his record as an aberration unlikely to be replicated. Do you see this attitude changing in Finance departments today?

Warren Buffett has had tremendous influence on the academia. In 2003, I invited him to Georgetown University to conduct a question-answer session and the response from the students and the faculty was overwhelming. The finance discipline now acknowledges that professors during the 1970s to 1990s overemphasized the market efficiency paradigm. Fortunately, we have people like Buffett who constantly reminded the academia that the professors had much to learn. And professors have learned. For example, in one of the courses at Georgetown, the first class of the course centers on what we may learn from Warren Buffett. Thanks to Buffett that we do not claim that markets are efficient all the time. It is not easy but if investors work hard, they can beat the indexes and possibly earn very high returns.

Q:  How can investors prepare themselves to mentally deal with temporary declines in the market value of their investments? Even if an investor finds undervalued companies, it is obviously possible for market prices to suffer material declines. We have seen this in Berkshire Hathaway, for example, over the past two years. Is the ability to deal with temporary declines a matter of inherent temperament or personality that cannot be changed, or can investors find ways to improve their investment temperament over time?

Knowledge is the best antidote to making bad decisions. For example, if you know about jewelry and diamonds, all that glitters is not gold for you. Your knowledge will allow you to pick diamonds in the rough and hold on to them. In investing, if you know a lot about certain companies and their managers, you will not become nervous and sell the stock at the wrong time or when the market declines. No wonder, Buffett suggests that you should invest only in companies you understand. Both in 2000 and 2009 when Berkshire stock prices went down by about 50%, I added to my Berkshire holdings.

Q:  Most individual investors attempt to pick stocks on a part time basis. How much time per week do you think is required for part time investors to dedicate to this pursuit? It seems like spending a couple of hours each weekend reading Barron’s or The Wall Street Journal simply wouldn’t be sufficient, yet most people do not have 15 to 20 or more hours per week to delve in more deeply. How should investors think about the time investment required to actively pursue undervalued opportunities?

This is related to an earlier question. If a person has a full time day job, he should study only one industry at a time. Only after he understands one industry, he should move to studying other industries. If he does that, he would not need more than a few hours a week. After several years, he should end up with 20 stocks to invest about 5% in each. In the meantime, he can invest partly in an index fund and party in individual stocks. An average investor need not hold more than 20 stocks in a portfolio. Buffett does not invest in a large number of stocks and most of his holdings are for the long term. In Berkshire, five of the top stocks have often constituted 50% of its total stock holdings. Finally, if a person is very busy and does not have any time to find good stocks, he should simply invest in an index fund such as the Vanguard S&P 500 index fund.

Q:  If an investor decides that he has no particular circle of competence or lacks the time to dedicate to the pursuit, does it make more sense to invest in index funds or in mutual funds such as Fairholme that are run by proven value oriented managers? In your book, you recommend against investing in hedge funds due to the asymmetry that is common in the “2 and 20” compensation models. Does the same caveat apply to value oriented mutual funds? Although they are more cost efficient, certainly index funds remain far cheaper.

For a person who has no particular circle of competence but has decided to invest in the stock market, I recommend investing an index fund and not in mutual funds. An investor is less likely to sell an investment in an index fund when the market goes down than if he were to invest in a mutual fund. I am afraid that the investor would blame the manager for not performing well in a down market and sell all his holdings at the wrong time. It may not be the manager’s fault at all but the investor may not be able to see through the effect of the market on an otherwise well run mutual fund. Even the best of managers do not outperform the market in all the years. The only time a busy investor should invest in a mutual fund is when the investor is extremely comfortable with the manager’s style of investing and has examined it in great detail. It is not enough to simply examine a manager’s past performance and invest with the manager.

Q:  One of the most difficult decisions involves when one must sell an investment at a loss. You cover this topic in the book and suggest that investors should be willing to sell at a loss if subsequent events lead the original investment thesis to be invalid. This is perhaps the most difficult aspect of investing for most people because selling at a loss involves admitting a mistake and making it “permanent”. Is this just a matter of inherent “stubbornness” or can investors take any steps to mentally allow them to sell at a loss with more philosophical detachment?

I think we are hard-wired not to admit mistakes. Selling at a loss is indeed difficult. Or, we are optimistic and hope for an improvement in the stock price. I recommend two specific steps. First, one should write detailed notes whenever a purchase decision is made. Periodically, as the company makes earnings announcements or other important announcements, the notes should be updated. I have benefited from this practice a lot. When individuals are forced to write their thoughts on the paper, they can more easily see the right thing to do. For example, if one has a good knowledge of the company’s products, managers and financial statements, a decline in the stock market may be a good time to invest more in the stock market. Second, they should compute a stock’s intrinsic value periodically. I discuss the concept of intrinsic value in detail in my book.  When the intrinsic value is below the current stock price, they may find it easier to sell.

Q:  Berkshire Hathaway is often misunderstood by the media and characterized as Warren Buffett’s “hedge fund”. This leads many investors to worry about succession at Berkshire. Do you have any views regarding who Mr. Buffett’s successor will be and how confident are you that the success will (a) be able to retain Berkshire’s unique culture and (b) continue Mr. Buffett’s capital allocation track record? It seems like the next CEO will have impossible shoes to fill. Could this result in a “shooting for the moon” attitude that could introduce greater risk at Berkshire?

If the Berkshire board decides to have only one person at the top, I think Ajit Jain is the right person. After all, Buffett talks to him every day, insurance is the most important part of Berkshire, and he has been at Berkshire for about 25 years. (This has nothing to do with the fact that I have the same last name. I don’t know him at all.) The two other names often mentioned are those of Tony Nicely of GEICO and David Sokol of MidAmerican and NetJets. It will however not matter much if any one of the three is the CEO. After all, the Berkshire CEO does not interfere with the subsidiary CEOs.

Yes, the culture! What is the culture at Berkshire, I have often asked myself. Once we reflect on some of the unique features of the Berkshire culture, we are less likely to be concerned about the future of Berkshire even if the next CEO is not as good as Warren Buffett. There are at least two important features of the Berkshire culture. First, the subsidiary CEOs (and employees) are compensated according to what is most meaningful. Buffett has often talked about compensation based on return on assets or other appropriate metrics. This creates a sense of fair play resulting in high productivity. Second, subsidiary CEOs are given independence to make all decisions at the subsidiary level. Hence, Berkshire will continue to do well after Buffett because of its decentralized management structure. The capital allocation process may not be as good as it is today under Buffett but there are many people who have been close to Buffett and my guess is that the new CEO will continue to do a good job for a long time to come.

Professor Jain, this has been very insightful.  Thank you very much.

The author of this post 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 06:47 PM | Permalink | Comments (0)

By Greenbackd

Alfred Winslow Jones is generally regarded as the progenitor of the modern “hedge fund.” Jones’s strategy, to construct a portfolio 130% long and 30% short (known as “130/30″), seems pretty prosaic by today’s standards, but it was state-of-the-art when he established the partnership A. W. Jones & Co. in 1949. In the April 1966 Fortune article, The Jones Nobody Keeps Up With (.pdf), by Carol Loomis (the same Carol Loomis who edits Buffett’s Berkshire Hathaway shareholder letters), Loomis described Jones’s strategy thus:

[The] fund’s capital is both leveraged and “hedged.” The leverage arises from the fact that the fund margins itself to the hilt; the hedge is provided by short position – there are always some in the fund’s portfolio.

How did Jones’s “hedge” work?

In effect, the hedge concept puts Jones in a position to make money on both rising and falling stocks, and also partially shelters him if he misjudges the general trend of the market. He assumes that a prudent investor wants to protect part of his capital from such misjudgements. Most investors would build there defenses around cash reserves or bonds, but Jones protects himself by selling short.

And his strategy seemed to perform. Loomis reports that he was up 670 percent for the ten-year period to May 1965. Here’s Jones’s performance chart from the article (performance of a $100,000 investment net of fees):

Particularly interesting was Loomis’s assessment of Jones’s ability to predict the direction of the market:

Jones’s record in forecasting the direction of the market seems to have been only fair. In the early part of 1962 he had his investors in a high risk position of 140 [indicating Jones was unhedged 140% long]. As the market declined, he gradually increased his short position, but not as quickly as he should have. his losses that spring were heavy, and his investors ended up with a small loss for the fiscal year (this is the only losing year in Jones’s history). After the break, furthermore, he turned bearish and so did not at first benefit from the market’s recovery. Last year, as it happens, Jones remain quite bullish through the May-June decline, and then got bearish just about the time the big rally began. As prices rose in August, Jones actually moved to a minus 18 risk – i.e., his short positions exceeded his longs, with the unhedged short position amounting to 18 percent of partnership capital.

A perfect contrary indicator. Regardless, he seems to have generally been right when purchasing individual stocks:

Despite these miscalculations about the direction of the market, Jones’s selections of individual stocks have generally been brilliant.

Loomis credits someone else with the idea for the limited partnership structure and fee calculation adopted by Jones:

The idea is common to all the hedge funds, and the idea was not original with Jones. Benjamin Graham, for one, had once run a limited partnership along the same lines.

It’s hard to find a place in investment where Ben Graham hasn’t gone first.

Posted by manualofideas at 10:30 AM | Permalink | Comments (0)

Click here to listen to an interview with Eric Sprott, dated March 27, 2010, or visit the source page.

"Eric Sprott has over 35 years of experience in the investment industry and manages roughly $5 billion.  Eric has been stunningly accurate in his writings for quite some time and is one of the highly respected industry professionals who foresaw the current crisis and chronicled the dangers of excessive leverage as well as the bubbles the Fed was creating while correctly forecasting the tragic collapse we are all enduring.  In this interview Eric discusses the stock market, bond market, inflation, deflation, gold, silver, gold stocks, consolidation in the gold sector, the economy, the US Dollar, paper currencies globally, tax revenues going down, layoffs in US government jobs in states, oil and much more."

Posted by manualofideas at 10:05 PM | Permalink | Comments (0)

H. Kevin Byun, managing partner of Denali Investors, provides some enlightening commentary in his just-released Q1 letter to investors. Byun argues that the equity market is behaving as irrationally on the upside today as it did on the downside in late 2008 and early 2009. He attributes some of the recently exuberant action to so-called "Mr. Magoo pretenders" who suffered big losses in 2008 and may still be chasing their high watermarks. In a quest to recoup losses and get paid, Messieurs Magoo appear content to gamble with their investors' capital, risking disaster yet again. Byun also discusses his concerns surrounding the recent rise of protectionism.

Download Byun's Q1 letter or keep reading his market commentary here:

The first quarter of 2010 has been marked by a continued upward creep in the markets, in stark contrast to recent fear and dislocation. From the lows reached far back in March, when the S&P broke to 667, we have seen a rally of over 75%.

2010, as it turns out, is a make-or-break year for many funds. The severe drawdown in 2008 and massive run-up in 2009 showed once again that it is better to fail conventionally than to succeed unconventionally. With many funds still below high water marks, their urgency for near-term performance in 2010 is greatly magnified. How can these fund managers properly invest with a long-term view when a short-term sword of Damocles hangs precariously above? Can these Mr. Magoo pretenders make it another year? And so career risk, business risk, and behavioral finance, rather than the best interests of their investors, comes to the fore.

With 2010 shaping up to be another interesting year, my view remains that the potential big-picture range and probability of outcomes have widened considerably, although the expected value or average represented through the market may appear narrow. With all the dislocations, machinations, and interventions, the potential energy in the markets is building once again. Exactly how and when the kinetic shifts occur remain an unknown, but the set up to dramatic changes appears to be in place. Expect the water to be choppy.

One related area that has become a topic of increasing attention, just to pick one out of the hat, is that of exchange rates, namely the call coming from some corners for China to let their currency float. From my perspective, it is not analytically prudent to draw a line in the sand on the issue due to the tricky and ever present law of unintended consequences. There are many interpretations even for concepts far simpler than floating and fixed rate frameworks, but let’s venture through. Regarding these unintended consequences, I would like to humbly present the following words as food for thought.

I often see politicians on the news putting the issue in binary terms, as right versus wrong, as good versus bad, as us versus them. This may prove to be a great disservice. Indeed, our country has outsourced many jobs, and low level ones at that. But this means we have also outsourced our unemployment and social unrest. Can you imagine what our unemployment number would look like if the capital base and employee base that supplies our goods just from China were simply put inside the US? Would it surprise you that this would approach Great Depression numbers? The migrant workers and unemployed masses of the Great Depression actually do exist today. But it simply goes unnoticed here because that too has been outsourced!

Conversely, what I have never seen a politician ever mention in the exchange rate debate is the likely resulting inflation. Why not? The average person is already stretched and living paycheck to paycheck. The group that will be impacted the most, which is that same group to which politicians pander, will find costs for basic items moving further out of range. Does it make sense that twenty pairs of tube socks from China are available for $8 retail? For every dollar prices for these tube socks move up to reflect true domestic and rate adjusted costs, a dollar less is available for other necessities. Such limited financial resources create an increasingly desperate zero sum game. Do I buy food or do I buy school supplies for the kids? If exchange rates do float and there is inflation, what will be the call to action then? Who will be the scapegoat? This may result in further finger pointing and a resurgence of social unrest, trade tariffs, trade barriers, and protectionism. This will be part of a negative reflexive process that may have much more severe and unfortunate consequences. But no one is talking about that.

If you are intellectually honest, you have to admit this is not a simple scenario to figure out for which this discussion barely scratches the surface and does not do justice.

