Victoria Contrarian Investing

Victoria Contrarian Investing Club Google Groups

2009-05-17T08:07:00.000-07:00

Just a reminder-- I'm blogging quite a bit less now since I started the Google Group "VictoriaContrarianInvesting" in February of this year.

If you're interested in joining up with like-minded beginner (mostly) value investors, send me an email at lporayko@gmail.com and I'll send you an invitation back. All of our discussions are kept on the VCIC website for future reference. There is a files section where I upload selected investing gems. When I have time, I throw together an informal newsletter with one or two stocks that I've been studying-- mostly for further discussion.

Most of us are not interested in "hot stocks" or buying the latest trend (gold?) so if that's your bent, you probably will find it frustrating. It's my experience that your brain is either wired to be a value investor or you are destined to follow the crowd as a momentum investor. This is why certain value gurus like Bruce Berkowitz, Warren Buffett and Seth Klarman (my 3 favourites, can you tell?) are so open about their analysis techniques and even concerning the stocks that they've bought recently.

From Klarman's "Margin of Safety":

"You may be wondering, as several of my friends have, why I would write a book that could encourage more people to become value investors. Don't I run the risk of encouraging increased competition, thereby reducing my own investment returns? Perhaps, but I do not believe this will happen. For one thing, value investing is not being discussed here for the first time. While I have tried to build the case for it somewhat differently from my predecessors and while my precise philosophy may vary from that of other value investors, a number of these
views have been expressed before, notably by Benjamin Graham and David Dodd, who more than fifty years ago wrote Security Analysis, regarded by many as the bible of value investing.

That single work has illuminated the way for generations of value investors. More recently Graham wrote The Intelligent Investor, a less academic description of the value-investment process. Warren Buffett, the chairman of Berkshire Hathaway, Inc., and a student of Graham, is regarded as today's most successful
value investor. He has written countless articles and shareholder and partnership letters that together articulate his value-investment philosophy coherently and brilliantly. Investors who have failed to heed such wise counsel are unlikely to listen to me."

People can make money using either approach. I think that you make a mistake when you develop "style drift" away from what suits you best, but that's a different whole discussion. I also think that momentum investing is too difficult for me. I'm just not smart enough to figure out group psychology, particularly on that scale. I'll leave that to George Soros, who obviously can.

I plan to track the performance of all the stocks that we discuss in a spread sheet every 6 months. Clearly, the best way to learn is to get continuous feedback- on our objective performance as well as from level headed colleagues that you respect.

l

Insider Ownership helps... or does it?

2009-05-10T11:16:00.000-07:00

One of my hypotheses for buying Seaboard SEB and Columbia Sportswear COLM was that a very high insider ownership (about 70% for each of them) would provide the following attractive investment features:

a strong incentive for management to align its interests with the minority shareholders
a limit to the downside of the share price during general market downturns as insiders tend to hold on to their shares when they are considered cheap and sell them when they are expensive (or they really need the money)

These advantages are offset by the potential for a complacent management that doesn't have to worry about activist shareholders stirring things up. When a company outgrows the skills and experience of the founders that are reluctant to give up control of the company, that bodes poorly for the business' prospects. The other downside is a legacy curse: rampant nepotism in family owned companies often leads to bad governance as children or grandchildren of the founders do not possess the gifts to lead a company forward, yet they maintain control. Wrigley was a prime example of this issue you need to watch for.

SEB has mostly tracked the major indices pretty well-- particularly since Dec '08. It's price action doesn't support my hypothesis very well. On the other hand, COLM has definitely outperformed the markets. These are both family businesses that I believe are well run. I do wish SEB's executives were a bit more forthcoming with information, though. This is probably one of the main reasons it has been sidelined by Wall St.

Obviously looking at just 2 companies with a high degree of insider ownership over the short term is not even close to conclusive. I was impressed how well their stock prices held up compared to the rest of my portfolio and that's why I decided to look into it further.

Read this interesting and thought provoking study from Oxford that shows 9% excess returns v.s. the S&P 500 for firms where the CEO owns 10% of the outstanding shares or greater. This may indicate that choosing selected stocks with high insider ownership may also increase the upside potential in addition to limiting the downside.

IMHO, it's one of many important factors to consider when you're doing your research.

l

2009-05-03T13:25:00.000-07:00

As I've mentioned before, I'm slowly raising cash in order to exploit upcoming opportunities... I'm anticipating a large correction in the next 6-9 months. The market has become irrationally exuberant once again.

My estimate for AEO's intrinsic value is around $15-20/share, so I plan to sell it into strength.

SPLS, a company with management that I've admired and owned for the longer term, is also approaching my guess for its intrinsic value of around $25/share. I'll sell it too soon. I wouldn't hesitate to buy it back again at <$15/share.

Targets I'm monitoring closely, all trading at least 30% above my entry position:

Y (I already own some)
CVL.UN
BDI.UN
PDLI
FACT (I already own some)
PFE
URI
KMX (own it, want more!)
BBEP
BBSI (I already own some)
COP

There are others as well. Yes, I know that many of the above are ideas shamelessly stolen from the revered (for excellent reasons) Mr. Klarman and Mr. Berkowitz. Imitation is definitely the most sincere form of flattery. I also believe that I deeply understand their investment thesis in these companies and my conviction to own them comes along with that understanding.

When Pigs Fly

2009-04-27T06:47:00.000-07:00

Although the swine flu may turn out to just be a wake up call for developed nations' health authorities to dust off their "pandemic plans" and actually see if they are workable, there is little doubt in my mind that this event will stress test the world markets.

With the memory of SARS still fresh in the minds of Torontonians and in particular, the citizens of Hong Kong, fear will probably dictatet o the markets until the coast is clear. I think this will be particularly pronounced in highly populated Asian centres if the flu breaks out there.

Of course, there is no need to panic. You and your family should be prepared for this just like any other natural disaster such as an earthquake. Make sure you have a source of fresh water and lots of canned food. It might be nice to have a supply of N95 masks at home for when you need to enter public places with a high traffic rate of potentially infected people like a grocery store or an airport. Soap and water is plentiful in every home-- use it. A small container of hand disinfectant can be carried around and used each time doors are opened and hands are shook. All simple stuff.

When it comes to a financial strategy, I don't think changing tack makes sense to me. I've used the rally to sell my weaker positions into relative strength and consolidated my portfolio a bit. The majority of my holdings are debt free companies with prodigious free cash flows OR are net-net stocks with unlocked value (i.e. a pile of cash the management needs to be forced to distribute to shareholders...). I think that the game plan should not change one iota. If fear knocks down quality companies' market prices well below intrinsic value, then you should buy them, just like always.

It just so happens that Pharma stocks have been out of favour for a few years now and have some of the best balance sheets and cash flows of any sector. I've been accumulating shares in various companies (NVS, SNY, BMY) over the past 3 years and only sold one (SGP).

One could speculate that some of the Pharma companies will get a boost from world wide stockpiling of anti-viral agents and vaccines; however, I think that this is probably overblown. Roche and Glaxo-Smith-Kline have seen little boosts in their share price because they have Tamiflu and Relenza in their portfolio. Novartis' share price actually dropped a bit this morning despite being assigned the task (and being best positioned to do so) of developing a H1N1 vaccine by WHO and the CDC. This process takes 6 months using the "egg" technique, so they've been told to get cracking. I doubt very much that NVS (which I own, BTW) will profit much from this activity in the short term. I think that it is a great company with excellent prospects, but not because of the swine flu.

Morningstar's article on this topic.

Globe and Mail article.

Pork producers could be hurt temporarily and irrationally by the pandemic. Russia has banned all pork products from North and Latin America and other countries are likely to follow suit. The virus is not spread by ingesting the meat or by dead animals; however, governments are likely to react in this fashion to garner political brownie points from their paranoid electorate. I'm watching SEB carefully for an opportunity to add to my position.

Watching the insiders

2009-04-25T08:06:00.000-07:00

Read this Ockham research article.

And this Kenyon one too...

for this amongst many other reasons, I've been selling into strength-- mostly positions that I've either lost confidence in because of changing business dynamics or realizing that I made a mistake in my original analysis. Fortunately, with the 6 week bear market rally (is that what this is?) and the favourable forex, I've either broken even or made a modest profit on most of the positions.

