It's tough not getting depressed....

The more I read the newspaper, the more convincing the headlines seem. There are very disturbing macroeconomic signs in every country in the globe, even our own supposedly steadfast one (Canada). Unemployment rates are rising, net worth is dropping, people are walking away from their homes and there is no light at the end of the tunnel. Some very erudite essays in the Economist and those insightful pieces written by Vitaliy Katnelson paint a gloomy picture for China, India and Russia's outlook in contrast to their recent stellar view .

No place to run. No place to hide. Cheap energy and a devalued loonie is suddenly our enemy when only a year ago the opposite was true.

Believe it or not, there is another way to view the market's prospects. It's my personal belief that there's a 90% chance that the US will lead the world out of this mess just as they lead us into it the first place. I sure don't know when, though.

Consider these points, made by the Southwestern Asset Management group in a recent conference call:

• "The earnings yield of the S&P 500 relative to Treasurys has made equities the most compelling since the mid 1930s.
• "The annual 10 year return for large company stocks has turned negative – something that has occurred only two other times, in 1938 and 1939, since tracking began in 1926.
• " The VIX, an index measuring expected volatility and therefore fear, hit an all-time high in November.
• "Significant margin calls and capital calls from various types of private funds have caused widespread selling of equities.
• "Advisor sentiment measuring bulls versus bears has fallen to the lowest level in over two decades.
• "The amount of cash being held on the sidelines by individuals has grown to a sum significantly greater than the total market cap of U.S. stocks.
• "Investors have bought Treasurys with no return, an indicator of the fear of other investments.
• "Institutional managers have held high cash balances in spite of acknowledging equities’ undervaluation.
• "Warren Buffett and Prem Watsa, two of the best fundamental investors, have made significant moves into equities.
• "Insider buying at companies has been rampant."

I think the last point is debatable. In late 2007, insider buying was much higher than it is now, particularly in my holdings. The rest have merit.

The bottom line is that I agree with the bears that more pain is probably due. These problems will work themselves out over a number of years. The thing is that the stock market is forward looking (usually 6-9 months or so) and when the first sparkle of light shows through the darkness it's not unreasonable to expect a violent ramp UP from pent up demand to invest the money on the sidelines. T-bill's are in negative territory and bank accounts don't look very appealing.

Over the next 6 months I plan to find a number of small to mid cap companies with excellent management, very solid balance sheets and liquidity and preferably with a decent dividend and sock my money away there. Stay tuned.

l

Why you should ignore experts and do your own research.

Worst Predictions of 2008.

Mea culpa note: I got sucked into AIG as well. My mistakes were buying a complex company that I didn't really understand and to interpret aggressive insider buying as a buy signal in isolation. It looks like in retrospect that the AIG insiders didn't understand the company any more than I did!

PETER COY, BusinessWeek Economics Editor

Just about everybody got wrong-footed by 2008, but some people's mistakes were truly spectacular. Here are some of the worst predictions that were made about 2008. Savor them -- a crop like this doesn't come along every year.

1. "A very powerful and durable rally is in the works. But it may need another couple of days to lift off. Hold the fort and keep the faith!" -- Richard Band, editor, Profitable Investing Letter, Mar. 27, 2008

At the time of the prediction, the Dow Jones industrial average was at 12,300. By late December it was at 8,500.

2. AIG "could have huge gains in the second quarter." -- Bijan Moazami, analyst, Friedman, Billings, Ramsey, May 9, 2008

AIG wound up losing $5 billion in that quarter and $25 billion in the next. It was taken over in September by the U.S. government, which will spend or lend $150 billion to keep it afloat.

3. "I think this is a case where Freddie Mac and Fannie Mae are fundamentally sound. They're not in danger of going under…I think they are in good shape going forward." -- Barney Frank (D-Mass.), House Financial Services Committee chairman, July 14, 2008

Two months later, the government forced the mortgage giants into conservatorships and pledged to invest up to $100 billion in each.

4. "The market is in the process of correcting itself." -- President George W. Bush , in a Mar. 14, 2008 speech

For the rest of the year, the market kept correcting ... and correcting ... and correcting.

5. "No! No! No! Bear Stearns is not in trouble." -- Jim Cramer, CNBC commentator, Mar. 11, 2008

Five days later, JPMorgan Chase took over Bear Stearns with government help, nearly wiping out shareholders.

6. "Existing-Home Sales to Trend Up in 2008" -- Headline of a National Association of Realtors press release, Dec. 9, 2007

On Dec. 23, 2008, the group said November sales were running at an annual rate of 4.5 million -- down 11 percent from a year earlier -- in the worst housing slump since the Depression.