As such, I present the following parable not as an answer, but as a surprisingly liberating approach for the analytical mind. It is a story my father told me a long time ago.

“Seh-Ong Ji Ma”
(Seh-Ong’s Wise Horse)

There was a farmer named Seh-Ong that had a beautiful and strong horse. The neighbors complimented, “You are so lucky to have such a beautiful and strong horse.” The farmer replied, “We’ll see.”

Days later, the horse ran away from the farm and could not be found. The neighbors wailed, “You are so unlucky to have lost such a beautiful and strong horse.” The farmer replied, “We’ll see.”

Days later, the farmer’s horse returned, but had brought back seven other wild horses that were equally beautiful and strong. The neighbors complimented, “You are so lucky to have so many beautiful and strong horses.” The farmer replied, “We’ll see.”

Days later, the farmer’s son was attempting to train one of the wild horses, fell off the horse, and broke his leg. The neighbors wailed, “You are so unlucky to have your son break his leg.” The farmer replied, “We’ll see.”

Days later, the king’s army came through to take all the able-bodied young men for war. The neighbors complimented, “You are so lucky to have your son spared from the war.”

The farmer replied, “We’ll see.”

For me, this is one of the most powerful, simple, and elegant lessons of life and, therefore, investing.

Read Kevin Byun's Q1 2010 Denali Investors letter.

Download Kevin's 2009 presentation at Columbia Business School.

Read an excerpt of our exclusive interview with Kevin.

Posted by manualofideas at 09:20 PM | Permalink | Comments (0)

Tariq Ali's Street Capitalist blog has an excellent analysis of Michael Burry's posts on a value investing thread he started in 1996.

Read it here.

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

By Greenbackd

Dr. Michael Burry has been a very popular topic on Greenbackd recently as a result of Michael Lewis’s The Big Short and the Vanity Fair article Betting on the Blind Side. I have posted a link to Burry’s techstocks.com “Value Investing” thread (now Silicon Investor) and another to Burry’s Scion Capital investor letters, but the thirst for all things Burry remains undiminished. The New York Times now has an article, The Origins of Michael Burry, Online, discussing some of Burry’s early postings on his techstocks.com thread. Here Burry discusses his strategy for shorting:

I mentioned that I pick stocks to short based on valuation, not ratios (I ask you to find the correct free cash flow — I bet most people don’t kow they’re working with negative net working capital, either). But I ENTER based on technical analysis. KO could go up or down. The odds are down, technically, but that’s what buy stops are for. This isn’t a long term short by any means. Research on shorts show that profitable shorts make money with small gains, not by waiting for businesses to bankrupt. The small gains are usually there for the picking. Another indicator – if it’s mentioned in Barron’s as a buy three different times <g> — set me onto Wells Fargo.

What’s there to understand about Coke? The business is a KISS model. This gets to my value/short strategy. When people start claiming a business deserves a special valuation above all reasonable fundamental analysis (because of the “franchise”, because there’s so little institutional ownership for a big cap growth stock, because Buffett’s in it, because global expansion will provide endless opportunity, because ROE is so damned high, because it’s nearly a monopoly, because Buffett’s in it…), that’s a short, IMO.

I just read a bunch of Graham, and he doesn’t deal with shorts (I assume it would be “speculation”), but EMT isn’t all that its panned to be either, IMO.

Just trying to think independently,

Mike

The NYT has also unearthed a Forbes magazine article from 2000:

VALUESTOCKS.NET www.valuestocks.net Supposedly for value investors, though Warren Buffett might not agree with this definition of value. Run by a 28-year-old neurology resident, Dr. Michael Burry, Valuestocks.net showcases Burry’s own $50,000 portfolio, which includes some surprising choices including Pixar, the maker of Toy Story. Has good information on how to identify net-net stocks (trading for less than assets minus all conceivable liabilities). Accompanying all this are Burry’s incisive reports, as good as anything from Wall Street. One of the site’s best features is a list of essential finance texts, including thumbnail reviews and links to Amazon.com (Burry’s only source of revenue, since he doesn’t accept banner ads). BEST: Original analysis, links to great finance sites, and a must-read book list for value investors. WORST: Limited content is sometimes dated.

It seems Greenbackd is rapidly, if unintentionally, becoming Mike Burry’s Of Permanent Value, which is Andrew Kilpatrick’s encyclopedic collection of stories about Warren Buffett. Incidentally, my copy of Of Permanent Value is around ten years old, which means it’s one-third the size of the 2010 edition (I’m not even joking. Mine came in a single volume, and it now seems to be a three-volume extravaganza. Buffett has been busy over the last 10 years).

Posted by manualofideas at 10:04 PM | Permalink | Comments (0)

By Greenbackd

The New York Times has a fantastic profile on Carl Icahn called Does Icahn Still Make Them Tremble?

He is one of Wall Street’s most colorful, controversial and complicated characters.

Wearing slightly rumpled khakis and waving his eyeglasses to punctuate key points, Mr. Icahn is constantly jumping from one topic to another in an endless stream of dialogue. In that respect, he more closely resembles an absent-minded professor than a master of the universe.

Corporate executives visiting his offices walk through hallways adorned with paintings of battle scenes and sculptures of cowboys on bucking broncos. One large painting in the conference room features a lion gazing at the bones of an animal in a desert.

Yet he bristles at being labeled a “raider,” despite the fact that he is widely viewed as a founding member of the clan that roamed Wall Street in the 1980s, occasionally pursuing hostile takeovers with ruthless abandon.

He prefers to paint his role in those years with the same “activist investor” brush he holds today, arguing that he has created tens of billions of dollars of value for shareholders in companies in which he invested. (In conversations, he declares that he has created $30 billion, $40 billion and even $50 billion worth of value for shareholders. What is a few billion among friends?)

This is Icahn’s thesis for his investments in the biotechnology sector:

“The biotechs have been his big winners recently,” particularly investments in ImClone Systems and MedImmune, said Mr. Young at Institutional Shareholder Services. “His thesis, which is no secret, is that biotech firms should be purchased by Big Pharma, which is always in need of new products. In his mind, that’s a match made in heaven.”

I love this story:

Mr. Icahn does not seem to let anything, including a very close friendship, get in the way of protecting his and his investors’ profits. Late in 2008, through his hedge fund, he sued Realogy, a real estate company controlled by Leon Black, the head of the private equity firm Apollo Management. Mr. Black was trying to reduce Realogy’s hefty debt load by offering to exchange some of the debt with bondholders.

Mr. Icahn, a bondholder who has known and been friends with Mr. Black for decades — the two have been longtime tennis partners — objected to some terms of the exchange and sued.

“Carl and I have been good friends for over 25 years,” Mr. Black said in an e-mail message. “Occasionally we skirmish as couples are wont to do, but I believe we both feel that when the chips are down that the friendship is paramount.”

How, exactly, does one sue and still be good friends with someone on Wall Street? Mr. Icahn smiles sagely over his cup of coffee: “The two of us have a saying that we always use whenever there is friction in our business dealings. We always say, ‘there’s only one Maltese Falcon.’ ”

At one point in that classic 1941 film, a character chasing a valuable figurine says to a close associate, “You’ve been like a son to me,” Mr. Icahn explains, paraphrasing from the movie.

Then, lowering his voice with mock intensity, Mr. Icahn adds that the character says that if you lose a son, it’s possible to get another — “but there’s only one Maltese Falcon.’ ”

Click here to see the rest of the article.

Posted by manualofideas at 04:23 PM | Permalink | Comments (0)

From The Wall Street Journal's Deal Journal:

Michael Burry and John Paulson both made a killing betting against the housing market.

As a result, the fortunes of Burry, Scion Capital’s founder, and Paulson, of Paulson & Co., have earned them spots as the subjects of books: Burry, as the subject of Michael Lewis’s “The Big Short: Inside the Doomsday Machine,” and Paulson, as the subject of Wall Street Journal reporter Gregory Zuckerman’s “The Greatest Trade Ever.” Zuckerman also touches on Burry in his book.

But looking at the portraits from the two books, these two investors have more in common than their money. Here are some quirks Burry and Paulson share:

They were viewed as different, even socially awkward. Burry believed you had to be unusual to succeed. And he was. “He found it maddeningly difficult to read people’s nonverbal signals, and their verbal signals he often took more literally than they meant them. When trying his best, he was often at his worst,” Lewis writes.

Paulson, similarly, seemed different than his peers. They dressed casually; he wore ties and dark suits. They were making money; he wasn’t. “When he met with clients, they sometimes were surprised by his limp handshake and restrained manner, both unusual in an industry full of bluster,” Zuckerman writes.

Obsessive. Both lived inside their heads for hours at a time, reading hundred-plus-page mortgage-bond prospectuses and studying the housing market to plan their strategies.

“His mind had no temperate zone: he was either possessed by a subject or not interested in it at all,” Lewis writes of Burry.

Paulson’s growing fixation on housing even sparked doubts about his business, writes Zuckerman. “One long-time client, big Swiss bank Union Bancaire Privée, received an urgent warning from a contact that Mr. Paulson was “straying” from his longtime focus, and that the bank should pull its money from Paulson & Co., fast.”

But this obsessiveness likely helped the men in their search for investors supporting the risky bets against the housing market. By mid- 2005, “Burry’s fund was up 242%, and he was turning away investors.” And Paulson made $15 billion for his firm in 2007 alone. (Read an interview with Gregory Zuckerman in Newsweek.)

They did it their way. Neither Burry nor Paulson were experts in derivatives, mortgages or real estate. Burry, a former medical resident, was a self-taught investor, and Paulson focused specialized in corporate mergers.

“Burry did not think investing could be reduced to a formula or learned from any one role model. The more he studied [Warren] Buffett, the less he thought Buffett could be copied.” Lewis writes. “Indeed, the lesson of Buffett was: To succeed in a spectacular fashion you had to be spectacularly unusual.”

Posted by manualofideas at 09:44 PM | Permalink | Comments (0)

Another snippet:

Posted by manualofideas at 11:35 AM | Permalink | Comments (0)

A Conversation with George Soros at HKU from JMSC HKU on Vimeo.

Posted by manualofideas at 06:55 PM | Permalink | Comments (0)

Respected value investor Aaron Edelheit writes a very interesting piece on his excellent blog:

A very, very strange thing happened to a company I follow called Contango Oil & Gas (AMEX: MCF). This is an extremely well-run company that generates tons of cash from natural gas in the Gulf of Mexico. You couldn’t ask for a more efficient and well run company. Consider that Contango has raised $60.5 million in its life and yet has already bought back $65 million, thus having a negative capital situation due to negative dilution. Quite an astonishing task for a commodity company. Further the company’s costs are the lowest around with their find, develop and acquire costs at a measly $1.36 per mcf (thousand cubic feet).

Mr. Ken Peak, the CEO, is a straight shooter, no-nonsense kind of CEO. In fact, I wish most CEOs were more like him. In their last press release for earnings, Mr. Peak said, “Concerning natural gas prices, the weather is cooperating on the demand side, but natural gas supply continues to hold steady. I wouldn’t be surprised by either $3.00 or $6.00 natural gas over the next year or so, but we have good prospects and are aggressively moving forward to drill.” Now how many CEOs would have the guts to say that $3 mcf natural gas prices could happen? Compare him to Chesapeake Energy’s rather repugnant CEO, Aubrey McClendon, who is a perma-bull who enriches himself at shareholder’s expense and has created no value for shareholders.

For disclosure purposes, I have invested in Contango in the past and wrote a research report on it at $38.30, exclaiming how cheap it was. I have since taken my profits with its move to over $50 per share and reallocated my money elsewhere. I still follow Contango, in case it sells off again, and to see what Mr. Peak is doing.

So imagine my surprise when I see Monday’s press release, which has been getting absolutely zero press or news. Contango, which has been strictly an oil & gas company, announced that they were making an investment of up to $3 million in looking in Alaska for gold!

Here is what Mr. Peak said:

“This investment does not signal, foreshadow or represent a change in our natural gas and oil exploration business model. We recognize that the risks and challenges inherent in gold exploration are quite different from our natural gas and oil exploration business and were attracted to invest in this project solely by what we perceive to be its reward/risk ratio, where a relatively small amount of initial exploration risk capital ($3 to $5 million is envisioned) could potentially lead to a more extensive gold exploration/development project. Our 2009 exploration program found relatively few samples of commercial grade gold ore – generally considered to be 0.5 grams per tonne or more – but we believe our results merit an expanded exploration program for the summer of 2010.”

Mr. Peak continued, “Our planned 2010 exploration program will be directed toward additional rock sampling, trenching and drilling core holes. Shareholders are reminded that at this early exploration stage our investment should be considered as nothing more than an ‘interesting speculation’ and that the odds of our ultimately being successful in finding gold in a volume sufficient to support a commercial gold mining operation are quite low. To put it in oil and gas parlance, this ‘play’ is the rankest of ‘wildcats’ that is currently only at the ‘idea’ stage and we are hoping, based on our 2010 work program, to learn if we can mature it to the ‘prospect’ stage in order to justify committing additional risk exploration capital. After we have taken our core, rock and pan samples, they will be assayed in an independent lab and then evaluated for prospectivity and commercial development potential. This process will likely take until December 2010.” Here is the link to the release: Contango Gold Investment

I think this is a big warning sign. Neither Contango, nor Mr. Peak, as far as I know have any experience looking for gold, and the company has made all of its money on natural gas. This investment raises a host of questions. What also does it say about the natural gas market, or Mr. Peak’s view of it, that he would be willing to spend $3 million on gold instead of drilling for natural gas? What does it say about the value of Contango’s stock, that Mr. Peak would rather search for gold and not buy his own stock back?