I'm raising cash to exploit a few special situations that may present catalysts in the nearer term but I'm waiting for a market pullback before committing too deeply to them. I'm prepared to wait up to and including the fall if I have to.

Age before beauty

2009-04-12T16:13:00.000-07:00

Three more grumpy old men give their view on investment opportunities today.

Chou gets crushed

2009-04-08T19:00:00.000-07:00

My only mutual fund holdings are Chou Bond and Chou Associates. I've discussed in the past why I'm a fan of this modest but highly skilled capital allocator.

Like many (including the humbled author of this blog), he has suffered from premature accumulation syndrome. Jumping in too early is tough to avoid and one wonders if you're not just lucky if you don't. It's easy to confuse skill with luck until you look at long term track records-- Mr. Chou has one of the best.

Another lesson I learned the hard way is to only entrust your hard earned capital to a person of the highest integrity. Any red flags at all should make you run in the other direction. See below for why I have no plans to redeem my units despite short term underperformance:

News from globeandmail.com

The manager who gave back his fees

Thursday, April 2, 2009
ROB CARRICK

The mutual fund industry is going to hate this.

Investors will be angry that they don't see more of it.

Unhappy at the returns he has generated for clients, money manager Francis Chou is refunding almost all the management fees collected by his Chou Europe fund since it opened for business in September, 2003.

"We have not made money since inception," explained Mr. Chou, a widely respected investing figure whose financial career began in an investment club he formed in 1981 with six Bell Canada co-workers. "I don't like negative numbers long term. Short term - one year, two years or three years, if you do badly that's fine. But long term, you want to make sure you're making money for your unitholders."

What a difference there is between Mr. Chou's tiny, eponymous fund company and his big-boy competition. He looks out for unitholders. They look out for shareholders.

Investors are lax about understanding the cost of owning mutual funds, which means they may not realize that the fees charged by funds don't typically vary with results they produce for investors. Among the 15 largest equity and balanced funds by assets, losses for the 12 months to Feb. 28 range from 16 to 38 per cent. Don't waste your time waiting for fee rebates from any of them.

Mr. Chou's company, Chou Associates Management, has five funds in its lineup and their losses in 2008 ranged from a better-than-average 17.6 per cent for Chou Asia to a lower-than-average 44 per cent for Chou Europe.

As of the end of February, Chou Europe had lost a compound average annual 6.2 per cent since inception. This is the result that prompted him to ask the Ontario Securities Commission for guidance on how to do what may never have been attempted before by a fund company: Rebate all fees taken in by a fund throughout its history.

"It was the right thing to do," Mr. Chou said from his office in the Toronto suburb of North York, which is way off Bay Street.

In fact, Mr. Chou has rebated fees on a limited basis several times in the past. Most recently, he decided to waive roughly 77 per cent of the management fees collected last year from Chou Bond, a fund that holds high-yield corporate bonds. In the mid-1990s, he waived 19 months' worth of fees taken in by Chou RRSP. In 1990, he waived fees for Chou RRSP and his flagship fund, Chou Associates.

These moves are costly, even for a small firm like Mr. Chou's. About $700,000 extra will be available in Chou Bond so it can be invested for the benefit of unitholders, and a total of $547,000 will be put back into Chou Europe.

It's not only unique for a fund company to give back fees it has collected, it's also difficult because of the need for regulatory, legal and accounting advice. "When you go and give back money, you sometimes have to jump through hoops to get it done," Mr. Chou said.

What eased the way was an unusual clause in the prospectus for the Chou family of funds. It states that the matter of waiving management fees entirely or in part is reviewed annually at the discretion of the manager without notice to unitholders.

Management fees are what fund companies pay themselves from their mutual fund returns to cover the costs of running a fund. Some companies have fixed their management fees so they can't rise, others leave themselves the flexibility to charge more.

Mr. Chou's take: "I look at it more that you have to earn that fee rather than have it given to you. If I feel I earned it, I take it."

Here's something else Mr. Chou takes - responsibility for his investment returns, both good and bad. In 2008, the results were largely bad as a result of his value investing approach of seeking beaten-down stocks with the potential to rebound. In the financial crisis that blew up last year, these stocks have been pounded still lower.

In his annual report to clients, Mr. Chou wrote about how he was worried about irresponsible lending and the U.S. housing market, but did not foresee how severely the financial system would be hurt when the bubble burst.

"And so, based on the information we had in 2007, we purchased some stocks at prices that, in hindsight, were too high," Mr. Chou wrote. Go contrast that with the explanations you're going to be seeing from other fund companies as they explain the fiasco of 2008.

***

The Wisdom

of Francis Chou

THE MARKETS

"I think the economy may go south somewhat, but the stock market may not go along. The stock market tends to be a leading indicator by nine months to a year. So it could go up if the economy goes south."

PICKING SECTORS

"All sectors are cheap. Right now, we're just trying to wade into some financials."

FURTHER OPPORTUNITIES

"Everything is depressed, but corporate bonds are more mispriced than equities."

HOW LONG A COMMITMENT INVESTORS SHOULD MAKE TO HIS FUNDS

"I would prefer 10 years."

Priceless

2009-04-03T07:21:00.001-07:00

A friendly 'bot: ISRG

2009-03-21T08:47:00.000-07:00

I look for "hot stocks" that are way overvalued on any objective basis
and then wait to buy them when the market over reacts in the other
direction. I think that ISRG is an example of such a company-- it's
been thrown out in the bathwater.

All of you who spend some time in the OR are probably familiar with
this company: they make the famous Da Vinci robot used for minimally
invasive surgeries such as prostatectomies, hysterectomies and some
cardiac indications.

Each unit costs the hospital $1.5 M and $120,000 p.a. to maintain the
device. There's one at Vancouver General Hospital. We have a single
surgeon on our staff who is trained to use the Da Vinci. He is
threatening to leave for greener pastures (down South) if the hospital
doesn't acquire one soon. (I hope he can speak American..... lol... I
wouldn't hold my breath waiting for it to come).

Target procedures:

Urology (over 150K target procedures in US)

􀂃da Vinci®Prostatectomy –dVP
􀂃dV Nephrectomy
􀂃dV Cystectomy
􀂃dV Pyeloplasty

Gynecology (over 350K target procedures in US)

􀂃da Vinci®Hysterectomy –dVH
􀂃dV Sacral Colpopexy
􀂃dV Myomectomy

Cardiothoracic (over 120K target procedures in US)
􀂃da Vinci®Mitral Valve Repair
􀂃dV Revascularization

General Surgery

The reason it is a GARP stock is that it is not remotely cheap in
absolute terms (sorry about the formatting):

Stock Industry S&P 500 Stock's 5Yr Average*
Price/Earnings 19.0 21.4 13.6 53.8
Price/Book 3.0 2.2 88.5 7.5
Price/Sales 4.4 2.0 19.4 13.2
Price/Cash Flow 13.9 12.7
8.1 20.3
Dividend Yield % --- --- 3.1 ---
* Price/Cash Flow uses 3-year average.

The thing is that even in this depressed economic environment, double
digit earnings growth is expected in this company for the next 5-8
years. The reasons for this are:

1. low market penetration so far
2. being designated "standard of care" for prostatectomies and
probably soon for hysterectomies. (as you all know these procedures
are demographically loaded! The expectation is that the number of
procedures will undergo almost logarithmic growth over the next 20
years).
3. high barriers to entry-- regulation, difficult to learn and
resistance to changing to new 'bots by surgeons

Other financial considerations:

1. no debt
2. very high and increasing free cash flows (215 M p.a. 2008)
3. "fat" net margins in the mid 30's
4. carrying $23/share of cash on the balance sheet to help it through
the recession/downturn.

Downsides to consider:

1. competition will eventually arise and squeeze margins
2. political risk-- Obama has his eye squarely on big Pharma and the
med device makers-- draconian legislation is not out of the question
3. pipeline? very expensive R&D

My approach will be do buy in the 80's and sell at $160 and above. I
don't intend to hold for the very long term (over 5 years) as I prefer
to invest in boring companies that are in slowly changing industries.
Surgical robots sure don't fit that criterion, eh?