7. "I think you'll see [oil prices at] $150 a barrel by the end of the year" -- T. Boone Pickens , June 20, 2008

Oil was then around $135 a barrel. By late December it was below $40.

8. "I expect there will be some failures. … I don't anticipate any serious problems of that sort among the large internationally active banks that make up a very substantial part of our banking system." -- Ben Bernanke , Federal Reserve chairman, Feb. 28, 2008

In September, Washington Mutual became the largest financial institution in U.S. history to fail. Citigroup needed an even bigger rescue in November.

9. "In today's regulatory environment, it's virtually impossible to violate rules." -- Bernard Madoff, money manager, Oct. 20, 2007

About a year later, Madoff -- who once headed the Nasdaq Stock Market -- told investigators he had cost his investors $50 billion in an alleged Ponzi scheme.

Victoria Contrarian Investing Club Launch

Starting in January 2009, I'm putting together a email list of interested investors of all knowledge levels who have a value bent. The idea is that about once a month one of us will present an investment idea in detail to the others via email. About twice a year we can get together in person for wine, appies and either a guest speaker or a presentation from one of the members, mostly for fun.

I'm going to analyze Fortress Paper Ltd. FTP.TO as the first project. I'm trying to establish a format that will be easy to understand for members of all levels. I'm guessing that most of us will be caught up to the others within a few months. Questions about the terminology etc. will be encouraged.

There are many different approaches to value investing i.e. deep value, distressed company investing, GARP, risk arbitrage etc etc so I don't care what you like-- just teach us! Hot stocks with premium valuations and/or junior mining ventures with no earnings probably won't go over too well, though.

After you do your first one, you'll see how much work it is to do a full analysis. Nothing comes easy in this world and investing is no different.

The main point of each presented idea is to increase our level of knowledge and not necessarily as a prompt to invest with real money. That's your decision, of course. I will track all the securities presented and present their performance once a year.

I've tried to get a listserv set up but am experience "technical difficulties", so for the short term anyway, we'll just email the list by hitting "reply all". If interest grows, I'll figure something much better out.

I'll continue to blog and include gems from all over the internet here, of course.

Anybody interested in joining (even if you don't live in Victoria) please email me at lporayko@gmail.com. I'll add your name to the mailing list.

Those of you who want an invaluable resource to read about value investing (second only to "The Intelligent Investor" by Ben Graham) please open yourself a gmail account. I have a very large file to send you that will be your investing bible.

l

Sum of the parts analysis

This is a superficial but intriguing example of two opportunities at Gurufocus.com. Read about it here.

P/B

Book Value Bargains

The Cheapest Buffett stocks at Gurufocus.com

Seth Klarman speaks on the value investor's perspective

One of the most admired value investors in the world who only rarely talks to the media about his methods. Read the brief interview here.

l

Fortress Paper: a cheap, profitable microcap

As I grow older I've learned an important lesson: age (experience) and treachery will always trump youth and enthusiasm. Unfortunate but true-- and nowhere else do you see this as well demonstrated as in the investing world.

Along these lines, I'm never afraid to steal a great idea from people that may be smarter than me. Even more satisfying is the opportunity to buy a fractional ownership in a company at a considerably more favourable price than a good or even great investor has--- essentially utilizing all their expensive expertise and resources for FREE! Sounds pretty parsimonious, doesn't it? Isn't that what value investing is all about?

Of course the usual caveat applies: don't ever follow gurus (not even Warren Buffet) blindly. Their investment objectives and constraints are likely vastly different than yours. You need to understand the investment thesis in depth. If you don't want to do the research to do that, buy a few ETFs.... the couch potato's portfolio will do better than 90% of the "experts" at any rate and now is probably one of the best times to set one up.

Although I get a lot of my best ideas from the value gurus that I follow from gurufocus.com, I also search SEC sites for the smaller cap stocks that the giants pretty much need to ignore. These companies may have a lot of promise but they are simply too small to move the needle for these funds.

One company that has caught my eye for a couple of years and I'm intensifying my research efforts is Fortress Paper Ltd FTP.TO.

In my thieving and lazy fashion, I'm going to let the ABC funds guys (value investing oriented hedge fund, based in Canada) describe the compelling fundamentals, strong management and excellent prospects for this company that is trading at a fractional of its tangible book value-- providing a decent margin of safety. A sum-of-the-parts and DCF analysis conservatively indicates an intrinsic value of $10/share and FTP.TO is trading at half that today. I think that they are dead right about what the "Street" is missing: this is not a commodity play whatsoever. The market is treating the stock as if the company had a crappy balance sheet or negligible or absent earnings. This type of dislocation is where opportunity for small investors lies. I also think that investors see the wallpaper segment and run away screaming.... because it has something to do with housing and construction. We're still suffering from that hangover and probably will be for some time. Surprisingly, the wallpaper part of the company has been doing very well by selling to eastern European customers doing inexpensive renos.