But then I pause my this line of questioning and remember that Mr. Peak has been an excellent allocator of capital and has an excellent eye for value. So, I turn the question around and ask, what does it say about Mr. Peak and Contango’s thoughts on gold and the future of gold?

I think this news deserves a lot more attention and analysis. I know Contango is much smaller, but could you imagine if Exxon announced they were looking for gold? Ken Peak and Contango have an excellent reputation and are held in high regard, their decision should be viewed no less important than if a major such as Exxon had announced it.

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By Greenbackd

Seth Klarman’s teachings, which I’ve covered on this site on several occasions (see, for example, Klarman on calculating liquidation value, on identifying catalysts, and on investing in liquidations), are always worth reading. In his most recent investor letter Klarman has provided a list of twenty investment lessons of 2008 (via the always superb Zero Hedge):

Things that have never happened before are bound to occur with some regularity. You must always be prepared for the unexpected, including sudden, sharp downward swings in markets and the economy. Whatever adverse scenario you can contemplate, reality can be far worse.

When excesses such as lax lending standards become widespread and persist for some time, people are lulled into a false sense of security, creating an even more dangerous situation. In some cases, excesses migrate beyond regional or national borders, raising the ante for investors and governments. These excesses will eventually end, triggering a crisis at least in proportion to the degree of the excesses. Correlations between asset classes may be surprisingly high when leverage rapidly unwinds.

Nowhere does it say that investors should strive to make every last dollar of potential profit; consideration of risk must never take a backseat to return. Conservative positioning entering a crisis is crucial: it enables one to maintain long-term oriented, clear thinking, and to focus on new opportunities while others are distracted or even forced to sell. Portfolio hedges must be in place before a crisis hits. One cannot reliably or affordably increase or replace hedges that are rolling off during a financial crisis.

Risk is not inherent in an investment; it is always relative to the price paid. Uncertainty is not the same as risk. Indeed, when great uncertainty – such as in the fall of 2008 – drives securities prices to especially low levels, they often become less risky investments.

Do not trust financial market risk models. Reality is always too complex to be accurately modeled. Attention to risk must be a 24/7/365 obsession, with people – not computers – assessing and reassessing the risk environment in real time. Despite the predilection of some analysts to model the financial markets using sophisticated mathematics, the markets are governed by behavioral science, not physical science.

Do not accept principal risk while investing short-term cash: the greedy effort to earn a few extra basis points of yield inevitably leads to the incurrence of greater risk, which increases the likelihood of losses and severe illiquidity at precisely the moment when cash is needed to cover expenses, to meet commitments, or to make compelling long-term investments.

The latest trade of a security creates a dangerous illusion that its market price approximates its true value. This mirage is especially dangerous during periods of market exuberance. The concept of “private market value” as an anchor to the proper valuation of a business can also be greatly skewed during ebullient times and should always be considered with a healthy degree of skepticism.

A broad and flexible investment approach is essential during a crisis. Opportunities can be vast, ephemeral, and dispersed through various sectors and markets. Rigid silos can be an enormous disadvantage at such times.

You must buy on the way down. There is far more volume on the way down than on the way back up, and far less competition among buyers. It is almost always better to be too early than too late, but you must be prepared for price markdowns on what you buy.

Financial innovation can be highly dangerous, though almost no one will tell you this. New financial products are typically created for sunny days and are almost never stress-tested for stormy weather. Securitization is an area that almost perfectly fits this description; markets for securitized assets such as subprime mortgages completely collapsed in 2008 and have not fully recovered. Ironically, the government is eager to restore the securitization markets back to their pre-collapse stature.

Ratings agencies are highly conflicted, unimaginative dupes. They are blissfully unaware of adverse selection and moral hazard. Investors should never trust them.

Be sure that you are well compensated for illiquidity – especially illiquidity without control – because it can create particularly high opportunity costs.

At equal returns, public investments are generally superior to private investments not only because they are more liquid but also because amidst distress, public markets are more likely than private ones to offer attractive opportunities to average down.

Beware leverage in all its forms. Borrowers – individual, corporate, or government – should always match fund their liabilities against the duration of their assets. Borrowers must always remember that capital markets can be extremely fickle, and that it is never safe to assume a maturing loan can be rolled over. Even if you are unleveraged, the leverage employed by others can drive dramatic price and valuation swings; sudden unavailability of leverage in the economy may trigger an economic downturn.

Many LBOs are man-made disasters. When the price paid is excessive, the equity portion of an LBO is really an out-of-the-money call option. Many fiduciaries placed large amounts of the capital under their stewardship into such options in 2006 and 2007.

Financial stocks are particularly risky. Banking, in particular, is a highly lever- aged, extremely competitive, and challenging business. A major European bank recently announced the goal of achieving a 20% return on equity (ROE) within several years. Unfortunately, ROE is highly dependent on absolute yields, yield spreads, maintaining adequate loan loss reserves, and the amount of leverage used. What is the bank’s management to do if it cannot readily get to 20%? Leverage up? Hold riskier assets? Ignore the risk of loss? In some ways, for a major financial institution even to have a ROE goal is to court disaster.

Having clients with a long-term orientation is crucial. Nothing else is as important to the success of an investment firm.

When a government official says a problem has been “contained,” pay no attention.

The government – the ultimate short- term-oriented player – cannot with- stand much pain in the economy or the financial markets. Bailouts and rescues are likely to occur, though not with sufficient predictability for investors to comfortably take advantage. The government will take enormous risks in such interventions, especially if the expenses can be conveniently deferred to the future. Some of the price-tag is in the form of back- stops and guarantees, whose cost is almost impossible to determine.

Almost no one will accept responsibility for his or her role in precipitating a crisis: not leveraged speculators, not willfully blind leaders of financial institutions, and certainly not regulators, government officials, ratings agencies or politicians.

See also Klarman’s False Lessons of 2009.

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Warren Buffett includes an “Owner’s Manual” for Berkshire Hathaway shareholders in each annual report which is also available separately on the company’s web site.  The Owner’s Manual does not change very often which is appropriate since it is supposed to communicate basic business principles that are not likely to change each year.  For this reason, it was easy to miss a change that has significant implications for Berkshire Hathaway’s earnings retention policy going forward.

Original Retained Earnings Test

The following statement has been documented as business principle #9 ever since Mr. Buffett published the Owner’s Manual in 1983:

We feel noble intentions should be checked periodically against results. We test the wisdom of retaining earnings by assessing whether retention, over time, delivers shareholders at least $1 of market value for each $1 retained. To date, this test has been met. We will continue to apply it on a five-year rolling basis. As our net worth grows, it is more difficult to use retained earnings wisely.

The basic meaning of this business principle is that earnings retention must, in the long run, deliver at least $1 in market value to shareholders for each $1 that management retains.  It had the virtue of simplicity and was also very easy to measure.  Anyone can calculate Berkshire’s retained earnings for a five year rolling period and then examine whether the retained earnings resulted in a corresponding rise in market value.

Limitations With Original Principle

While the principle is simple and measurable, there are clearly problems with the way it is formulated.  It is obvious that over the past decade, valuation extremes were common for companies both on the upside and downside.  As Mr. Buffett noted in his latest shareholder letter, Microsoft CEO Steve Ballmer and General Electric CEO Jeff Immelt both had the misfortune of taking over as CEO near the peak of a bubble in their company’s stock valuation.  Just as it is difficult to evaluate the performance of these CEOs over the past decade based on share price performance alone, it is difficult to evaluate the wisdom of earnings retention using the same standard.

Berkshire’s Modified Earnings Retention Test

The updated version of Berkshire Hathaway’s earnings test reads as follows:

I should have written the “five-year rolling basis” sentence differently, an error I didn’t realize until I received a question about this subject at the 2009 annual meeting.  When the stock market has declined sharply over a five-year stretch, our market-price premium to book value has sometimes shrunk. And when that happens, we fail the test as I improperly formulated it. In fact, we fell far short as early as 1971-75, well before I wrote this principle in 1983.

The five-year test should be: (1) during the period did our book-value gain exceed the performance of the S&P; and (2) did our stock consistently sell at a premium to book, meaning that every $1 of retained earnings was always worth more than $1? If these tests are met, retaining earnings has made sense.

It must be noted that any modification of a long standing test that recently failed should be treated with a healthy dose of skepticism.  Is management changing the test due to a legitimate problem in the formulation of the original wording or is the goal line simply being moved?  The fact that the CEO is Warren Buffett does not mean that this question should not be asked.

Mr. Buffett’s argument is that the original test was improperly formulated because markets can remain extreme for a long period of time, which is certainly true.  During such times, Berkshire’s price to book value often falls.  This is certainly the case as we noted in The Rational Walk’s Berkshire Hathaway Briefing Book. As Mr. Buffett notes, this also happened during the early 1970s far before he formulated the Owner’s Manual principles.

Allowing Mr. Market to dictate earnings retention policy even over a five year period can cause unintended consequences.  For example, Berkshire Hathaway failed to meet the test at the market lows in 2009.  A strict interpretation of the original rule would have forced a dividend in February or March 2009 and would have limited the capital available to Mr. Buffett to take advantage of opportunities caused by the market crash.  This would not have served shareholder interests.

Does the New Rule Make Sense?

The new retention principle says that the litmus test should be whether Berkshire’s book value gain exceeded the performance of the S&P 500 and whether the stock consistently sells at a premium to book – meaning a price to book ratio of at least 1.  Based on this formulation, Berkshire would have passed the earnings retention test even at the 2009 lows.

One obvious problem with the new rule is that book value is only a rough proxy of changes in Berkshire’s intrinsic value, as Mr. Buffett himself tells us in his shareholder letters.  In addition, Mr. Buffett has told us that intrinsic value far exceeds book value.  From a directional standpoint, changes in book value are likely to signal changes in intrinsic value, but a price to book ratio of 1.0 or 1.1 is almost sure to signal an undervaluation of Berkshire shares.

Under the new rule, future managements at Berkshire could argue that earnings should be retained under the new test even if the price to book value is only slightly above 1.0 provided that the change in book value over a five year period at least exceeds the S&P 500 change.

One other objection is that looking at Berkshire’s overall price to book value ratio does not measure the wisdom of retention of incremental capital.  It is perfectly possible to have value destroying earnings retention coincide with maintenance of a price to book value ratio well in excess of 1.0 because of the cumulative effect of decades of good decisions that have created the bulk of the intrinsic value.  At the margin, earnings retention could still destroy value while the price to book ratio remains above 1.0, although below what it otherwise might have been without earnings retention.

No Substitute for Management Judgment

The bottom line is that few shareholders would have wanted Mr. Buffett to declare a dividend in March 2009.  Shareholders trust his judgment based on his cumulative history at Berkshire and are willing to grant a huge amount of latitude based simply on the track record.

The problem with attempting to define this type of rule is that some element of management judgment is always going to be required when deciding on earnings retention policy.  Only after a period of time passes will shareholders be able to evaluate whether the retained earnings created value or not.  Future CEOs at Berkshire Hathaway will find it impossible to alter any of the business principles in any way whatsoever because they will be accused of trying to modify the company culture.  Therefore, Berkshire shareholders must be comfortable with these principles as they apply to the next CEO, not just Mr. Buffett.

The fact that Berkshire Hathaway has an Owner’s Manual with clear principles is a great example for other companies to follow but the recent revision to the earnings retention test demonstrates the inherent limitations associated with static principles that meet the irrational behavior of Mr. Market.

The author of this post 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.

The author owns shares of Berkshire Hathaway and is the author of The Rational Walk’s Berkshire Hathaway 2010 Briefing Book which provides a detailed analysis of the company along with estimates of intrinsic value.

If you receive Portfolio Manager's Review in the mail each month, you are eligible to receive Ravi Nagarajan's newly published 70-page Berkshire Hathaway 2010 Briefing Book and Excel model for FREE. Click here to buy the briefing book, then email your purchase confirmation to support at manualofideas dot com. We will promptly refund the $19.96 purchase price to you via PayPal.

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By Ravi Nagarajan

Despite a snowstorm that caused the absence of several speakers, the Columbia Investment Management Conference in New York today included many interesting presentations and panel discussions.  The highlight of the day was the conversation between Columbia Professor Bruce Greenwald and Martin Whitman, Founder and Portfolio Manager of Third Avenue Management.

Mr. Whitman has a sixty year history in the investment management field and represents a distinguished voice of experience we can all learn from.  This article includes several topics that were included in the discussion between Prof. Greenwald and Mr. Whitman but it is not a complete transcript and, unless otherwise noted, is based on the authors notes and recollection of the conversation rather than a presentation of direct quotes.

The Evolution of a Value Investor

Most investors who have arrived at a “value oriented” strategy moved toward the approach over a period of time.  Many of us know the story of Warren Buffett reading every book on investing in the Omaha library but not reaching the conclusion that value investing represents the best strategy until reading Ben Graham’s The Intelligent Investor in 1950.  A similar “evolution” was the case for Mr. Whitman who entered the business as a security analyst at Shearson, Hammil in 1950.  For the first four years, Mr. Whitman focused on many of the traditional benchmarks that security analysts today still concentrate on such as earnings per share growth and predicting near term price movements.