Another old, wise man speaks--- you should pay attention

2009-03-16T19:42:00.001-07:00

Positioning for a recovery---- whenever that will be

2009-03-15T09:15:00.000-07:00

KSW Inc KSW.-- a microcap "value" engineering firm based in NYC that is highly profitable, holds 33% more cash than its market cap and pays a generous dividend (for now). Benjamin Graham would smile. I bought an original position at $2/share. A more detailed analysis will come out in our newsletter-- hopefully this week.

Fortress Paper Inc. FTP.TO-- I've covered this in detail in January and this was my first newsletter stock to study. Their Q4 numbers were strong, as expected. The balance sheet and valuations are highly favourable and management is executing their promised iniatives. The security paper segment is bottlenecked and FTP has had to politely turn away business to their competitors. An accretive acquisition or even a new build is likely in the offing and I believe the management has the experience and track record of good stewardship to pull it off without getting into trouble. Like many value investors, I'm very leary of M&A's as most don't go well, are not in the best interest of the shareholder and achieve only diworseification!. I plan to add to my small position at the company's 52 week low of $4.60/share.

DOW Diamonds Trust DIA , an ETF that buys all 30 DOW Industrial companies, weighted according to their market cap-- I was able to buy in near the short term bottom at $67/share. The dividend yield of the basket is just under 5%, providing incentive to sit on it for the intermediate term rather than play trader and try to time the market (which frankly, I suck at). I realize that the components of the DOW will be changing soon as it casts off some of the uber-dogs like GM and possibly Citigroup. This is a play on historically low valuations (except for McDonalds), cheap diversification and global exposure leading the recovery. I've mentioned before that the DOW companies should not be thought of as "American". Many of the larger components (i.e. IBM) get over 50% of their revenue from overseas. I'll buy (cautiously) again if DIA drops to 6000 and again at 5000. If it drops lower than that, we will be in interesting times, indeed! It's pretty tough to pin a fair market value on DIA as it would be even more of a moving target than its components' FMVs. To simplify matters, I'll take Graham's approach of selling (part or whole of a position, depending on the fundamentals at the time) after a 50% capital appreciation and/or 2-3 years pass by, whichever comes first. I could be persuaded to wait as long as 5 years-- the 2-3 year rule seems pretty arbitrary to me.

Belzberg Technologies BLZ.TO-- I've touched on this company in the past. In short, it provides secure, turn-key brokerage systems for trading equities and options for banks and the big brokers. It's in a hated sector, debt free and trading below its cash holdings ($1.50/share cash v.s. $1.33/share trading on Friday). Last quarter Q4 reported a small loss/share for the year due to restructuring charges. I think it represents another asymmetric intermediate term bet, with the catalyst being the eventual and inevitable return of Wall St. along with the European trading centres that represent BLZ's customer base.

Interesting times and more mea culpa

2009-03-08T15:03:00.000-07:00

“A common mistake that people make when trying to design something completely foolproof is to underestimate the ingenuity of complete fools.”

Douglas Adams (author of "The Hitchhiker's Guide to the Universe")

My wife bought me a copy of the 6th edition of "Security Analysis" by Dodd and Graham for my birthday--- with forewards by Warren Buffett, Seth Klarman, Bruce Berkowitz and the like. I'm going to digest every word... I can hardly wait.

On the more sobering matter concerning the markets and our hemorrhaging portfolios, I've been slowly and methodically changing my positions in the following securities, while reflecting what I've done wrong and reasonably well:

LYG Lloyd's TSB: SELL (for a 90% loss)-->Pro forma results of Lloyds pre-merger business were very decent ($1 B profit) considering the toxic atmosphere for banks, particularly of the UK sort. Not that this matters a whit, as the hasty and politically motivated deal went through without much discussion with shareholders. The share price was quite rationally sliced to ribbons (<$3/share from over $20) as it became clear to investors that HBOS' aggressive corporate bond and mortgage portfolio was going to bring on eye-popping losses for an extended period. The combined entity has become semi-nationalized with the UK gov't owning 65% of equity in the company as it required more and more funding to cover these losses.The dividend was terminated about 6 months ago, of course. Where I made the error was not in assuming that LYG was "too big to fail"; it was in not realizing that the government needs to protect the interests of the national economy, often to the detriment of shareholders. I was impressed by Lloyd's track record of conservative management and their very good balance sheet. In the past, they have always been very careful about costs (to the point of having a reputation for being stingy) and I figured that this good stewardship would pay off down the line when the competitors gave up market share to LYG during the meagre times we're in now. After the HBOS merger was announced, I was lulled into complacency by the CEO's message that the new company would emerge from the crisis as a largely unchallenged semi-monopoly of the mortgage market in the UK. In retrospect, when management makes uncharacteristically risky moves (particularly a merger or acquisition), I should sell-- even if it means taking a loss. Lesson #12322, engraved into my eyeballs for posterity. UNH United Health (an HMO)-- sold for 30% profit due to difficulty of assessing political risks. For much the same reasoning, (I read Obama's budget carefully) I'm not entering a position in SYK Stryker or IHI (med device ETF) although I find the investment profile very appealling of those stocks. You just can't ignore the political aspects. Thanks To Steven Friedman for his insight here.

DELL-- SELL -half of my position was sold after digesting the last quarter's results, for a loss of 35%. I'm not certain that this company still isn't very undervalued and the balance sheet is very strong indeed; however, the key profile that brought me in in the first place isn't as compelling-- the cash flow/share.

PCs, laptops and netbooks are becoming commodities, pure and simple. Dell made its name for being the lowest cost producer and a reliable, quality product. It will now face fierce and probably insurmountable competition from Chindian firms. Its franchise has been deeply eroded due to austere product lines (albeit, better lately) and damage to its reputation by providing poor support for its products (outsourcing and poorly executed quality control of that support network). Insider and guru buying is mixed. This company has confounded me. What I am most certain of is that there are better businesses with fatter margins and wider moats to deploy capital into. We'll see if I'm wrong.

SGP Schering-Plough- SELL- a great company with a great pipeline of products that I was lucky to get in at $12/share after the Vytorin media spin knocked the stock down irrationally. The impending acquisition of SGP by Merck was announced today and the share price appreciated 14% just today. I plan to take profits, hopefully in the mid 20's. I have no interest in owning Merck and even less interest in owning a mega-mega cap combined company with all the execution risk involved in such a large deal and the hostile political exposure to big Pharma evident in the Obama administration's budget. I am interested in the smaller non-US companies who have excellent balance sheets, strong pipelines and generic exposure like SNY, NVS and NVO.

CX Cemex- SELL- for a 65% loss- a potentially great company that was crushed by its debt load. I made the mistake of expecting historic nadir cashflows (the bottom of previous business cycles and other recessions Cemex has weathered through) to be sufficient to meet Cx's debt covenants. I then realized that I wasn't aware of the massive derivative holdings of the company (other than the hedges held for feedstock) and the largely unhedged forex risk. This was poor research on my part and I can blame no one other than myself.

more on the "buy side" in another post...

A Silver-back Grizzly roars again

2009-02-20T14:02:00.000-08:00

Prem Watsa, like Jeremy Grantham, was a perma-pessimist about equities until very recently.

Read this interview with him at the Financial Post

l

p.s. I've put in a bid for the DIA ETF at $70/share. I currently have a bid that will probably be filled soon for $40/share of NVS, one of my favourite pharm companies. I've been waiting to buy NVS for a long time this cheap.

Bear Market Rallies and Opportunities

2009-02-18T08:33:00.000-08:00

When the general market rises on a hope and a dream rather than any tangible fundamentals, I use the opportunity to sell some of the companies I've been holding that meet any of the following criteria:

the share price is at or near the target (usually 90% my estimated fair market value)
the management, business plan or prospects for the business has changed materially and most likely, permanently
Mea culpa--->I identify a mistake I made in the original analysis that either significantly diminishes the FMV of the company or makes it too difficult to determine.

With the recent rally (and even more recent crushing of that rally), I had a good, long look at my portfolio and decided which positions I should pare down or exit completely.