The other issue is that not just anyone can open up shop and start printing security papers and currencies (lol) for obvious reasons. There are regulatory hurdles and expertise/reputation to attain first. I think this warrants FTP an economic moat albeit a narrow one. That is rare for such a small company.

The only thing I can add that isn't covered in the link above is that management owns 25% of outstanding shares and insider buying has occurred throughout 2008--- having the top people with "skin in the game" is almost mandatory for my investments, particularly these days. It firmly aligns their interests with ours, focuses their minds when market values dwindle and encourages long term thinking.

Downside risks:

• microcap and smallest in its industry
• competition coming on line for non-woven wallpaper niche
• material costs/capex high and difficult to anticipate
• really in the tech sector and in a rapidly changing industry-- we prefer slowly changing ones
• no dividend (a considerable downside when a near-term catalyst is not on the horizon)

I'm in no rush to invest in this company mostly because of downside #5. I plan to continue studying it for another quarter. A possible entry point would be <$5/share and target of >$10/share.

l

SYK v.s. IHI

I use the time spent actively ignoring the bear market rallies such as the one we're in now to study companies in depth for possible entry positions during the inevitable pullbacks.

Stryker SYK, a wide moat high quality medical device company, has caught my attention as it comes off of 52 week lows. Strong management, a bullet-proof balance sheet and great free cash flow growth certainly makes it attractive. Even in the current environment, SYK has increased its modest dividend by 20% (effortlessly sustained with a miserly 12% payout ratio). I'm still doing my due digilence on this one and fortunately, it's well within my circle of competence.

iShares Dow Jones Medical Device ETF IHI is also very interesting. It's a concentrated ETF with the top 10 out of 43 companies making up about 80% of the holdings. It's trading at about 40% discount to Morningstar's fair market value and I'm quite familiar with the most highly weighted companies 2/3rds of which are wide to narrow moat entities. Great FCF mean values, very tax efficient (no capital gains distributions since inception) and diversification of litigation risk (one of the major downsides of investing in this group) make this ETF quite compelling.

enjoy your research.... I do. :-)

from Barron's: LUK (one of my favourite long term investments now)

Leucadia's Unmined Potential

By ANDREW BARY

Leucadia has savvy management and cheap assets -- an enviable combo.

LEUCADIA NATIONAL MAY BE THE CLOSEST THING to what Berkshire Hathaway was 20 years ago, before Berkshire became so large that Warren Buffett needed investments of several billion dollars to move the needle.
AFP/Getty Images
Above, a western Australia mine run by Fortescue Metals, a company in which Leucadia has a big stake.
Run for 30 years by a secretive duo, Ian Cumming and Joseph Steinberg, Leucadia has invested in a wide variety of stocks and a diverse group of businesses. It has generated impressive returns and developed a cult-like following among value-oriented investors who like its investment style -- and results. Buffett is a fan of Leucadia, although Berkshire doesn't own the stock. Leucadia's book value, which stood at $23 a share on Sept. 30, is up from just 11 cents in 1979, an annual growth rate of more than 20%.
Leucadia (ticker: LUK), however, has fallen 60% since Sept. 30, to about 17, leaving it way below its May peak of 57 and slashing its market value to $4.3 billion. Investors fear that Cumming, 68, and Steinberg, 64, have lost their touch, owing to declines in many of Leucadia's key equity holdings, including Australian iron-ore producer Fortescue Metals Group (FMG.Australia), securities firm Jefferies (JEF), Canada's Inmet Mining (IMN.Canada) and auto-finance outfit AmeriCredit (ACF).
MANY OF THE COMPANY'S OTHER investments are suffering, including Cresud (CRESY), an Argentine agricultural and real-estate company, and Leucadia's 10% stake in a hedge fund run by William Ackman of Pershing Square that owns a single stock, retailer Target (TGT). Leucadia probably has lost half of the $200 million it put in the fund last year.
Fans argue that Leucadia is oversold, noting that it rarely has traded below book in the past decade and in recent years typically has commanded 1.5 to two times book. The stock could hit $30 in the next year if the company's equity holdings turn around and if Steinberg and Cumming take advantage of the current financial distress to display their old stock-picking magic. Says one Leucadia holder: "I don't think that they suddenly took stupid pills." Given market declines since Sept. 30, Leucadia's book value has now probably fallen closer to $20 a share.