In 1955, Mr. Whitman read Between the Sheets by William J. Hudson which is a book (currently out of print) regarding the importance of paying particular attention to the balance sheet.  This book combined with several real life examples at the time convinced Mr. Whitman that emphasizing balance sheet quality should be more heavily considered in the field of security analysis.  Mr. Whitman also gained a great deal of experience working as a portfolio analyst for William Rosenwald starting in 1956. Experience in stockholder litigation and bankruptcy, fields that were shunned at the time, also provided important lessons regarding analyzing the capital structure of distressed firms.

“Cheap is Not Sufficient”

At several points in the discussion with Prof. Greenwald, Mr. Whitman came back to a central theme:  It is not sufficient for a security to be “cheap”.  It must also possess a margin of safety as demonstrated by a strong balance sheet and overall credit worthiness.   In other words, there are many securities that may appear cheap statistically based on a number of common criteria investors use to judge “cheapness”.  This might include current year earnings compared to the stock price, current year cash flow, and many others.  However, if the business does not have a durable balance sheet, adverse situations that are either of the company’s own making or due to macroeconomic factors can determine the ultimate fate of the company.  A durable balance sheet demonstrates the credit worthiness a business needs to manage through periodic adversity.

A New Take on Graham’s “Net-Nets”

Mr. Whitman believes that it is a “myth” that there are no “net-net” opportunities available in the market today.  We discussed Graham’s concept of net-nets in a prior article and came up with some examples of such opportunities over the past year (for example, see the articles on Hurco and George Risk Industries).  However, such opportunities are very rare and often exist only in the most thinly traded stocks and therefore are rarely actionable.

Rather than adhering to Ben Graham’s original concept of “net-nets”, Mr. Whitman has made a few modifications.  Instead of using current assets as the store of value, he looks at “readily ascertainable asset value” and tries to buy at a large discount to that value.  Assets that can be readily convertible to cash may include high quality real estate, for example.  In certain situations, assets such as real estate may be more valuable in a liquidation than inventories which are part of current assets but often highly impaired in distressed situations.

One other point that Mr. Whitman made while discussing corporate governance also applies to many net-net situations.  The true value of a company may never come out if there is no threat of a change in control.  This obviously makes intuitive sense because the presence of a very cheap company alone will not result in realization of value unless management is willing to act in the interests of shareholders either by liquidating a business that has no future prospects but a very liquid balance sheet or taking steps to improve the business.

When asked if the management of a typical public company is overpaid, Mr. Whitman said “you’d better believe it” due partly to the fact that most Boards of Directors are “a bunch of wimps, including me.”  This serves as a reminder that there is one other characteristic that many value investors share:  Humility and a willingness to admit errors.

The author of this post 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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Edward Lampert, Founder of ESL Investments and Chairman of Sears Holdings Corporation, has released his annual letter to shareholders.  Mr. Lampert’s investment style has often been compared to Warren Buffett’s approach particularly when it comes to capital allocation.  While many companies fail to adhere to disciplined capital allocation practices, Sears has taken a more intelligent approach.

Maintenance vs. Expansion Capital Expenditures

Mr. Lampert has been criticized for failing to make the necessary investments to keep Sears and K-Mart stores competitive.  Personal experience and anecdotal evidence does suggest that Sears Holdings retail properties are not necessarily the most modern facilities in many locations.  However, this fact alone does not automatically justify blindly committing funds to expansion or improvements beyond “maintenance” levels of capital expenditures:

I have written previously about what I believed was the reckless expansion of retail space leading to lower profitability for many retailers and to low or negative returns on the investment required to expand space. In other industries, consolidation rather than expansion has led to a more sensible competitive environment and better returns for shareholders. If you examine the level of capital expenditures over the past decade at many large retailers and compare that expenditure to value created, it would not paint a pretty picture.

Additionally, the dramatic declines in capital expenditures over the past couple of years at most large retailers are strong evidence that the level of maintenance capital expenditures for a big box retailer is materially below what many analysts and experts previously believed. Most of the capital spent over the past decade has been largely for store expansion, with some lesser amount required for maintaining existing stores.

The cost of updating or expanding properties must be weighed against the best possible alternative uses for the funds such as improving Sears’ strongest brands like Kenmore and Craftsman or authorizing share repurchases:

While we continued to repurchase shares during the economic crisis because the value was attractive and because we had significantly lower leverage than others in our industry, many of our competitors suspended their repurchase programs to appease credit rating agencies only to resume them again after their share prices recovered significantly.

Mr. Lampert also criticizes ratings agencies for simplistic analyses that automatically favor capital investment to share repurchases ignoring the fact that capital investment at negative rates of return can end up harming bondholders as well as stockholders.

Owner Orientation

While many executives only pay lip service to “shareholder value” and “management alignment with shareholder interests”, Mr. Lampert’s record and ownership interest in Sears Holdings serves to back up his claims.

We do some things differently than others, and we have certain beliefs that differ from theirs. Our culture is owner-oriented, because we have owners who serve on the board that governs the company. We believe that ownership makes a difference, especially when owners have significant financial interests in the company and a long-term perspective. Instead of this raising concern, rating agencies should welcome and value owners with a demonstrated track record of long-term value creation and conservative capital policies, even when some of the capital allocation preferences differ from those that others believe lead to higher long-term credit performance.

This is the type of owner orientation that makes it preferable to repurchase shares rather than plowing funds into capital expenditures at negative rates of return even though doing the latter is more popular within any organization in the short run and also will win the praises of local community leaders at ribbon cutting events.  The problem with companies that pursue popularity rather than intelligent capital allocation is that eventually the day of reckoning will arrive and the music will stop.

Regulation and Politics

Wading into more controversial topics, Mr. Lampert is critical of policies that may over-regulate the economy by placing government bureaucrats in place of private sector capital allocators when it comes to sustaining an economic recovery.  In terms of financial regulation, Mr. Lampert advocates the removal of the implicit “too big to fail” guarantee which would level the playing field.  However, it is unclear how the government can remove the “too big to fail” perception without some form of regulation to constrain financial institutions from reaching the size and interconnectedness that makes government bailouts inevitable.

Capital can quickly reorganize and provide financing for businesses and projects that create value for our society, without the heavy hand of government planning and policy. I disagree with most people calling for a gigantic overhaul of our financial system led by new and “improved” regulations. Instead, begin the process of allowing more competition in financial services and begin the removal of implicit and explicit government guarantees that provide the perception that some are “too big to fail.” While there are those that claim that their institutions are not too big to fail, they surely recognize the significant competitive advantages that come from this perception. Of course they will accept regulations as long as these regulations do not permit additional competition from entities and institutions that do not take insured deposits, do not have access to Federal Reserve funding, and do not have government guarantees associated with their debt offerings. Regulatory capture comes when there is little competition allowed outside regulated entities and a “freezing” of competitors and innovation in an industry.

Mr. Lampert also protest the special treatment given to Amazon.com and other online retailers that are not required to collect sales and use tax in locations where they do not have a physical presence.  It is difficult to argue with the logic behind treating traditional retailers and online retailers in a uniform manner and the observation that current practices will prove unsustainable as more commerce shifts online.

The real story here is that it is not the payment of taxes or the charging of taxes that is at issue. It is the collection of taxes on behalf of local governments from purchasers of goods and services from stores in a locality or for use in such locality. It is the latter fact that is often ignored. A person who buys products from Amazon.com is required by law to pay sales or use tax to their local jurisdiction. In practice, almost nobody does so. The cost and unpopularity of enforcing such laws has allowed customers to avoid paying sales or use taxes, even though they are required in many states and localities. If you buy a work of art or piece of jewelry in NYC, for example, and have it shipped to New Jersey or California, the seller does not collect sales tax on that purchase but the buyer would be required to pay sales or use tax on the purchase where they receive the merchandise and use the merchandise. So, a piece of jewelry shipped to California would require the buyer to pay California sales or use tax.

Mr. Lampert recommends Thomas Sowell’s latest book Intellectuals and Society.  Although I have not kept up with Mr. Sowell’s work in recent years, I consider one of his previous books, The Vision of the Anointed, to be one of the best essays on the mentality that often drives the decisions of those in high positions of power.

Click on this link to read Edward Lampert’s full letter to Shareholders.

The author of this post 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 does not own shares of Sears Holdings.

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By Ravi Nagarajan

Note to Readers:  The following essay is part of an introductory section of an upcoming analysis of Berkshire Hathaway to be published by The Rational Walk shortly after the 2009 Berkshire Hathaway Annual Report is released at the end of February.  The full analysis will be available for purchase as premium content with certain excerpts to be provided on The Rational Walk blog free of charge.

For a formatted PDF File of the following essay, please click on this link.

From Cigar Butts to Business Supermodels

There are numerous books and publications that provide detailed accounts of the history of Berkshire Hathaway as well as Warren Buffett’s life and career.  It is also impossible to fully understand Berkshire without studying the life and career of Vice Chairman Charles T. Munger.  A list of resources for those interested in a comprehensive history of the company and its leaders is provided as an appendix to this document (available in the forthcoming full analysis).  This section merely attempts to provide some context regarding the remarkable history of Berkshire Hathaway and Warren Buffett’s investment approach.

Warren Buffett’s Early Investment Philosophy

Warren Buffett’s early investment philosophy was largely based on the principles developed by Benjamin Graham.  Mr. Buffett has stated on many occasions[1] that his view of investing changed dramatically when he first read Mr. Graham’s book, The Intelligent Investor, in early 1950.  Up to that point, Mr. Buffett had read every book on investing available at the Omaha public library but none were as compelling as Mr. Graham’s straight forward approach summarized in the phrase: “Margin of Safety”.

Benjamin Graham’s approach is more fully documented in Security Analysis which, in contrast to The Intelligent Investor, is more targeted toward professional investors.  Mr. Graham’s approach involved examining securities from a quantitative perspective and making purchases only when downside risks are minimized.  This approach rarely involved speaking to management since doing so could adversely influence the analyst’s impartial view of the data.  In particular, Mr. Graham was a proponent of purchasing stocks selling well under “net-net current asset value” arrived at by taking a company’s current assets and subtracting all liabilities.  In such cases, the buyer was paying nothing for the business as a going concern and had some downside protection due to liquid assets far in excess of all liabilities.

Mr. Buffett was able to leverage the “deep value” approach advocated by Benjamin Graham throughout the 1950s.  In the five year period ending in 1961, the Buffett Partnerships trounced the Dow Jones Industrial average with a cumulative return of 251 percent compared to 74.3 percent for the Dow[2].  While Mr. Buffett employed multiple strategies, one approach involved finding companies that fit the “cigar butt” mold, meaning that they had “one puff left” and could be purchased at a deep bargain price.  This approach led Mr. Buffett to begin acquiring shares of Berkshire Hathaway, a struggling New England textile manufacturer, in late 1962. While Berkshire Hathaway was trading well under book value at the time, Mr. Buffett would later say that book value “considerably overstated” intrinsic value[3].

From Cigar Butts to Insurance

Berkshire Hathaway, as it existed in 1963 when the Buffett Partnership became the company’s largest shareholder, was a cheap company from a quantitative perspective but it was not a good company in terms of offering a business that had durable competitive advantages.  In fact, over the next two decades, Berkshire Hathaway continued to invest in the textile mills but would never gain sufficient traction to complete with overseas competitors with lower cost structures.  Textiles are a commodity business and the low price producer has the advantage.  In retrospect, Mr. Buffett’s purchase of Berkshire Hathaway was a mistake[4].

While Berkshire’s textile mills were doomed to eventual failure, a period of profitability[5] appeared in the mid to late 1960s that presented Mr. Buffett with a choice:  He could either reinvest the profits in the textile business or redeploy the funds elsewhere.  Above all else, Mr. Buffett is a master capital allocator.  He could see the troubles brewing in textiles and, despite attempts by Berkshire’s textile managers to obtain capital for new investments, Mr. Buffett chose to deploy the funds elsewhere.

Berkshire’s entry into the insurance business with the purchase of National Indemnity in 1967[6] was a transformational event for the company.  The textile business, despite a temporary period of profitability, required significant capital investments to continue to remain competitive.  In contrast, insurance operations that are well run generate significant cash in the form of “float”.  Float represents funds that are held by an insurance business between the time when policyholders submit payment and when funds are eventually paid out to settle claims.  As long as underwriting practices are sound, float represents a low cost means of funding investments.  By purchasing National Indemnity, Berkshire was on its way to transforming from a textile manufacturer consuming large amounts of capital at low to negative rates of return into an insurance powerhouse generating large amounts of float for investment in other businesses offering better prospects of high returns.

See’s Candies:  The Turning Point

Few Californians can recall a holiday season where See’s Candies were not a prominent part of the festivities.  The brand is so powerful in California and other western states that many consumers would never think of buying a competing product.  See’s Candies is a textbook example of a company with a formidable “moat”.  Such companies have built up brand identity that cannot be replicated by new entrants even with significant capital investments[7].

Berkshire Hathaway Vice Chairman Charles Munger has been widely credited with convincing Warren Buffett that there are certain situations where deviating from Benjamin Graham’s “deep value” approach can be justified.  Mr. Munger has rebutted[8] the notion that his influence was a deciding factor in Mr. Buffett’s overall record, but many accounts[9] of the events surrounding the See’s Candies purchase supports the conclusion that Charlie Munger deserves much credit for shifting Berkshire’s bias from cigar butts selling at a “bargain price” to excellent businesses selling at a “fair price”.