PHG-- Royal Phillips Electronics-- I sold my entire stake for a loss of 40% (not including dividends collected over 18 months). Compelling valuations, a generous dividend and the "green" angle (the LED arm) were more than offset by the inherent complexity of a large conglomerate, onerous competition (like GE and Siemens), a deteriorating balance sheet and a management that had a questionable record of execution. Although I liked what I saw initially when I first evaluated this business, I overlooked how complicated its corporate structure was and I certainly didn't have a feel for the committment and long term goals of the management. Mason Hawkins obviously doesn't agree and has increased his stake to 28M shares in December

UNH-- United Health Group (an HMO)-- I sold my entire stake for a gain of 30%, not including dividends. Very attractive valuation and what I thought was a overblown market reaction to political risk lead me to take a position. I sold because of a continuously deteriorating medical cost ratio, management with shaky ethics (I value reputation and this is one of the most hated companies in the world... hated by its customers!) and increasing competition from UNH's not-for-profit peers who will likely be more favourably treated in the upcoming reform measures (if they actually happen). I notice that many of my favourite gurus have sold recently as well including Warren Buffett, Seth Klarman, David Einhorn and Jean-Marie Eveillard.

LYG Lloyd's TSB Group and HOG Harley Davidson have both been thoroughly trashed but I continue to hold on to my stakes (despite the termination of the dividend in LYG and the cut in Harley's) as I remain to be convinced that either business will completely fail and instead emerge down the line in even a more dominant position than prior to the crisis. I am considering adding carefully to both positions although I'm more likely to do so for HOG than LYG. Buffett's almost usurious loan to HOG makes it less likely that their financial division will drag down their rather decent balance sheet. LYG's fate seems to be less to do with the market and what a solid, conservative bank it used to be and more to do with backroom deals with the UK government who pushed them into the HBOS merger and then on to the possibility of nationalization down the line. It's really impossible to have an edge in this kind of situation so I'm going to have to think long and hard about what to do about LYG.

Recent new positions:

LUK Leucadia National at $14

BLZ.TO Belzberg Technologies at $1.75

FTP.TO Fortress Paper Ltd. at $4.60

Addition to existing positions:

BBSI at $9.00

I'm actively researching:

IIC.TO Ing Canada
JOE St. Joe Company
BIP Brookfield Infrastructure Partners
KSW KSW Inc.
BNI Burlington North Santa Fe railroad

More on these later....

l

Mad about James J. Cramer

2009-02-08T15:35:00.000-08:00

See the article in Barron's below. One thing you can say about Jim Cramer is that very few people who watch him feel neutrally about his abilities and his attitudes. In other words, either you hate him or you love him.

I have to admit that I do enjoy watching the show.... that is, when my wife lets me watch it (his antics give her a headache). I certainly don't pay much attention to his specific buy and sell advice which changes wildly over very short periods of time... something he readily admits to. I have been surprised by calm, rational and independent insight he very occasionally offers. It's usually near the end of the show. The CEO interviews are definitely worth listening to. Jim will often ask them very tough and surprisingly incisive questions.

Unfortunately, the rest of the material he offers is as inconsistent as the market. I believe that Todd Kenyon referred to him as actually being the insane "Mr. Market" Graham refers to in "The Intelligent Investor". I think that this is spot on. Mr. Cramer and his support staff are obviously well informed and very intelligent. The problem is that he is obviously a very emotional man and this extends into his investment psyche. If you don't know what I mean, see the video below. It doesn't bode well for his followers.

He often refers to himself as a "value investor" (sorry, I just can't keep a straight face typing that) who chooses stocks because of their "fundamentals" and compared himself earlier this week to Warren Buffett and Benjamin Graham! Hmmm.... I wonder if he realizes that he is a momentum investor who almost routinely buys high and sells low?

When I research potential companies, I try to take on the same sort of psychological approach that I find is optimal in my medical practice: a cool, mostly detached and perpetually skeptical tack. If I feel myself getting excited or depressed about a particular position I will force myself to invert (along the lines of Charlie Munger's advice) the feeling, usually by presenting both sides of the argument to an intelligent but uninformed person. Just articulating the bull and bear case to an interested party who has no bias on the subject (otherwise this may influence you) will often clear your head of irrational, emotionally based noise.

In other words.... you want to be the Anti-James J. Cramer.

You can read the Barron's article below. As always, take it with a grain of salt as I suspect the author's objectivity isn't exactly up to my standard.

from Barrons - SATURDAY, FEBRUARY 7, 2009

Cramer's Star Outshines His Stock Picks
By BILL ALPERT

JIM CRAMER'S CELEBRITY IS BIGGER THAN EVER. As financial markets came apart in October, more than 600,000 viewers turned to his Mad Money show -- the biggest crowd since the Nielsen Company started tracking the CNBC series. He is giving advice to huge audiences on NBC's Today Show and getting awestruck coverage in Esquire magazine.

And why not? An earthquake has hit Wall Street, and the 53-year old broadcaster has spent more time there than most any TV journalist. The guy is a hardworking genius with a word of advice for everyone...many words of advice, actually. He dispenses thousands of Buy/Sell recommendations a year and has declared that those stock picks will help you get rich.

In 2007, when we questioned Cramer's performance, he told viewers we were know-nothings and assured them his Mad Money picks had "killed" the S&P 500.
The only regrettable thing about any of this is that CNBC and Cramer won't meaningfully discuss how his advice pans out.

Cramer's recommendations underperform the market by most measures. From May to December of last year, for example, the market lost about 30%. Heeding Cramer's Buys and Sells would have added another five percentage points to that loss, according to our latest tally.

To his credit, Cramer's Sells "made money" by outperforming the market on the downside by as much as five percentage points (depending on the holding period and benchmark). His Buys, however, lost up to 10 percentage points more than the market.

These batting averages represent his stock-picking over a stretch of time, but Cramer is wildly inconsistent, and the performance of individual picks varies widely. So widely, in fact, that it is impossible to know with confidence that any sample of Cramer's recommendations will enable you to outperform the market.

These facts don't mean that viewers should avoid his informative and entertaining show -- they should just be wary of his stock picks.

OTHER CAREFUL, HONEST EXAMINATIONS of the CNBC star showed the same underperformance -- including several independent studies by finance researchers, and a 2007 review by Barron's that found the only way to reliably profit from Cramer's stock picks was to short them (see "Shorting Cramer," Aug. 20, 2007).

That seems to be what smart traders have done, from the evidence of options-market activity examined by a finance professor, who found that betting against Mad Money's Buy recommendations can yield 25% in a month.

The recent performance of Mad Money's stocks resembles past periods in another striking way. Our research reveals that the stocks Cramer picks as Buys have been rising versus the market for several days in advance of his show, while his Sells have been falling. This doesn't prove there is a leak in the tight security surrounding CNBC's show. It could merely mean that Cramer and his staff are heavy-footed in their research. Or it could mean that his stocks are primarily momentum plays. That is the network's explanation. "Jim likes to recommend 'what is working'," said CNBC communications vice president Brian Steel in a written response Friday. "So it is no surprise there would be movement in these stocks prior to Jim mentioning them."

In any event, these pre-show moves are the probable cause of Cramer's underperformance. As the stocks revert to the market's trend in the weeks after the show, Cramer's followers get hurt [See chart below]. Like any active-investing strategy, Cramer's advice must always be measured against the market return that his viewers could get in an index fund.

IT IS RARE THAT ANYONE BEATS the market over time, so there is no disgrace in the underperformance of Mad Money's stocks. The stocks featured in Barron's bullish stories did even worse than the market last year. ("Oops! We Missed the Mark in '08," Jan. 19)

Yet the last time Barron's inquired about Cramer's stock-picking, CNBC responded with cherry-picked success stories; lawyers; calls to Dow Jones executives; and an end to Barron's regular presence on CNBC. Cramer shouted to his viewers that we were know-nothings and assured them that his Mad Money picks had "killed" the Standard & Poor's 500 index. This time around, CNBC wouldn't let us near their headliner and said our questions were aimed at helping CNBC's less-watched rival, Fox Business News (owned by News Corp. , as is Barron's).

"You wrote a premeditated hatchet job to curry favor with your new bosses at News Corp.," said CNBC's Steel on Friday. "[Cramer] doesn't consider you a journalist."

The pre-show moves made by Mad Money stocks relative to the market were first observed by doctoral students at Northwestern's Kellogg School in a 2006 working paper. After hearing from an indignant CNBC, co-author Joseph Engelberg stopped labeling the moves "information leakage." When Barron's asked in 2007 about the pre-show moves we had found in Mad Money stocks, CNBC scrambled $100,000 worth of lawyers and sternly explained the broadcast lockdown procedures at the Mad Money set.