Table: Leucadia's Key Investments


Steinberg and Cumming, who couldn't be reached for comment, focus on minimizing Leucadia's tax bill. The company now has $1.6 billion of deferred tax assets, indicating that it expects to shield some $5 billion of future profits from federal income taxes. Strip out that tax asset to reflect no future gains, and estimated book falls to around $14 a share. "That's a worst-case assumption. You're not paying much above that for the stock," says a recent Leucadia investor.
Book value also may be understated because of conservative valuations for real estate and other assets the company owns, plus a potentially lucrative agreement with Fortescue that pays Leucadia 4% of net revenues from its Australian iron-ore mine for more than a decade. The deal could produce more than $100 million of annual profits for Leucadia, assuming ore prices don't collapse.

Leucadia's operating businesses, including plastics, wood products, pre-paid phone cards, as well as a Napa Valley winery and the Hard Rock Hotel & Casino in Biloxi, Miss., don't generate much profit. Investors tend to value the company on book value, rather than earnings, because most of its worth lies in investments.

LEUCADIA ALSO HAS INVESTED about $100 million for an 87% stake in a medical start-up called Sangart, which is developing a blood substitute now in clinical trials. There have been many failures in this field, but Leucadia hopes that Sangart's product, Hemospan, is a winner.
Many holders simply view Leucadia as a play on Cumming and Steinberg's investment acumen. Both intend to stay on the job for a while; their employment contracts run into 2015. Some Leucadia watchers believe the company will be liquidated or sold when Cumming and Steinberg leave the scene.

Like Buffett, Cumming and Steinberg believe in a strong balance sheet. As of Sept. 30, Leucadia's $8.4 billion in assets significantly exceeded its $2.6 billion in debt and other liabilities. Leucadia had about $500 million of cash and equivalents on Sept. 30, down from $1.4 billion on Dec. 31. Dividends certainly aren't a drain on its cash. This year, there will be none; last year, the payout was only 25 cents a share.

Unlike Berkshire, Leucadia lacks significant operating businesses; its focus tends to be on more speculative companies. It has paid $405 million for 32 million shares -- a 28% stake -- in AmeriCredit, which provides auto loans to those with weak credit. Reflecting a tough economy and tightness in the credit markets, AmeriCredit shares are 40% below Leucadia's cost.
Cumming, Leucadia's chairman, and Steinberg, its president, may be the lowest-profile leaders of any sizable public company. Outside of their annual shareholder letter and appearance at the annual meeting, they stay out of public view. There are no earnings conference calls, no investor presentations and no financial guidance. There are no photographs of Cumming or Steinberg in the annual report. Hardly any analysts cover the company because of its complexity and minimal communications.

LEUCADIA INVESTED IN FORTESCUE in 2006, when founder and CEO Andrew Forrest needed money to build a giant mine in a remote area that would compete with Australian iron-ore titans Rio Tinto and BHP Billiton to supply the voracious Chinese steel industry. Leucadia, which initially invested $400 million, now owns 9.9% of Fortescue. The miner's shares got as high as A$13.15 in May, at the height of the commodity boom, making Leucadia's stake worth $3 billion and pushing up Leucadia stock. Since then, Fortescue has slid to A$2.50 still more than double Leucadia's cost.

The Bottom Line
Leucadia is trading near 17, versus a book value now estimated at 20. If Leucadia's two top managers haven't lost their investment touch, the stock could hit 30 in a year.
Leucadia also has a close relationship with investment firm Jefferies, reflecting in part Steinberg's friendship with CEO Rich Handler. Last year, Leucadia took a 50% stake in Jefferies junk-bond trading unit, in return for $350 million, even though securities firms rarely sell outsiders parts of their trading operations. This year, Leucadia has accumulated a 30% stake -- 48.6 million shares -- in Jefferies itself, at an average cost of $16. But the stock has dropped to around 10, less than 80% of book value.

Jefferies isn't immune to Wall Street's troubles -- it laid off about 10% of its staff last week -- but its losses have been relatively modest because it doesn't take big trading positions. Still, its high-yield trading business has lost more than $80 million this year. Jefferies, a scrappy niche firm, focuses on equity trading and junk bonds, as well as investment banking.
Leucadia now looks like an attractive play on its depressed investments and on the ability of Cumming and Steinberg to find new opportunities. Unless the pair has indeed taken "stupid pills," investors could do well taking a ride with them

Risky business

The Economist article on bond spreads and dividend yields.

l

ps I'm putting together a few presentation for investing ideas together that I'll post in the next few weeks.