See’s Candies is the perfect example of a business that produces an excellent return on equity year after year but requires very little capital investment in order to sustain the “moat” that makes such returns possible.  When Berkshire purchased See’s Candies for $25 million in 1972, the company only had $8 million of net tangible assets.  However, See’s was earning approximately $2 million after tax at the time[10].   $17 million of the $25 million purchase price could not be accounted for by assets on See’s balance sheet but represented the value represented by intangible “brand equity”.

Over the first twenty years of Berkshire’s ownership of See’s Candies, sales increased from $29 million to $196 million while pre-tax profits grew from $4.2 million to $42.4 million.  However, that is not even the most amazing part of the story.  What is more remarkable is that Berkshire Hathaway only had to reinvest $18 million of retained earnings over that twenty year period while $410 million of cumulative pre-tax earnings were sent back to Berkshire for redeployment in other investments[11].

There have been many other key turning points in the history of Berkshire Hathaway but the decision to pay a “premium price” for See Candies in 1972 may best symbolize the transformation of Mr. Buffett’s approach toward investing.  This is perfectly summarized in Mr. Buffett’s 1992 Letter to Shareholders:

In my early days as a manager I, too, dated a few toads.  They were cheap dates – I’ve never been much of a sport – but my results matched those of acquirers who courted higher-priced toads.  I kissed and they croaked.

After several failures of this type, I finally remembered some useful advice I once got from a golf pro (who, like all pros who have had anything to do with my game, wishes to remain anonymous).  Said the pro:  “Practice doesn’t make perfect; practice makes permanent.”  And thereafter I revised my strategy and tried to buy good businesses at fair prices rather than fair businesses at good prices.

Berkshire Hathaway is the company it is today because Mr. Buffett stopped kissing toads like the original Berkshire textile business and started aggressively pursuing supermodels like See’s Candies instead even if they were more “expensive dates”.  As we shall see, Berkshire has no shortage of supermodels today.

[1] For example, see Mr. Buffett’s preface to any recent edition of The Intelligent Investor.
[2] The Buffett Partnership track record is available in many publications.  See, for example, Roger Lowenstein’s Buffett: The Making of an American Capitalist, 1995 Hardcover Edition, Page 69.
[3] See comment in Berkshire Hathaway Owner’s Manual, Page 5.
[4] Mr. Buffett directly stated that buying Berkshire was a mistake in his 1989 letter to shareholders.
[5] See Lowenstein, Page 133.
[6] For a good history of the National Indemnity purchase, see Lowenstein, pages 133 to 135.
[7] For an excellent brief history of See’s Candies, see Max Olson’s paper entitled Quality without Compromise.
[8] See Mr. Munger’s statement in Poor Charlie’s Almanack, Third Edition, “Rebuttal:  Munger on Buffett”
[9] For example, see Alice Schroeder’s account of the See’s Candies purchase in Snowball:  Warren Buffett and the Business of Life, Chapter 34.
[10] See the appendix to Warren Buffett’s 1983 Letter to Shareholders.
[11] See Warren Buffett’s 1991 Letter to Shareholders.

The author of this post 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.

Posted by manualofideas at 11:18 AM | Permalink | Comments (0)

The Manual of Ideas: Are there any books on value investing, particularly globally oriented investing, that you have found valuable but investors may not be broadly familiar with?

Ori Eyal: Reading voraciously is a characteristic that all great investors share in common. There is simply no better way to gain wisdom and learn about the world than to read great books.

For international investing, Jim Rogers’s earlier books, Investment Biker, Adventure Capitalist, and Hot Commodities are good. The Economist is a great weekly magazine to read and learn about the world. I also think Mohnish Pabrai’s The Dhandho Investor and Joel Greenblatt’s You Can Be a Stock Market Genius are great investing books.

Economics is a key investing skill so I think everyone should read Milton Friedman, especially his books Capitalism and Freedom and Free to Choose.

Trying to forecast what the future will look like is an important investing skill. To this end I recommend books by Ray Kurzweil, Fantastic Voyage and The Singularity Is Near. Bill Gates has called Ray Kurzweil “the best person I know at predicting the future of artificial intelligence.”

To broaden your latticework of mental models, I highly recommend books by Richard Dawkins, Jared Diamond, Richard Feynman, Michael Pollan and John Brockman. I also think Buzzmarketing by Mark Hughes and Influence by Robert Cialdini are must read books.

Finally, I highly recommend the fantastic publications by The Manual of Ideas: Downside Protection Report, Portfolio Manager’s Review, etc. I also think that Value Investor Insight is great.

Read a sample issue of Downside Protection Report.

Read a sample issue of Portfolio Manager's Review.

Posted by manualofideas at 03:45 PM | Permalink | Comments (0)

Respected value investor Aaron Edelheit of Sabre Value recently discussed his investment approach and current investment opportunities in an exclusive interview with Portfolio Manager's Review. The full interview will be published in the forthcoming monthly issue of the Review. Here is a quick excerpt for those looking to pick up a good book:

The Manual of Ideas: Are there any “off-the-beaten path” books that have made you a better investor?

Aaron Edelheit: I just read a fantastic book called “The First Tycoon,” by T.J. Stiles, about Cornelius Vanderbilt. There were many lessons and ideas I drew from the book about what made him so successful, and I think there is a lot to learn about history as well.

Read the full interview with Edelheit as soon as it is published -- subscribe to Portfolio Manager's Review today.

Posted by manualofideas at 04:26 PM | Permalink | Comments (0)

Those of our readers who have followed the evolution of Steak n Shake (SNS) over the past couple of years know that the company has made huge strides in terms of stabilizing operations and creating value for shareholders. Whereas the previous management team almost ran Steak n Shake into the ground, new chairman Sardar Biglari quickly restored the company's fiscal health, ensuring that Steak n Shake will be around for a long time to come. Not least, Steak n Shake's stock price has enjoyed a renaissance of sorts after languishing for years under the old management.

Despite all the positives that Sardar Biglari's involvement has brought to Steak n Shake, the Indianapolis Business Journal (IBJ) has published an article that can hardly be described as anything other than a hatchet job. In the article, Cory Schouten writes:

"Biglari in June persuaded the board to transform Steak n Shake into a holding company for a diverse range of investments and give Biglari sole discretion over asset allocation. The board’s vote essentially allowed the hedge-fund owner to use the publicly traded company as a personal investment vehicle."

"The unanimous vote came after Biglari, the board chairman, managed to push out every board member unwilling to give him dictatorial authority over Steak n Shake despite his relatively modest ownership stake."

"Personal investment vehicle"? "Dictatorial authority"? This language might be more appropriately used to describe the state of Steak n Shake under previous management. Biglari's words -- and, more importantly, actions -- have made it clear that his paramount goal is maximizing long-term value for all Steak n Shake shareholders. Biglari's authority could be described as "dictatorial," but so could every CEO's authority. The question is whether such authority is used for the benefit or detriment of shareholders. In Biglari's case, the business results and stock price of Steak n Shake speak volumes.

The IBJ article also stokes fears about Steak n Shake relocating to Biglari's hometown of San Antonio, Texas, implying that jobs and capital investment might be lost in Indianapolis. We have no problem with a hometown paper looking out for its town, but in this case the IBJ is far off-base. Steak n Shake "The Restaurant Company" will continue to be based in Indianapolis. Meanwhile, Steak n Shake "The Holding Company" will operate out of San Antonio, Texas, likely with a very lean holding company staff.

The inability of organizations such as the IBJ to distinguish between Steak n Shake "The Restaurant Company" and Steak n Shake "The Holding Company" is precisely why Steak n Shake "The Holding Company" will be renamed Biglari Holdings. Listen up, confused IBJ readers: The restaurant business will continue to be called Steak n Shake.

The reader comments posted on the IBJ website show just how destructive it can be in the fast-paced online age when misleading or outright wrong information is spread by a supposedly authoritative voice. Writes IBJ reader Mike,

"This is an unexpected turn of events. I frequent Steak n Shake for many reasons, but mostly b/c of the local headquarters. I for one will not go as often (or ever) if most of the local corporate jobs are moved."

Adds IBJ reader Joe,

"when did we...decide to let sleazeball Iranian refugees (from the Shah's regime no less)purchase/own good 'ol 'Merkan companies and run 'em into the ground...my guess is his family has millions in Swiss bank accounts they've been living off of for years (used to work with one of these Iranian ex-pats years ago and had he was the sleaziest 'businessman' I ever met!)"

Another IBJ reader who calls himself Indy Observer takes a more lighthearted approach to spreading baseless rumors:

"Any truth to the rumor that the Steakburger is being renamed the Big Lari Burger?"

On second thought, that last one could actually catch on. Give it a few decades, by which time Biglari Holdings may well be another stock with a six-figure price tag and tens of thousands of happy shareholders attending each annual meeting. At that time, "Big Lari Burger" just may become a no-brainer name for a burger that will be enjoyed by droves of happy shareholders.

Disclosure: No position.

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

The following are links to hedge fund manager interviews posted on the website Hedgefundnews.com. The interviews were conducted between 1995 and 2004.

• John B. Kleinheinz, Kleinheinz Capital Partners - January 2004
  
• John Paulson, Paulson & Co. - July 2003
  
• Russell Abrams, Titan Capital Group - April 2003
  
• John Muresianu, Lyceum Capital - January 2003
  
• Robert P. Rotella, Rotella Capital Management - June 2002
  
• Alexander J. Roepers, Atlantic Investment Management - April 2002
  
• Ernst von Olnhausen, Robert Vicas, Double V - October 2001
  
• Raj Gupta, Epoch Funds - July 2001
  
• Michael Rome, Lazard Frères - April 2001
  
• Brian Stark, Michael Roth, Staro Asset Management - January 2001
  
• Thomas M. O'Neill, Navigator Asset Management - October 2000
  
• Gregg D. Groechel, American Express - July 2000
  
• Marc J. Gabelli, Gabelli Asset Management - April 2000
  
• Fabien Pictet, Fabien Pictet & Partners Ltd. - January 2000
  
• Errol M. Rudman, Rudman Partners, L.P.-October 1999
  
• Morris Mark, Mark Asset Management-July 1999
  
• Stephen Edwards, Magus Capital Management Ltd.-April 1999
  
• Sanford Grossman, Quantitative Financial Strategies-Jan. 1999
  
• George Hall, Clinton Group-July 1998
  
• Charles Schaffran, Alliance-April 1998
  
• Wayne Cooperman, Ricky Sandler, Fusion Partners-January 1998
  
• Stacy Ruchlamer, The Consumer Fund, L.P.- October 1997
  
• Geoffrey L Symonds, Trace Global Opportunities Fund-July 1997
  
• Raj Rajaratnam, The Galleon Group-April 1997
  
• Charles Davidson, Joseph Jacobs and Shaiy Pilpel, Wexford Management LLC-January 1997
  
• John Armitage and William Bollinger, Egerton Capital Limited-November 1995
  
• Gerald R. Jordan, Jr., Hellman, Jordan Management-July 1995
  
• Michael Sofaer, Sofaer Capital Inc. -May 1995
  

Posted by manualofideas at 08:15 PM | Permalink | Comments (0)

Canadian value investor Vito Maida, founder of Patient Capital Management and former Prem Watsa protege, discusses his strategy and market outlook in this interview with the Financial Post.

If video fails to load, click here to watch.

If video fails to load, click here to watch.

Here is how Patient Capital describes the firm's investment philosophy:

PCM's investment philosophy is based on long-term absolute value. The objective of the investment philosophy is to focus on the preservation of capital while earning superior rates of return. PCM attempts to meet these objectives by purchasing only those securities that meet very strict criteria for value and quality. PCM's mandates allow for substantial cash balances to accumulate if securities cannot be found that meet its very high standards. Investments are only considered in companies that have a long history of operation and are in stable businesses that PCM can analyze and understand with a high degree of certainty.

PCM’s portfolios are constructed entirely on a bottom up basis. Each investment is analyzed through a very independent and rigorous analytical approach. Reliance on external research is minimal. Historical annual reports are analyzed to determine balance sheet strength, sustainability of cash flows and profitability. A very important component of the analytical process is an assessment of the company’s accounting policies. In depth interviews are often conducted with company management in order to assess future strategy and competitive position. In addition, a considerable amount of time is spent attempting to estimate “intrinsic value” through the use of discounted cash flow models and traditional valuation measures such as price/earnings ratios and price/book ratios.

New investments are only purchased if PCM’s criteria for high quality fundamental characteristics such as superior returns on capital, substantial free cash flow and low debt are present as well as a security price that is trading at a substantial discount to PCM’s estimated intrinsic value.

Although PCM’s investment horizon is five to ten years we will exit an investment for any one or more of the following reasons:

• The security price reaches our targeted sale price;
• Significant management changes occur;
• A dramatic change in strategic direction is undertaken;
• Increased debt levels are incurred;
• Adverse changes in accounting policies are implemented.

We believe that our investment philosophy is very different from virtually every other Canadian value manager. Because our clients do not require us to be fully invested we do not have to compromise our standards for quality and price in order to meet a fully invested mandate. Other value mangers that must remain fully invested must by definition practice “relative value investing.” In addition, PCM portfolios are concentrated and will hold a maximum of twenty securities.

(Thanks to Corner of Berkshire and Fairfax for the interview link.)