In the recent seven-month period, the pre-show runs are still the most dramatic thing about Cramer's stocks. We found that his bullish picks had risen 4% against the S&P in the two weeks ahead of his recommendation, while his bearish selections had dropped more than 7%. This action looks all the more interesting when compared with the pre-show activity in stocks that Cramer considers only when asked by a caller during the show's "Lightning Round." As the chart below shows, there are almost no market-excess moves before he tells a Lightning Round caller to Buy, while the Lightning Round Sells make but a fraction of the pre-show moves of previously prepared Sells.

MEASURING SUCH MOVES was easy, thanks to the tools available at EventVestor.com, a startup created by Wharton Business School and Merrill Lynch alumnus Anju Marempudi, with the advice of finance professors. Hedge funds and investor-relations firms are using EventVestor to study the returns of stocks around events like dividend cuts and earnings preannouncements.

So we got a record of the Mad Money recommendations from a source that Cramer endorses as the definitive way to track his performance. It is a trailing six-month database updated daily at TheStreet.com, the Website that Cramer brought public in the dot-com boom (see it yourself at MadMoney.TheStreet.com).

We then poured Cramer's data into EventVestor. Event-study tools like EventVestor aren't hard to understand. They simply track the performance of stocks over identical periods; for example, 10 trading days before through 45 trading days after each Mad Money show (as illustrated in the chart). You can leave out the impromptu advice he gives callers during the Lightning Round -- which Cramer has said shouldn't count toward his performance, even though the next-day stock moves show that Lightning Round watchers take him at his word when he tells them to Buy.

Looking at just the 650-odd recommendations Cramer prepared for the show's Discussion or Feature blocks between June and December, his bullish picks underperformed the S&P by about 3.5 percentage points over the 45 trading days after each show. His bear calls turned a slim profit of one point versus the market -- with all of the profit coming the day after broadcast, so viewers would do well to ignore Cramer's occasional urging that they wait five days before following his calls. You can even isolate the stocks of companies whose executives Cramer interviews and usually endorses -- those endorsed stocks dropped six points versus the S&P in the 45 days following the interviews. Considered separately, Cramer's Lightning Round Sell recommendations did better than those he prepared, while his Lightning Buys did even worse than those he prepped. [For charts of these results, and others, see Barrons.com.] It is reasonable to measure Cramer's stocks over such a relatively brief interval because -- as CNBC points out -- he isn't running a fund in which he reviews each position daily.

But the network and Cramer have alternatively argued that his picks are meant as long-term investments, so we also measured their performance from each show date through the end of the year. On that basis, Cramer's Buys finished five percentage points behind the Nasdaq and 10 points behind the Dow, while his Sells were one point less profitable than the Nasdaq but five points more profitable than the Dow.

Cramer bashers and acolytes typically argue in anecdotes. His critics remind you that he scolded a caller "No! No! No! Bear Stearns is fine! Do not take your money out!" just days before the firm collapsed in March. But boosters brag of his Oct. 6 market call on the Today Show, when he said: "Whatever money you may need for the next five years, please take it out of the stock market. Right now!"

That Oct. 6 advice saved investors "millions," said CNBC's Steel, by allowing folks to escape the market's 15% plunge through December. In fact, says Steel, that single piece of advice means Cramer beat the market, if you credit the 15% to his performance through Oct. 6. Of course, Cramer went on to make 800 more recommendations through December -- most of them Buys. Cramer would have saved investors even more, said Steel, had they put 20% of their assets in cash on Sept. 19, as he suggested. "Jim made two of the greatest prepared bearish calls of all time," crowed Steel.

We gamely worked through the details of CNBC's argument: Ending the measurements on Oct. 6 makes Cramer look worse, with his recommendations losing eight percentage points against the S&P. If you then spot him the Today Show 15%, as Steel insists, Cramer would finish the year seven points ahead of the market.

If readers don't buy CNBC's complicated argument, it has others. "Jim's advice is nuanced, complex and often qualified on either a future price or a specific market event," said Steel, who says that even Cramer's official Mad Money database misses nuances. It is kind of bizarre to hear the network impugn the Website that carries Cramer's endorsement as the record of "exactly what I say, when I said it, and how I feel about each stock now." He urges -- "passionately" -- that his show's performance be measured with those data.

When Barron's asked CNBC for their own preferred database of Mad Money recommendations, we heard something equally strange: The investment news channel keeps no track record of its stockpicker's Buys and Sells. "The show as it is currently produced," said Steel, "isn't set up to track every stock Jim mentions every day as if it was a fund."

Instead, Steel demanded that Barron's join him in watching six months of recorded shows so that he could decide whether Cramer really meant that viewers should buy or sell a stock. He said Cramer's Website had misinterpreted recommendations on four dates- for example, putting down a Buy recommendation when Cramer meant it sarcastically.

The Bottom Line

By most measures, Jim Cramer did worse than the market, but CNBC and the TV journalist have taken few steps to clarify his exact performance for his show's growing audience.In other words, CNBC wanted to debate its horse bets after knowing how the races ended. There is no way such a post hoc selection could be as credible as the record made at the time of each show (and before the recommendation's outcome is known) by Cramer's official Website. That would also be the time for Cramer to correct confusion in the record he tells viewers to rely on. Still, we recalculated Mad Money's returns without the four dates that Steel says had errors: Cramer's performance was precisely as bad without them.

The finding that Mad Money lags the market has been replicated using other records of Cramer's picks, too. University of Dayton finance professor Carl Chen used the third-party Website called MadMoneyRecap.com to study options-market trading in stocks that Cramer recommended. Chen found signs that the smart money bets against Cramer's Buy recommendations by using short-term in-the-money puts. Those bets could earn over 25% in a month, Chen concludes, at the expense of Cramer's fans.

CNBC's evasiveness about Mad Money's performance can't be attributed to Cramer, since the network wouldn't let us talk to the star. We were scolded that we didn't understand the mind of a genius. "Barron's and News Corp.'s repeated attempts to take Jim down have been a complete and utter failure," said spokesman Steel.

A little demonstration of what an intensely emotionally guy he is:

(although in retrospect he appears to have been right on this one):

A billion here and a billion there... soon you'll be talking about REAL MONEY

2009-02-01T17:35:00.001-08:00

From the Financial Times:

The charges laid against us

By John Kay

Published: January 30 2009 18:26 | Last updated: January 30 2009 18:26

Over the 42 years that Warren Buffett has been in charge of Berkshire Hathaway, the company has earned an average compound rate of return of 20 per cent per year. For himself. But also for his investors. The lucky people who have been his fellow shareholders through all that time have enjoyed just the same rate of return
as he has. The fortune he has accumulated is the result of the rise in the value of his share of the collective fund.

But suppose that Buffett had deducted from the returns on his own investment – his own, not that of his fellow shareholders – a notional investment management fee, based on the standard 2 per cent annual charge and 20 per cent of gains formula of the hedge fund and private equity business. There would then be two pots: one created by reinvestment of the fees Buffett was charging himself; and one created by the growth in the value of Buffett’s own original investment. Call the first pot the wealth of Buffett Investment Management, the second pot the wealth of the Buffett Foundation.

How much of Buffett’s $62bn would be the property of Buffett Investment Management and how much the property of the Buffett Foundation? The – completely astonishing – answer is that Buffett Investment Management would have $57bn and the Buffett Foundation $5bn. The cumulative effect of “two and twenty” over 42 years is so large that the earnings of the investment manager completely overshadow the earnings of the investor. That sum tells you why it was the giants of the financial services industry, not the customers, who owned the yachts.

So the least risky way to increase returns from investments is to minimise agency costs – to ensure that the return on the underlying investments goes into your pocket rather than someone else’s.

The effect of these costs on returns depends on the frequency with which you deal. Online trading is so inexpensive and easy that you may be tempted to trade often. But only one thing eats up investment returns faster than fees and commissions, and that is frequent trading. Do not succumb. Do not accept the invitation to subscribe to level two platforms or direct market access. The total costs of running your own portfolio should be less than 1 per cent per year.