Posted by manualofideas at 03:47 PM | Permalink | Comments (0)

Here are some recent letters that you may find worthwhile:

• Chuck Akre: Akre Capital Management Q4 letter
• Christopher Begg, Ben Favazza: East Coast Q4 letter 
• Bruce Berkowitz: Fairholme annual letter
  
• Sardar Biglari: 2009 Steak n Shake chairman's letter
  
• John Burbank: Writeup on gold investment thesis 
• Kevin Byun: Denali Investors Q4 letter
• Carr, Coates and Phillips: Oak Value Fund Q4 letter
• McLane Cover: Mistral Capital Partners December letter
  
• David Einhorn: Greenlight Capital Q4 letter 
• Ori Eyal: Emerging Value Capital Management letter
  
• Bill Gates:2010 Bill & Melinda Gates Foundation 2010 letter
• Jeremy Grantham: GMO Q4 letter
• Bill Gross: February commentary, "The Ring of Fire" 
• Robert Hagstrom: "Who's afraid of a sideways market?"
• John Hussman: Latest weekly comment
• Tomas Jelf: Prologue Capital December 2009 letter
  
• Jonathan Lourie: Cheyne Capital 2010 newsletter
  
• Howard Marks: Latest memo, "Tell Me I'm Wrong"
• Angus Murray: 2010 market outlook for precious metals
• Richard Perry: 2009 annual letter 
• Jay Petschek: Corsair Capital Q4 letter 
• Eric Sprott: December letter, "Is it all just a ponzi scheme?"
  
• Whitney Tilson: T2 Partners annual letter
• Pruitt, Miller and Koster: Chanticleer Advisors annual letter
  

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

The blog My Investing Notebook has posted Bill Ackman's presentation on Kraft (KFT), dated February 3rd. The slides provide a good overview of the businesses of Kraft and Cadbury. Ackman also shares a valuation analysis of the combined company, not surprisingly suggesting that the stock should earn a strong return over the next couple of years.

While we like the presentation, we would take some of the assertions with a grain of salt, particularly Ackman's claims regarding merger synergies, potential margin expansion, and a "good" price paid for Cadbury.

Somehow investors always seem to believe there is room for margin expansion. Needless to say, margins don't always expand.

The following classic Buffett quotation may ultimately prove prescient with regard to Kraft/Cadbury: "In some mergers there truly are synergies - though often times the acquirer pays too much for them - but at other times the cost and revenue benefits that are projected prove illusory. Of one thing, however, be certain: if a CEO is enthused about a particularly foolish acquisition, both his internal staff and his outside advisors will come up with whatever projections are needed to justify his stance. Only in fairy tales are emperors told that they are naked."

Posted by manualofideas at 05:49 PM | Permalink | Comments (0)

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In the following interview, Bruce Berkowitz of The Fairholme Fund discusses his recent sale of Pfizer, which had been Fairholme's largest holding through most of 2009.

Berkowitz also opines on the issue of tax rates in the pharmaceutical industry and says that effective tax rates have been too low for too long. The implication is that this could change, potentially depressing earnings -- or at least slowing earnings growth -- across the industry.

Finally, Berkowitz suggests that Fairholme is moving away from a defensive posture toward a more offensive stance in terms of picking investments. Underlying the more aggressive posture is Berkowitz's view that the financial crisis is essentially over and that we are now in recovery mode.

Posted by manualofideas at 05:54 PM | Permalink | Comments (0)

Posted by manualofideas at 05:52 PM | Permalink | Comments (0)

Bruce Berkowitz's Fairholme Fund (FAIRX) disclosed a new position in Citigroup in the annual report of The Fairholme Fund for the fiscal year ended November 30, 2009.

Bruce Berkowitz is one of more than 20 superinvestors regularly covered in Portfolio Manager's Review.

Posted by manualofideas at 05:52 PM | Permalink | Comments (0)

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

We recently had the pleasure of interviewing Mary Buffett, author of Buffettology, The New Buffettology and the newly published Warren Buffett Management Secrets: Proven Tools for Personal and Business Success. We will be bringing you various portions of the wide-ranging exclusive interview in the next few days.

We start this series of posts with Mary Buffett's description of Warren Buffett's approach to "winning an argument," which is also discussed in Chapter 17 of Warren Buffett Management Secrets: Proven Tools for Personal and Business Success.

Click here to listen to or download the MP3 audio.

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

Wilbur Ross, chairman and CEO of WL Ross & Co., discusses his interest in New York's Stuyvesant Town:

Posted by manualofideas at 11:49 AM | Permalink | Comments (0)

By Nadav Manham

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Bill Ackman of Pershing Square went on the air right before Warren Buffett this morning. Quite interesting that Ackman appears to have misread Buffett's views on the Kraft deal for Cadbury. Watch Ackman's comments first and then scroll down to the Buffett interview in our next article. The juxtaposition is fascinating.

Part One of Bill Ackman Interview:

Part Two of Bill Ackman Interview:

Posted by manualofideas at 03:36 PM | Permalink | Comments (0)

If Kraft CEO Irene Rosenfeld was hoping for a public vote of confidence from Warren Buffett, she is surely disappointed this morning.  Perhaps not surprisingly based on his unusual public criticism of Kraft on January 5, Mr. Buffett says that he “feels poorer” in light of Kraft’s richer bid for Cadbury and he disagrees with the decision to shed a highly profitable frozen pizza business to provide funding for the deal.

The statement today in a CNBC interview prior the special meeting of Berkshire Hathaway shareholders clearly refutes yesterday’s Wall Street Journal article which cited an unnamed source within Kraft who indicated that Mr. Buffett was “totally supportive” of the new terms.

Mr. Buffett also comments on a number of topics including the Obama Administration’s proposed bank tax, stating that he does not believe that banks are making “obscene profits” and companies that have already repaid TARP funds should not be forced to effectively pay for bailouts at Fannie Mae and Freddie Mac.

Other topics covered include the Berkshire Hathaway Class B stock split, Wells Fargo’s results, executive compensation, and Ben Bernanke’s prospects for a second term as Federal Reserve Chairman.  In addition, Mr. Buffett is not planning to increase Berkshire’s stake in Posco at this time and indicated that reports yesterday to the contrary may have been due to a misunderstanding with Posco’s CEO due to language translation.

CNBC Interview: Part One

CNBC Interview:  Part Two

The author of this post 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. The author owns shares of Berkshire Hathaway.

Posted by manualofideas at 02:08 PM | Permalink | Comments (0)

Longtime shareholders of Berkshire Hathaway know that Warren Buffett hardly ever comments directly on his assessment of the company’s intrinsic value.  In an interview with Bloomberg at today’s special meeting of shareholders, Mr. Buffett made an exception to his usual silence on the matter when he was asked about issuing shares of Berkshire to pay for part of the Burlington Northern transaction.

The question of whether the bid for Burlington sends any signals regarding Mr. Buffett’s views on Berkshire’s intrinsic value has been discussed here shortly after the transaction announcement in November and again after the proxy statement was released in December.

Here are excerpts from the interview:

You have no problem issuing shares if your stock is fully valued.  I think our stock actually, measured against book value which many people do and is not a crazy way to measure it, it’s at the low end … so I hate issuing shares.  And if I’m paying $100 a share to Burlington shareholders, it’s costing our shareholders more than $100 which I will explain to them in the annual report, because we’re using shares I don’t want to use.

Now, this deal still makes sense in our view.  I mean, we talk about this extensively at the Board.  But we value Berkshire [shares] that we’re giving out at what we think Berkshire is worth.  Unfortunately the Burlington shareholder is going to value it at the market, so we have to give them $100 worth.  Weighing all of that, we like the deal.  But we don’t salivate over it.  I mean, it was close.  We wouldn’t have issued any more shares than we’re doing.

To view the interview, click on the image displayed below or on this link.

The author of this post 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. The author owns shares of Berkshire Hathaway.

Posted by manualofideas at 01:23 PM | Permalink | Comments (0)

According to a Bloomberg article, Warren Buffett may be interested in increasing Berkshire Hathaway’s stake in Posco, a South Korean steelmaker. Posco cited Mr. Buffett as saying that he “should have bought more Posco shares when the stock price dropped during the economic crisis.”  According to Bloomberg, Mr. Buffett met with Posco CEO Chung Joon Yang in Omaha yesterday.  Mr. Buffett has not commented on the meeting.

Here is a brief except from the article regarding prospects for Posco this year:

World steel demand will rise 10 percent this year, Posco said last week when it announced a 77 percent jump in fourth- quarter profit and plans to push ahead with $30 billion of overseas expansion. Buffett, 79, may have a paper profit of more than $1.3 billion in his Posco holding, first disclosed in 2007.

“From the point of view of Buffett, there may be few steel stocks to buy in Asia,” said Chang In Whan, president of KTB Asset Management Co. in Seoul, which manages the equivalent of $8.9 billion in assets. “I’m sure Posco will acquire companies this year, which will help it secure growth in size as well as in efficiency.”

Berkshire held 3,947,554 shares of Posco on December 31, 2008 which represented a 5.2% stake in the company.  Berkshire did not report updates on positions in securities traded on foreign exchanges in quarterly 10-Q reports or in 13-F filings during 2009.

The price of Posco stock has increased from 380,000 Won on 12/31/2008 to 604,000 today while the U.S. Dollar has weakened from 1262 Won/USD on 12/31/2008 to 1124.61 Won/USD as of yesterday.  This would indicate that the value of Berkshire’s holdings in Posco has appreciated from $1.191 billion on 12/31/08 to approximately $2.12 billion today.

The author of this post 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. The author owns shares of Berkshire Hathaway.

Posted by manualofideas at 06:58 PM | Permalink | Comments (0)

By Greenbackd

Recently I’ve been laying the groundwork for a quantitative approach to value investment. The rational is as follows: simple quantitative or statistical models outperform experts in a variety of disciplines, so why not investing in general, and why not value investing in specific? Well, it seems that they do. A new research paper argues that quantitative funds outperform their qualitative brethren. In A Comparison of Quantitative and Qualitative Hedge Funds (via CXO Advisory Group blog) Ludwig Chincarini has compared the performance characteristics of quantitative and qualitative hedge funds. Chincarini finds that “both quantitative and qualitative hedge funds have positive risk-adjusted returns,” but, ”overall, quantitative hedge funds as a group have higher [alpha] than qualitative hedge funds.”

Definition of quantitative and qualitative

Chincarini distinguished between quantitative and qualitative equity-focussed funds thus:

Our main method used to classify was to look for the term quantitative or a description of a similar nature to place a fund in the quantative category. We also looked for words like discretionary to classify qualitative funds and systematic to classify quantitative funds. Of the four main hedge fund categories, we only found two of them reliable enough to classify. Thus, in the Equity Hedge category, we classified Equity Market Neutral and Quantitative Directional as quantitative hedge funds and Fundamental Growth and Fundamental Value as qualitative categories.

…

We did not classify any of the Event Driven funds since these funds vary too substantially within the category and it was not clear from the descriptions how to separate quantitative and qualitative funds. We also did not classify any of the Relative Value funds, even though many of these funds use quantitative techniques, because the broader descriptions left us no clear cut way to divide them.

…

We classified a fund as quantitative if the following words appeared in the fund description: quantitative, mathematical, model, algorithm, econometric, statistic, or automate. Also, the fund description could not contain the word qualitative. We classified a fund as qualitative if it contained the word qualitative in its description or had none of the words mentioned for the quantitative category.

Performance

Using return data from 6,354 hedge funds from January 1970 through June 2009, Cincarini concludes, based on the raw performance data:

Generally, quantitative funds have a higher average return and a lower average standard deviation than qual funds. Amongst the quant funds, the highest average return comes from the Quantitative Directional strategy. The correlations of the fund categories with the S&P 500 are quite low at 0.17 and 0.38 for quant and qual respectively. The risk-adjusted return measures provide mixed evidence, but overall seems in favor of quant funds.

…

The qual funds perform significantly better than quant funds in up markets (25% and 15% respectively). However, the quant funds do significantly better in down markets (-2% versus -16%). This is mainly driven by the presence of Equity Market Neutral funds. In the 1990s, the average qual fund return was higher than the average quant fund return. They were roughly the same from 2000 – 2009. During the financial crisis (which we measure from January 2007 - March 2009), quant funds did better than qual funds (3.29% versus -4.77%).

Table 9 below shows performance summary statistics for the various funds:

Advantages and disadvantages of quantitative vs qualitative

Chincarini identifies several advantages quant funds hold over qualitative funds:

…the breadth of selections, the elimination of behavioral errors (which might be particularly important during the financial crisis of 2008 – 2009), and the potential lower administration costs (after hedge fund fees).

And several disadvantages:

The disadvantages for quantitative hedge funds include the reduced use of qualitative types of data, the reliance on historical data, the ability to quickly react to new economic paradigms. These three might have been especially crippling during the financial crisis of 2007 and 2009.

Finally, there is the potential of data mining, which will lead to strategies that aren’t as effective once implemented. In this paper, we will only focus on the return differences rather than attempting to detail which of the advantages or disadvantages in central in the return differences.

Hat tip Abnormal Returns.

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

Value investor Amit Chokshi of Kinnaras Capital Management levels criticism at Bill Miller in a recent blog post, arguing that Miller has been overpaid given his lackluster long-term track record. Writes Chokshi:

It appears that Legg Mason is rolling out its public relations machine and finding amicable partners in the media to help bolster its reputation along with that of its most recognized fund manager Bill Miller.  This Bloomberg article attempts to repair Miller's deservedly tattered reputation but the authors missed a few key points that potential Value Trust investors should consider.