Investing in actively-managed funds will cost you more. The choice of funds, both open and closed-end, is unbelievably wide. There are more funds investing in shares than there are shares to invest in. This situation doesn’t make sense, and is both cause and effect of the high charges. Costs need to be high to recover the expenses of running so many different, mainly small, funds that all do much the same thing. At the same time, the high level of charges encourages financial services companies to set up even more funds.

The proliferation of funds means that choosing a fund may be no easier than choosing individual investments. The problem seems to multiply itself, as do the fees. The fees attract more advisers, and so on. This plethora of choice would be less confusing if all funds, managers and advisers were excellent, but most are not.

The underlying problem is one of information asymmetry. The marketing of financial services emphasises quality, not price, and for good reasons. It would be worth paying more – a lot more – to get a good fund manager. But since it is hard to identify a good fund manager, good and bad managers all charge high fees, with the consequences described above.

If you own a mainstream British unit trust for five years, it is likely that the direct and indirect costs and charges you incur in buying, holding and selling that investment will total 3 per cent a year. Other investment funds may cost you more. The total charges on a fund of hedge funds are such that it might yield less than a government bond even if the underlying investments returned more than 10 per cent per year.

There may be hope of better value from funds. In the US, the Vanguard Group, a not-for-profit company with a messianic founder, John Bogle, has become market leader in retail fund management with charges substantially lower than the norm.

The most attractive equity-based funds for small investors are generally indexed funds, exchange traded funds, and investment trusts (closed-end funds) with low charges and significant discounts to underlying assets. These funds provide more than sufficient choice for normal purposes. All of them can be accessed through your online execution-only share-dealing account.

Extracted from John Kay’s new book ‘The Long and the Short of It: Finance and Investment for Normally Intelligent People who are not in the Industry’, published by Erasmus Press. Next week: Diversifying

Grantham Video gives excellent advice

2009-01-25T14:08:00.000-08:00

if you don't have time to watch it the summary is:

equities are historically cheap but not "dirt" cheap
investors with a long term horizons (7 years +) can start to buy quality "blue chip" companies now, but should take their time over then next year and one half
keep cash on hand-- the more likely you are to freak out when volatility occurs, the higher your cash holdings should be

Slightly less depressing reading material

2009-01-23T19:23:00.000-08:00

Jeremy Grantham has been amongst the most negative of market prognosticators I've ever bothered reading---as long as I've ever can remember! I've dreaded reading his commentaries, particularly in the last 3 years.

Of course, the last year and a half have vindicated his viewpoints. Unfortunately, I notice that he's still losing his client's money in his mutual funds. It seems almost everyone has not escaped unscathed.

With all due respect to a very, very smart man... if you predict that something bad is going to happen for long enough, well of course, one day you're going to be right. So take that in consideration before you read his latest here. I'm so anti-macro prognostication, it's not funny. I just don't think it's possible. It's fun to do with your buddies over a few drinks but it DEFINITELY shouldn't be taken too seriously (i.e. put your hard earned money into a idea based on a macro economic guess).

The only thing you can do is find good companies run by good management (and only history will tell you that) and buy them when they are cheap. This usually means you have to buy them when everyone else thinks you're crazy to do so, unfortunately.

Note that Mr. Grantham is finally recommending buying stocks now, but carefully. I was pleasantly surprised to see that he suggested US blue chip stocks and "emerging equities". My point would be that if you look at the list of blue chips in the Dow 30 below, you'll find that most of them qualify as emerging equities as a significant number obtain more of their revenues overseas than in the US! IBM is just one example. An easy way to buy all 30 is with the DIA ETF. It's the only ETF I own currently.

Top 25 Holdings (why not all 30?)		Sector	P/E	YTD Return %	% Net Assets

	International Business Machines Corp*		9.92	6.33	7.61
	ExxonMobil Corporation*		8.64	-2.24	7.22
	Chevron Corporation*		6.41	-4.26	6.69
	McDonald's Corporation*		15.72	-6.71	5.63
	Procter & Gamble Company*		16.47	-8.79	5.59

	Johnson & Johnson*		13.57	-6.45	5.41
	3M Company*		10.89	-8.06	5.20
	Wal-Mart Stores, Inc.*		16.37	-13.75	5.07
	United Technologies*		11.29	-11.55	4.85
	Coca-Cola Company*		17.61	-6.78	4.09

	Caterpillar Inc.*		7.35	-19.32	4.04
	Boeing Company*		8.38	-1.62	3.86
	Hewlett-Packard Company*		11.16	-1.38	3.28
	Verizon Communications Inc.*		15.48	-8.91	3.07
	J.P. Morgan Chase & Co.*		15.17	-22.06	2.85

	Merck & Co., Inc.*		14.56	-7.24	2.75
	AT&T, Inc.*		12.59	-6.97	2.58
	Kraft Foods, Inc.*		16.29	6.78	2.43
	E.I. du Pont de Nemours & Company*		7.24	-4.51	2.29
	Home Depot, Inc.*		12.97	-5.65	2.08

	Walt Disney Company*		9.95	-9.17	2.05
	Microsoft Corporation*		10.28	-11.52	1.76
	American Express Company*		6.46	-12.97	1.68
	Pfizer Inc.*		11.39	-1.47	1.60
	General Electric Company*		7.70	-25.74	1.47

Look at Nokia NOK

2009-01-22T13:50:00.000-08:00

Nokia needs no introduction. What you may not know about this Finnish giant:

Bull Case:

40% of the market share of the global mobile pie is owned by NOK
Market Cap $60 B: world wide scale, distribution channels and manufacturing base give it at least a narrow economic moat
lowest cost supplier due to scale-- as cell phones become less of a brand and more of a commodity (think Dell's success 10 years or so ago with PC's), this gives NOK a boost
NOK has 32% of the global smartphone market share, contrary to general perception, and in the dismal Q4 just reported there was a 20% increase in smartphone sales revenue
#1 brand in India and China with a strong marketing base there and the strongest expansion potential (50-80% of consumers have cells already in developed nations, <>
Historically, NOK has been a free cash generating machine: FCF yield 10%+, operating cash flow averages 7 B euros/yr with a capex of only 14% that amount.
NOK has it's own "iPhone killers" models in the pipeline (and some in production in Europe) that will almost certainly favourably compete with Apple's products, particularly with respect to pricing.
NOK is planning to open source their phones operating system allowing 3rd parties to use the OS royalty free to develop apps for the phone consumers. This should make NOK's products more appealing v.s. many of the competition particularly due to NOK's massive scale.
A historic shareholder wealth builder with ROICs exceeding 50% for past 3 years!
the share price is at levels not seen since 2004 and at one of the best valuations since 2001.
a 6% dividend yield that is likely sustainable (30% payout ratio) helps ease the pain of waiting for the market turnaround.... that could take years!
NOK is a net guru choice: (from gurufocus.com) Charles Brandes bought 2,074,063 shares in the quarter that ended on 09/30/2008. David Williams owns 5,400,000 shares as of 09/30/2008, an increase of 12.5% from the previous quarter. Chris Davis owns 32,940 shares as of 09/30/2008, a decrease of 20.36% of from the previous quarter. George Soros and Richard Perry both sold out their holdings in the quarter that ended on 09/30/2008.
DCF analysis accounting for assumptions of margin compression and increasing cost of capital estimate a FMV in the mid 20's per share.

As always, one needs to try to kill the investment by presenting the Bear argument:

although NOK currently has 7B euros in cash and no long term debt (oops, I'm in the Bear section, aren't I?) most of that will vaporize with the NAVTEK acquisition (NAVTEK is a digital mapper for pedestrians bought by NOK at a much higher market price than it would command today)
RIM and AAPL have impressive products in the most rapidly growing segment (smartphones). Although they have only a small amount of the market share globally (17% and 5% respectively), they are much more dominant in North America than Nokia.
NOK's margins are eroding (due to competition and emphasis on lower margin sub 30 euro phones in emerging nations) to about 7% from 14% in Q3
NOK often grows by making acquisitions which are always subject to execution risk.

Here's a few more subjective concerns I have. Nokia is in an industry sector that is rapidly changing, "not boring" and clearly making the transition from brand to commodity. It is hardly out of the mainstream with 25+ analysts following. I don't believe I can out think all of them, can you? A narrow moat may soon be breached by an up and comer and usually is.

With all that said, if NOK was cheap enough to provide a very large MOS.... say $10/share, I'd be interested. Perhaps I'm too conservative. In this market environment, it seems that being an extreme cheapskate pays off.

I'll continue to watch and learn.

l

Appendix for detail freaks like me:

Valuation Metrics (from Morningstar)

	Stock	Industry	S&P 500	Stock's 5Yr Average*
Price/Earnings	7.8	9.3	12.4	14.5
Price/Book	3.0	1.9	3.0	5.1
Price/Sales	0.8	0.9	1.7	1.7
Price/Cash Flow	6.6	8.1	8.9	12.2
Dividend Yield %	5.7	0.6	3.1	---

Annual Rates (per share) 10 yrs 5 yrs 12 months
Revenue Growth (%) 16.6 25.5 25.8
EBITDA Growth (%) 12.1 15.2 41.2
Free Cash Flow Growth (%) 18.8 12.1 48.2
Book Value Growth (%) 14.4 6.2 23.1

Important Key Ratios:

Fiscal Period	Dec98	Dec99	Dec00	Dec01	Dec02	Dec03	Dec04	Dec05	Dec06	Dec07	Latest Q.	Sep07	Dec07	Mar08	Jun08	Sep08

Return on Equity (%)	34.30	34.90	36.40	18.00	23.70	23.70	22.50	29.70	36.00	48.80	32.00	47.60	52.50	33.80	36.90	32.00
Return on Assets (%)	17.40	18.00	19.80	3.30	12.00	14.20	14.70	16.30	19.60	23.40	10.80	18.40	20.50	11.10	10.00	10.80
Return on Capital* (%)	14.80	15.80	18.40	9.00	13.30	13.20	12.90	14.20	16.70	16.60	11.20	16.70	17.90	12.10	11.30	11.20
Debt to Equity (%)	6.20	3.70	2.00	1.70	--	0.60	--	--	--	--	--	--	--	--	--	--
Debt to Revenue (%)	2.40	1.40	0.70	0.70	--	0.30	--	--	--	--	--	--	--	--	--	--
Gross Margin (%)	18.80	20.10	19.50	13.70	18.10	17.30	15.10	13.40	13.40	11.90	12.50	13.70	15.00	14.30	12.90	12.50
Net Margin (%)	13.10	13.00	13.00	7.10	11.30	12.20	11.00	10.60	10.50	14.10	8.90	12.10	11.70	9.70	8.40	8.90

Feel a COP?

2009-01-15T07:33:00.000-08:00

I've covered Conocophillips' investment merits and risks previously. As the share price grazes 52 week lows and rock bottom valuation metrics (yes, I know that the "E" part of the P/E ratio remains a question mark), I plan to once again join Mr. Buffett as a fractional owner of COP.

I've put in a bid at $43/share for a small stake. If it keeps dropping, I'll add to my position in increments and hold for 3-5 years or until a target price of $100/share is reached.

I don't have time to explain how I came up with those rather arbitrary numbers--hopefully, I'll explain later.

l

3 gurus to watch

2009-01-06T07:20:00.000-08:00

Read the Kiplinger article here.

I do take issue with the tone of the article (albeit I admit I'm a fan of Mr. Berkowitz and less so Mr. Hussman).

"...too many of the stocks they deemed undervalued were actually overvalued" refers to some stocks picked by Chris Davis, Bill Miler and Bill Nygren-- all, BTW, who have 10 year+ track records that handily beat the market. So.... they underperformed (badly) for a year or two and suddenly they're bums? That's short term, Wall St herd type thinking and I utterly reject it. Warren Buffett has underperformed in the past and is underperforming now (measured over a short time frame). Was he "just lucky" as some academics insist, still pushing the efficient market hypothesis down our throats? Has he "lost his touch" as pundits so vociferiously state, each time BRK drops a bit or goes out of fashion?

The answers to these questions are clear to me.

There is a reason why top performing mutual funds are usually the worst performers over the subsequent 5 years, particularly those with a value bent to them: during bear markets, good and even great bargains take time to be recognized.

Stop chasing short term market returns. Very few people do it well.

l

ps I have nothing against Mr. Hussman. He is obviously very bright and knows it. I read his market commentary regularly. What concerns me is his fascination with the macroeconomic picture and how it impacts his investment choices. I'm a macroeconomic agnostic. I don't think ANYONE can figure it out. If they do make a profitable decision and even a few in a row, they were lucky. These folks usually eventually lose their shirt because they've convinced themselves that they've figured it out. Investors with the best long term track records try to ignore such questions as "Will the USD drop further? What's going to happen to oil/fuel prices? Interest rates? etc etc". Just think about what has happened to just those 3 variables in the last 18 months! Did ANYONE get that right?

Yet more reasons to ignore (most) analysts

2009-01-04T14:20:00.000-08:00

Read the Bloomberg article here.

My favourite part: "I did a study of stocks analysts love and loath, covering 1998 through 2007. It turns out that the four stocks analysts favored most as each year began did worse over the ensuing 12 months, on average, than the four stocks they most hated. Furthermore, both groups underperformed the Standard & Poor's 500 Index. Over the 10 years, the average despised stock rose 1.7 percent, compared with a loss of 2.2 percent for the adored ones. By contrast, the S&P 500 rose 7.2 percent a year on average."

Must watch

2009-01-01T14:46:00.000-08:00

Studying Conocophillips... again

2009-01-01T14:18:00.001-08:00

I haven't owned any commodity companies for over 2 years now (fortunately) as I find them too hard to analyse. There are too many other eyes and brains trying to figure out where oil/nat gas are going and no matter how well managed these resource co's are, the share price will follow where the commodity futures drag them. So often commodity pricing is based on external factors that are impossible to predict and out of a company's control. I put the vast majority of them in the "too hard" pile. Mining stocks are no different IMHO. Not to mention that they are far out of my circle of competence.

That said, there is an exception to every rule and COP may be the one. My portfolio probably needs some natural resource exposure. At the "right" price (bargain basement), I wouldn't be too upset if I got into a diversified oil/gas major a bit too early.

Mr. Buffet quadrupled his stake in COP in the last quarter. BRK now owns about 6% of the company (84 M shares) bought at an average price of $80/share. COP is trading in the low 50's and has dipped into the 40's time to time over the last 4 months.

I know the company quite well and have owned it twice before. I'd be sorely tempted to scale back in s-l-o-w-l-y if the share price fell below $45/share. With a dividend yield of 4% or so, I'd be prepared to sit on this one for 5 years+. I wouldn't be surprised if I might have to...

l

It's tough not getting depressed....

2008-12-31T11:51:00.001-08:00

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.

2008-12-27T15:17:00.000-08:00

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

2008-12-26T15:00:00.000-08:00

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

2008-12-26T11:23:00.000-08:00

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

P/B

2008-12-23T08:43:00.001-08:00

Book Value Bargains

2008-12-22T15:43:00.000-08:00

The Cheapest Buffett stocks at Gurufocus.com

Seth Klarman speaks on the value investor's perspective

2008-12-21T13:57:00.000-08:00

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

2008-12-11T10:02:00.000-08:00

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

2008-12-08T14:22:00.000-08:00

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)

2008-12-07T13:24:00.000-08:00

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

2008-12-07T13:19:00.001-08:00

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.

A few pictures that tell an important story... click on the graphs to see the whole thing

2008-11-23T11:56:00.001-08:00

to summarize:

investors are sitting on a LOT of cash-- historical highs
valuations are at 30 year lows while dividend yields are at their highs (albeit with more than a few US companies cutting dividends of late)
junk bond credit spreads are also at 30 year highs

is capitulation/a market bottom looming? If I had to guess, I would it will come over the next 6 months or so.

Happy bargain hunting!

Have a look at USG

2008-11-22T10:42:00.001-08:00

Read this article first.

Q&A with Buffet-- Part I, II and III

2008-11-22T10:35:00.000-08:00

Part I

Part II

Part III

Disclaimer: my wife and I own shares in USG, USB and COP

David Dreman's Forbes article

2008-11-22T10:33:00.001-08:00

read it here

More BAM: cash flow analysis

2008-11-22T09:11:00.000-08:00

from Desjardins Securities: read it here

BAM is one of my favourite longterm investments: wide moat real estate (both residential and commercial), "green" power generation assets along with prolific management fees, keeps the cash coming in. 17% of shares are insider owned. Capital allocation is carefully and intelligently considered: read CEO Bruce Flatt's comments regarding that topic in the Q3 2008 conference call transcript.