The Bloomberg article points out that Miller's Value Trust fund rose 43% through December 23rd, beating 93% of its peers.  This performance has led to some self-congratulatory comments with Miller stating "Even when things were really bad last fall, it was pretty clear that there would be a cyclical bullish phase to the market" and “It is too early to pat ourselves on the back...we’re just one year off of a very bad period, so we can’t get complacent."

This mentality of feeling like "you're back" after one good year despite prior years of destroying your investors capital through incompetent stock selection compounded by high fees is sickening, particularly to younger investment managers like myself.  Rather than even consider complacency, Miller should feel shame in his long-term performance and disregard for any risk management.  Miller should also show some level of concern for his investors as those that placed capital in Value Trust as far back as 1997 are underwater.  Even worse, Miller and his team were highly compensated for this incompetence.

LEGG MASON VALUE TRUST ("LMVTX") HISTORICAL PERFORMANCE

Read the full article by Amit Chokshi.

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

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In a recently published letter to shareholders, the managers of Oak Value Fund explain their investment strategy, results for 2009, as well as the investment case for several current holdings.  In addition, the managers comment on Berkshire Hathaway’s proposed acquisition of Burlington Northern Santa Fe.  Oak Value has a solid long term track record despite a relatively high expense ratio demonstrating the benefits of a rigorous value-oriented approach.  Two brief excerpts from the letter appear below.

Investment Philosophy

In our work we are neither interested in the value nor the price of “everything.” We focus our efforts on understanding a collection of growing, advantaged businesses and having an informed opinion of what we believe they are worth. For this group of companies, we are very interested in price, but only in relation to our estimate of their value. Determining price requires a buyer and a seller. Assessing value requires knowledge, insight and judgment. Price is a reaction to the present. Value is a function of the future – growth, predictability and quality. As another great investor once said, “price is what you pay, value is what you get.”

Berkshire Hathaway and Burlington Northern

Berkshire Hathaway made headlines during the quarter with the announcement that it would acquire the remaining 77% of the Burlington Northern Santa Fe railroad company. This is a large acquisition, even for Berkshire, but we believe it is consistent with Mr. Buffett’s longstanding position that it is better to pay a fair price for a good business than a good price for a fair business. The long-term economics of the railroad industry should remain quite attractive, and Burlington’s geographic footprint in the West, where long-term growth prospects appear to be above average, could make it especially compelling. The Burlington network is positioned to benefit from increased volume of imports from China, increased intra-country transport of coal out of the Rockies, and increased movement of grain out of America’s heartland. After a quarter century of consolidation and reorganization, the railroad industry today operates much more efficiently and rationally. As one of the industry’s largest players, Burlington should benefit from structural and competitive advantages for years, if not decades.

Meanwhile, shares of Berkshire Hathaway remained little changed during the quarter as the investment community seemed preoccupied with the task of interpreting some “hidden message” in the timing and/or structure of the Burlington transaction. In our opinion, the most important message for observers to glean from this transaction is the sheer economic power of the Berkshire Hathaway business model to accomplish such a transaction at this point in time.

Click on this link to read Oak Value Fund’s Letter to Shareholders (pdf)

The author of this post 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: No position in Oak Value Fund. Long Berkshire Hathaway.

Posted by manualofideas at 08:11 PM | Permalink | Comments (0)

In a new quarterly letter, up-and-coming special situation investor Kevin Byun describes his fund's success in 2009 and the fund's investment framework. Byun writes on the latter:

Based on the recent and continuing upheaval in the markets, it becomes worthwhile to revisit the fundamentals of our investment framework and to reevaluate the manner in which they hold us in good stead through current and future turbulent times. Although our partners already adhere to our investment mindset and believe in the validity of the tenets (which we consider sensible and logical), we know that most managed capital does not align with our framework.

Our basic structure (the allocation groupings and the incentive structure) is based on the Buffett partnerships from the 1950’s. Today, most people associate Buffett with a buy-and-hold-forever philosophy. However, most people do not know how he first created wealth for his investors and himself. What the popular view discounts is that Buffett began his career managing a hedge fund that was value-based and heavily involved in special situations. Basically falling into two categories, his “Generals” were undervalued stocks (still studied by many today) and his “Workouts” were special situations investments (unstudied by almost all).

Generals & Workouts: The Generals tend to produce returns that are more greatly affected by the overall market performance, as with rising or falling tides. The Workouts tend to provide market agnostic returns and tend to have more attractive risk-reward profiles in downturns. Much of Buffett’s consistency in outperformance even during years in which the markets declined is attributable to his special situation investments. Critically, the combination of the two is much more powerful than either one alone in producing absolute returns over an extended time frame.

The validity of this portfolio structure strikes me as powerful, simple, and elegant. In my view, those that focus only on one category at the exclusion of the other are at a fundamental disadvantage. The inherent balance in the combined structure is why Buffett himself said he expected, although could not guarantee, to outperform in bear markets and underperform in bull markets. By having a balanced tool kit, a portfolio remains flexible in allocating to the most promising opportunity set that presents itself.

Flexible mandate: We have a flexible mandate that allows us to look at any opportunities that may be attractive. Certain funds that are designed to fit into a ‘style box’ remain captive to a certain sector, geography or asset class. The problem for such fund managers is that capital can flood out as easily as it floods in (i.e. technology sector funds in 1999 versus 2000 or energy specific funds in 2008 versus 2009). Also, they become captive to a slice of the market when it is no longer attractive and are simultaneously prevented from areas that are attractive. Whether bargains are available or not is immaterial. The order of the day is to sell. As a generalist, our flexible mandate allows us to look at opportunities across the spectrum.

Concentration: Another advantage is our concentration of investments into our best five to ten investment ideas. Our opportunistic style of investing allows us to wait for investments with highly favorable risk-reward profiles and requisite margins of safety. Allocating more capital to really good ideas, which do not come around too often, simply makes sense. This builds a portfolio one idea at a time, such that performance over time correlates to the outcome of those ideas rather than to the market. On the flip side, the typical mutual fund holds about 80 positions, which practically guarantees below average performance and explains why 80% of them underperform the market simply due to frictional costs.

Cash: Another advantage is the ability to maintain net cash in the absence of other opportunities. Many funds must be fully invested according to the fund’s mandate. A fund manager must then perhaps buy at a time that may not be prudent or sell at a time that is even less prudent. Our ability to hold cash is a great advantage, especially as the current market dislocation unfolds. The use of leverage can be extremely dangerous. As has become apparent, investments that were mediocre at best were made to look superior in cooperative markets through the use of easy borrowing.

Alignment of Interests: We eat our own cooking. I have the lion’s share of my net worth in the fund and I will continue to keep my assets in the fund. The idea is if we do well, we all do well together. I can assure you that my focus is on judiciously growing partners’ capital. The fund manager, whose responsibility is to protect and shepherd capital, should not be exempt from the downside risk. One should cast a very skeptical eye at managers who consistently pull their fees out of the funds they
manage.

Read Kevin Byun's Q4 2009 letter to investors.

View Kevin Byun's recent presentation on special situation investing.

Posted by manualofideas at 04:58 PM | Permalink | Comments (1)

Robert Huebscher of Advisor Perspectives has published an engaging interview with Bruce Berkowitz, manager of the $11 billion Fairholme Fund and one of the most successful value investors of the past decade. Here is an interesting exchange from the interview:

My last question is an unusual one: Since you are obviously in a very competitive business, why do you do interviews with people like me?

We have no marketing. Our shareholders are wired for wealth creation. They are well-informed by using channels such as yours. Whatever I say here becomes public. It’s a great way to communicate with existing shareholders.

I can make points to you that I would be uncomfortable making to shareholders, because what you do is in the public domain. We don’t talk to that many people. You are an extremely efficient channel for our existing shareholders. It’s not cheap to reach 80,000 readers.

It’s also important for Fairholme to attract the right shareholders. For example, if someone called me up for the five-minute timing digest, we are not going to have a chat. The same would be true with the technical analysis channel.

If I can communicate with our shareholders and with other great potential shareholders, then it is very effective, because there is a natural ebb and flow. People leave us during difficult times. We want to keep in touch with our shareholders and keep a high-quality shareholder base.

This is why we charge a flat 1% fee with no loads and have never used a 12(b)1 fee and actually abolished the ability for us to use such a fee.

Last year, there were outstanding managers who had significant amounts of capital withdrawn, who were unable to execute their strategies. Fairholme did not have significant net outflows. It’s hard for me to remember if we had even a month of net outflows. That is a huge weapon and a big advantage – having the right shareholders who will stick with us while others are running for shelter. Without that we couldn’t execute.

I have to find ways to talk to smart people who can present our concepts to the kinds of people we would like to have as shareholders. That’s why we do it. I’m not giving anything away. I would never talk to you about what I am going to do today, what we plan for the future or what is not in our public reports.

The real service is for our shareholders, to let them know who we are, how we behave, how we maintain our level of integrity, how we perform during difficult times and whether we eat our own cooking. That is what’s important.Now that we’ve finished our tenth year, it’s good that people can look back and see what we had to say every six months and how we behaved during very difficult periods. They can stress test us.

At the end of the day, however, I know talk is cheap. You’ll know in three to five years whether I had anything interesting to say today.

Read the full interview with Bruce Berkowitz.

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Here is a video interview with HBS alumnus Seth Klarman "regarding his experience at HBS and his views on leadership and success and the priority of giving back to one's community."

(Thanks to Corner of Berkshire and Fairfax for the link.)

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Contrarian investor James Chanos of Kynikos Associates gained fame by predicting corporate failures such as Enron and Tyco. Now, Mr. Chanos believes China could be headed for demise. As quoted in a recent New York Times article, Mr. Chanos says that China looks like "Dubai times 1,000 - or worse." Accordingly, the hyperstimulated economy, including unsustainable growth in the real estate market, is headed for a crash.

Mr. Chanos' views on China differ not only from accepted conventional wisdom, but also run against the opinion of such informed and successful investors as Jim Rogers. For more on this debate, please read the recent New York Times story.

Michael Auslin of the American Enterprise Institute also had insightful recent remarks on China, echoing the views expressed by Mr. Chanos. Please click here for further reading.

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Via Bloomberg. Excerpt:

Shares of banks such as Citigroup Inc. and Bank of America Corp. were collapsing [in early 2009] on rumors they would be nationalized. On Feb. 25, the U.S. Treasury put out a white paper and a term sheet on its Web site for the government’s Capital Assistance Program. They said the preferred stock the government was buying in the banks would be convertible to common shares at prices far above where they were trading -- 37 percent higher in the case of Citigroup and 21 percent for Bank of America, Bloomberg Markets reported in its February 2010 issue.

For Tepper, 52, that meant it was time to buy. “If the federal government was putting out this paper, they weren’t going to nationalize the banks,” he says.

Second, the conversion price of the preferred shares meant the bank stocks were seriously underpriced.

“It was crazy,” says Tepper, a Pittsburgh native. “In February and early March, people were in a panic.” 

(Thanks to Nadav Manham for the article link.)

Posted by manualofideas at 09:59 PM | Permalink | Comments (0)

Miguel Barbosa of the multi-disciplinary Simoleon Sense blog recently interviewed fellow blogger and value investor Tariq Ali, founder of Street Capitalist. Ali sheds light on his investment approach and talks about some of his best and worst investments. Says Ali,

My worst investment was a small position in Mosaic, I definitely took a top down approach with that one, something I will never do again.

Ticketmaster was an investment I really liked. I entered into the position around $3.99 and sold out in the mid $11-range. It was a spinoff that I had watched since the summer when it began trading at $27. I had actually been excited about the business ever since the deal was announced, just because Ticketmaster is such a monopolistic business.

Fairfax financial was purchased at $210 in 2007 and now trades around around $400. Here was a business that has an amazing jockey, Prem Watsa, was bought at about 1/2 book value and had a great portfolio of credit default swaps to hedge against the financial crisis.

Read the full interview with Tariq Ali.

Posted by manualofideas at 05:33 PM | Permalink | Comments (0)

Max Olson of Max Capital Corporation and FutureBlind.com recently published an excellent article on the story of Steak n Shake and Sardar Biglari, the early-30s investor whom some are already calling the next Warren Buffett. We certainly agree that Biglari is someone to watch very closely as he sets out to transform Steak n Shake into a Berkshire Hathaway-like investment vehicle.

Read Max Olson's article.

Read Sardar Biglari's letter to Steak n Shake shareholders.

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By Nadav Manham

The WSJ profiles hedge fund manager David Tepper of Appaloosa, whose fund was up 120% in 2009.

Tepper's success this year is a testament not only to his gutsy bets, but to successful positioning.  After the annoying experience of having been unduly influenced by his investors not to short the Nasdaq in 2000, he resolved more or less to ignore his LPs.  By the time I got to Wall Street a few years later, Appaloosa was well-known as a fund that made bold bets, which would produce very great years but also some very stressful years.

If even I knew this, then Appaloosa's investor base knew it too, which reduced the fund's asset/liability mismatch in terms of risk tolerance.  A bold portfolio required bold capital providers, and over time that is what the fund has attracted,

Ultimately, this "everyone on the same page" state allowed Tepper to make his 2009 moves relatively unmolested (Alan Shealy of Boise does not count as a molester).

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 09:15 AM | Permalink | Comments (0)

Warren Buffett has often said that there are no called strikes in the field of investing.  Investors are presented with a series of “pitches” every business day by the market but there are no penalties for failing to swing other than the potential to miss out on interesting opportunities.

Of course, Warren Buffett gets many more “pitches” than ordinary investors.  Berkshire Hathaway’s huge cash balance in 2008 created many situations where Mr. Buffett  was offered unique investment opportunities but he passed on the vast majority of them.  The Wall Street Journal has published a detailed account of the many offers made to Mr. Buffett  in 2008 including some details that were previously not known.

One of the early “pitches” came from the CEO of Lehman Brothers on March 28, 2008.  According to the article, Mr. Buffett spent the evening of March 28 reviewing Lehman’s latest 10-K  report and jotted down the number of pages where he found troubling information.  By the time he finished the report, there were too many problems and he passed.  Click on this link for a copy of the 10-K cover provided by the  Wall Street Journal.

In the video below, the author of the Wall Street Journal article provides some additional background information and commentary:

The Wall Street Journal also made available a letter that Mr. Buffett sent to Treasury Secretary Hank Paulson on October 6, 2008 proposing a public-private investment fund.

When Mr. Buffett finally swung on the Goldman Sachs and General Electric pitches in October 2008, he was able to secure investments that have already proven to be very profitable for Berkshire Hathaway.  While he could have achieved even better results by waiting for the March 2009 lows, there was no realistic way to forecast the exact low or to time the market to produce an “optimal” result.

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.  

The author owns shares of Berkshire Hathaway.

Posted by manualofideas at 10:40 AM | Permalink | Comments (0)

Prem Watsa, the chief executive of Canada-based insurer Fairfax Financial (FFH), was a favorite target of short sellers only a few years ago. The shorts attacked Fairfax after the company's M&A strategy hit a major snag, but the shorts overplayed their hand, leveling ridiculous accusations at Fairfax and using (near-)criminal tactics to get their way (Fairfax's lawsuit against the short sellers is still pending). Watsa, who has had the strong loyalty of many value-oriented investors throughout the ordeal, has redeemed himself in the eyes of the marketplace as well. Fairfax investment strategy paid off handsomely during the recent financial collapse, with Fairfax making billions on credit default swaps and other bearish investments. Wasta turned bullish earlier this year, cementing his position as one of the all-time investing greats.

In a recent interview with Diane Francis of The Financial Post, Watsa comments on a wide range of topics, including what's next for stock market investors. Here are some highlights:

Q Are we at the bottom?

A It is difficult to say but the economy is still in a great deal of trouble. Do you think anybody is going to speculate in houses for the foreseeable future? People may do something else irrational, but not houses; a housing bubble is no longer in the cards. This goes to your point about international regulation: You don't have to worry about new rules and regulations, the free market is sorting itself out.

Q You began shorting, hedging with credit default swaps in 2003 before the bubble ended. Were you criticized for that?

A It was painful because we did not have a lot of income, the stock went down in 2006. Our $300-million worth of credit default swaps purchased in 2003 were worth only $75-million or so in 2006 before things turned. We were made fun of in Forbes magazine. We had to withstand some pain. But that is OK, we have a long-term philosophy.

Q Do you worry about concentration of economic power between Wall Street and Washington?

A There are other players coming up as we speak. They said IBM was too big, then came Microsoft, then came along Google, then IBM found a new path to success. The point is, big entities lose talent and they start their own firms. This is already happening at Goldman Sachs and other large institutions. Transparent and free markets and capitalism work in the long run.

Q The market's corrected but is the worst over?

A 80% of the economy [the private sector] is de-leveraging. 20% is government stimulus. Companies are operating at 65% of capacity or utilization rate. Unemployment is rising. If in six to 12 months' time, the stimulus and bailouts don't work, and we are at zero interest rates, what then? We had 20 years of good, meaning no recession to speak of, and only one year of bad. We are not worried about inflation, just the opposite. If wages start to go up, there will be inflation. But there is lack of demand. That's the problem.

Read the entire interview with Prem Watsa.

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Famed macro investor Jim Rogers offers a contrarian view on the dollar, predicting a rally in the greenback due to short-covering. Mr. Rogers is still negative on the longer term prospects for the dollar, however, and remains bullish on gold and other real assets. He also offers a frank assessment of Moody's AAA rating for the U.S., which leads to an awkward interchange with the reporter.

Follow this link to watch the interview with Mr. Rogers.

Posted by manualofideas4 at 01:11 PM | Permalink | Comments (0)

Robert Huebscher of Advisor Perspectives recently interviewed well-known Columbia Business School professor and author of Value Investing, Bruce Greenwald. In the wide-ranging, two-part interview (part one, part two), Greenwald dropped a bombshell when asked about Berkshire Hathaway's (BRK) stock deal for Burlington Northern (BNI). Here's the exchange from the interview:

I know you own Berkshire Hathaway, so I have to ask you what you think about Buffett’s purchase of Burlington Northern.

It’s a crazy deal. It’s an insane deal. We looked at Burlington Northern at $75 and I’ll give you the exact calculation we did. You don’t have a high earnings return. They are paying 18 times earnings, but it’s really much worse than that. They report maintenance cap-ex very carefully. They report depreciation and amortization, and they report only about 70% of the maintenance cap-ex. So they are under-depreciating, and their profit numbers are lower than the true profit numbers – and in a bad way, because the tax shield for the depreciation is undergone too. Their profitability is much lower than it looks.

Buffett’s paying 18-times [at $100/share] and at $75 he was paying 16-times. Our calculation is he was paying 21-times.

Secondly, there are two kinds of assets. There are the rights-of-way, which you can’t get rid of. So there’s no issue about having to earn a return on them because you have to keep it in the business, and because there’s nothing they can do with those rights-ofway. If you look at the asset value of the non-right-of-way equipment, and you write it up because it’s more expensive than it was originally, you get an asset value that’s very close to the earnings power value. We didn’t see a lot franchise value or hidden asset value.

The other thing is that if you try to calculate sustainable earnings, you have to cope with the fact that earnings are up enormously since 2003, when oil went up. There is a simple calculation you can do, which compares the cost-per-ton-mile for freight for a truck versus a railroad. If you build the increase in the price of diesel fuel into the post-2003 experience, when revenues suddenly start to grow, what you see is that the entire growth of the revenue is accounted for by the energy advantage that the railroads have and therefore how much business they can capture from the truckers, and how much pricing they can get because the competition is now more expensive.

There is nothing special about the railroads. It’s entirely an energy play.

If you look at what their margins should have gone up by, given the energy efficiency, the margins go up by only about half of that. So you don’t have a good aggressive management over these five years producing outsized returns.

We looked back at when they did the merger with Santa Fe, because then they did increase margins. But they got bored with it, and margins started to come down. The same thing happened recently. We don’t see a lot of hidden profitability in the culture of the company.

It looked to us like an oil play. He has a history of making bad oil play decisions. And that was at $75/share, we thought there were better oil plays. At $100/share we think he has lost his mind.

Greenwald's criticism of Buffett triggered a firestorm of disagreement, with some value investors suggesting that it was Greenwald who had lost his mind, not Buffett. One of the more lucid responses to Greenwald's criticism was published as a letter to the editor on the Advisor Perspectives website:

I read with some amusement professor Greenwald’s discussion of Berkshire Hathaway’s purchase of Burlington Northern (BNI), I could not disagree with his analysis more.  One of my Native American friends says that one must be careful not to view things with “old eyes” and I fear that is what is happening to the professor’s view of Burlington Northern.

When I first began to look at railroads in the 1980’s, they were the very epitome of capital-intensive, labor-intensive companies consistently earning less than their cost of capital and that was during a period when they all  had millions of acres low cost land holdings with attached mineral rights.  At that time, the one true measure of a railroad’s operating success, its operating ratio, was rarely below 90%.  Union work rules were killing them.

Since that time, a reduction in government regulation, mergers and disposals of surplus lines, changing crew consist rules, technology and improved motive power efficiency have combined to make railroads productive and highly profitable companies.  They have created huge cash flows which have funded debt reduction and capital spending, making them much more profitable. Today, any railroad with a operating ratio in excess of 75% is considered to be poorly managed.  They have not accomplished this by diversifying their business; their resource land grants are long gone they are almost pure rails now.  They have not done it with increased leverage as they carry less debt and preferred than they did 10 years ago.  They have done it by sticking to their knitting, serving the customer, driving down costs, capital discipline, technology investments and just hardnosed business practice.

An example of increased efficiency: changes in engine design have reduced the number of motive units needed per train, reducing costs in terms of both fuel and crew.   Recently, GE introduced a new line of motive units with 16 cylinder higher horsepower diesel engines that, at sustained speeds, turn off four cylinders and maintain their speed on the remaining 12.  The fuel savings are in the area of 30% for comparable runs.

The other issue unique to BNI is that the nature of its traffic has allowed it to replace many of its previously fixed costs with variable costs, giving it greater financial flexibility and the ability to change in an instant to accommodate business conditions.   This in turn allows greater capital discipline and better returns.

While Buffett’s purchase of BNI does not seem to satisfy Berkshire’s traditional pattern of purchasing irreplaceable franchises, it does meet a more basic precept of being a toll-taker by offering a product an economy cannot do without.   Most of the traffic on today’s railroads cannot be moved by any other modality. If we are going to continue to import goods from lower cost developing world countries, then the BNI route structure from the west coast ports  to the mid west will be one of the few (two actually) to move that traffic.

Did he overpay? Maybe.  Does it revalue all the rails? No.  Will it work out for Buffett and his shareholders? Probably and better than most viewing it with “old eyes” can see at this point.

Dennis Gibb
President
Sweetwater Investments
Redmond, WA

Visit Advisor Perspectives and sign up for their excellent free weekly email newsletter.

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An exclusive interview with European value investor Don Fitzgerald of Tocqueville Finance was published in a recent issue of Portfolio Manager's Review. The interview should be of interest to value-oriented investors anywhere. Excerpts:

MOI: Describe your investment process at Tocqueville Finance?

Don Fitzgerald: We focus on stock picking without consideration of benchmark, sector or country allocation and look for companies that are undervalued by the market relative to their fundamentals. Given our long term investment horizon naturally we keep our portfolio turnover relatively low and avoid overconcentration—for example, more than 5% in a single position. We avoid derivatives with the exception of very limited use of covered calls. In times of limited investment opportunities we can hold up to 25% in cash or equivalents.

MOI: What companies draw your attention? How do you generate stock ideas?

Fitzgerald: Investment ideas come from a number of sources, such as regular quantitative screenings, tracking of Tocqueville investments which have been portfolio holdings in the past, monitoring of the financial press, management meetings and conferences.

Opportunities caused by disappointments of short-term market expectations are good targets. Also spin-offs and de-mergers where existing investors often sell without doing their homework on the new company’s real value or situations where you have a forced seller pushing down the stock price are good hunting grounds for fundamental investors.

MOI: Do you have any favorite valuation methods? Are there any analytical approaches you avoid?

Fitzgerald: In the financial analysis we place strong emphasis on margins and returns stability, through-the-cycle profitability, free cash flow generation and balance sheet strength in order to generate our best estimate of intrinsic value. Valuation is judged in absolute terms, relative to the peer group, industry transaction multiples and relative to the company’s own valuation history. We often use sum-of-the-parts valuations for multi-business groups.

Regarding ratios I am wary of valuation ratios like P/Es and price to sales, which often understate the importance of creditor claims on company assets and cash flow. Likewise EV to EBITDA ratios forget that companies need to replace equipment one day and that profitable companies actually pay taxes. I think EV / NOPAT is a nice ratio that in theory corrects for a lot of these faults. However, don’t forget that ratios are just tools or marker points.

MOI: What European markets have you invested in the most and why? Do you invest in Eastern European markets? If so, are there any differences in the valuation approach you apply there compared to investments in more developed Western European stock markets?

Fitzgerald: We invest all across Western Europe and, given our bottom-up approach, there are no countries we avoid or focus on. We have limited experience investing in Eastern European markets and due to lower transparency, corporate governance concerns and issues with the protection of minority shareholders, we are not likely to change our stance in the short to medium term.

MOI: Have you favored or avoided any particular industry as a result of recent financial market dislocation and macro-economic turmoil?

Fitzgerald: For the last three years or so we have had limited exposure to financials, not necessarily because we foresaw all of the problems in the sector but merely because the profitability achieved in the sector from 2003 to 2006 did not appear sustainable and we had concerns about transparency.

MOI: What is the single biggest mistake that keeps investors from reaching their goals?

Fitzgerald: The biggest mistake investors probably make is following the herd and ignoring common sense. The herding instinct is part of the way our brains are wired and we must try to discipline our minds to avoid this default. The worst buying points in any asset occur due to bubbles caused by mass crowds pushing assets prices too far – like the Internet bubble at turn of millennium or house prices in many countries in recent years. Thankfully, value investing helps one to avoid bubbles by focusing on the difference between price and value. Other mistakes investors make is not having a proper strategy, philosophy or discipline to guide their investment decisions.

MOI: When you review your past investment successes, what key common traits do you observe?

Fitzgerald: Probably the best investments were made in companies where I had a very good understanding developed over time on the fundamentals of the company in terms of strategy, management and competitive positioning. This rigorous homework allows you to generate a fair view on the company’s intrinsic value so that you can pounce when Mr. Market offers an attractive entry price.

Read the full Manual of Ideas interview with Don Fitzgerald.

Posted by manualofideas at 07:49 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.

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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.

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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.

Posted by manualofideas at 06:04 PM | Permalink | Comments (0)

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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