I have a low ball bid in for $10/share (below book value of approx $11/share!).

l

A couple of opportunities to watch for...

2008-11-18T14:16:00.000-08:00

I don't have time to fully analyze these businesses for you now but 3 amazing values have come up today:

NOK Nokia- cash rich, market share hogging, well managed with a 6%+ yield etc etc trading at $13 and change. One of the few free thinking analysts, Vitaliy Katnelson, has a brief overview of the bull case for Nokia here.

LUK Keucadia National Corp- 28% increase in book value/year since 1968! trading at 1998 values $17/share. There's an analysis of some of LUK's portfolio here.

BRK-B Berkshire Hathaway-- grazing $3000/share, also trading at 2005 levels. I don't think I need to say more than that about this one.

I'd study them all.

l

Bill Miller's Q3 letter

2008-11-16T21:02:00.001-08:00

Whether you have respect for him as an investor or not, I think you'll benefit from reading this extremely insightful letter here.

Wait until Santa does his thing

2008-11-16T20:22:00.000-08:00

my comment: the article below is immoderate to say the least and I don't agree with a few things he says; however, there's a few nuggets of truth in there:

tax loss selling is likely to produce even better buying opportunities in quality companies next month
commodities could go down even further than they have and the recovery time will be difficult or impossible to predict, even if you believe that we are in the midst of a long term secular bull market in commodities

Tax-loss selling for 2008 will be the rule the next eight weeks.
Story By Rob Cornelius

Money on the sidelines isn't coming back to the market. Don't expect the cavalry to show up and save us. Money that is out of the market either vaporized as losses, is in "safe" investments, such as U.S. government securities, or capitalizing one of these banks that is begging for deposits.

Preserving capital is critical. Nobody is feeling greedy yet.

Tax-loss selling for 2008 will be the rule the next eight weeks. Investors will sell their losers (and, boy, do we have a bunch of those) to make up for their gains. The pressure on stock prices should continue to be downward. Hedge-fund and mutual-fund redemptions will happen before year's end as well.

Carryover losses will be awesome. Investors have seemed to fear a Barack Obama presidency, and the last 1,500 points of Dow fall appear correlated to his rise in the polls. Some will sell to incur taxable losses; others who have huge assets are trying to get rid of them now to avoid changes in tax laws.

Retirement Plan Disasters

Pensions, charities and endowments will continue to hide behind terms like "unrecoverable losses." Read the daily newspapers and you see that term come up. That simply means losses they were forced to take by selling a devalued asset. There still are plenty more on the books that will have to be taken eventually. Understand that many of those organizations' stocks now need to go up 100 percent to be where they were a few months ago: If you are down 50 percent, you have to go up 100 percent to be even.

As S&P and Moody's do their jobs in coming months, more corporate bonds will be downgraded. More companies adjust earnings estimates down. When they drop below certain ratings thresholds, pension funds will be forced to sell them at market, cascading still further "unrecoverable" losses.

Pension funds were and are handicapped by being slow-moving, committee-driven animals -- late to bull markets and slow to evacuate bad ones. Not active, but reactive. And they are paying for it.

While state pensions have embarrassed all over the country, their corporate or private brethren may be worse; the former have the ability to raise shortfalls via taxes or bigger employee deductions. Ask U.S. Steel or the UMWA where their pension plans will be in a year. They are based on increasing share prices of the underlying company or adding more jobs/members. Neither is happening.

The Federal Pension Benefit Guarantee Corp. is seriously short of money, and a couple of good-sized corporate failures could deplete its kitty. It is like the FDIC for pension plans -- the insurance of last resort.

Someone will be made to take responsibility. In 2010 or 2012, this will be a political tool for un-electing state treasurers or anyone else vaguely responsible of either party.

The only upside of all this may be the fact that inflation, for the short term, is dead. Deflation is the word, as everything shrinks in value, be it homes or tons of coal or barrels of oil. But that said, I can never imagine a scenario when governments reverse cost-of-living-increases to those on the dole. They seem to have little self-interest in shrinkage.

People in many non-Roth IRAs and employee savings plans of all sorts are trapped. Some plans have no way to become un-invested other than money markets, which were shown to be potentially deadly in recent months. Worse still, you have no way to go short or bet against the markets. No sector has been safe for the last 90 days.

For those who are still mad at people who short stocks, it was pension funds that got rich as part of that process. To short a stock, some other investor must loan it to you. In most cases, it was big pensions, such as CALPERS loaning you those shares of Citibank and collecting margin interest on the loan. Like prostitution, it was a mutual agreement of two parties -- one of whom never really expected Citi to fall to $12.

Who Else Can We Blame?

Illegal immigrants and their contributions to the real estate mess will be brought to the forefront to create scapegoats. National reporting states that as many as 5 million home mortgages may have been extended to illegal aliens, many of whom are in worse financial straits than Americans. In big, round numbers, and knowing that more illegals bought more homes in western states (where they are more expensive), say banks lose an average of $100,000 on each of those transactions. You're looking at a loss just there of $500 billion. Maybe that's overstating a dollar number, but protectionism and assessing blame tend to be big in economic disasters.

I cited "losers" and "poor people" as root causes of this crisis when I first started writing about it here on Aug. 9, 2007. That said, they were rational actors empowered by government to take what they knew they couldn't afford. When government told lenders to loosen standards so that anyone who could fog a mirror got a mortgage, these folks took advantage. Having everyone equal may be fine in a co-ed game of soccer among first-graders with no one keeping score. But in real life, some of you are richer/smarter/faster and get more playing time or score more goals. The market should reward that. Not all our children can be above average.

U.S. Dollar is Strong

U.S. Bank government guarantees are bringing every dollar here to federally backed investments. This strengthens our dollar and weakens foreign markets' currencies. The eventual inflection point will be when the rest of the world loses faith in the Treasury to pay back and our rates to borrow suddenly skyrocket. That's when inflation should return. At this point, the best course of action may be to sell as much new debt as possible while rates are super low. As other nations cut interest rates to spur their own economies, the flight to U.S. dollars should intensify further.

Thank God the U.S. didn't make many loans to developing countries, whose currencies are crashing. Typical European banks may have those loans filling 20 percent of their books; the U.S. averages 4 percent. Crashing currencies make it harder to pay back your loans.

The idea of rising interest rates at the same time as deflation is pretty unique in economic history. No one is really sure how to model this crisis after anything else except maybe the American Panic of 1873.

Hard Assets Soften

Cheap energy is a terrible sign for growth and the world economy.

Oil has more room to contract in price, as demand will slow further. The only thing keeping American refiners open is the fact that they can still make money on the middle distillates they refine (heating oil, diesel and aviation gasoline). They ship a lot of those to Europe. They are losing on auto gasolines right now. Once you see the diesel price in West Virginia slim down to maybe a 50-cent premium over regular gasoline, you'll know the refiners are in real trouble.

Low energy prices will destroy whatever progress has been made on alternative energy. Well-capitalized companies will do well as steel cheapens for massive windmills, but most of the solar guys were selling at ridiculous price/earnings multiples.

Ethanol is also dead if wholesale gasoline stays under $2 a gallon. Farmers may shift from corn to soybeans next spring for the sake of profits. Short term, alternative energy will expand only as a direct result of government handouts.

Gold/silver .... paper versus reality. Go to eBay. While gold that trades in the markets is less than $700, you see one-ounce gold coins selling for a three-digit premium to that at $850 or more. The percentage gap is still greater for silver and platinum.

People are hoarding gold and extra bullets it would seem. Central banks are trying to raise U.S. dollars and appear to be dumping physical gold while they can, depressing price. Price is now dropping enough to make mining unprofitable for not just gold but also many of the non-precious metals, such as copper and nickel.

Stop Whining, Learn

Great reads/blogs to scare yourself straight on this topic: calculatedrisk.blogspot.com, globaleconomicanalysis.blogspot.com, nakedcapitalism.blogspot.com ... and pay attention anytime "Dr. Doom" Nouriel Roubini or Oppenheimer analyst Meredith Whitney show up anywhere. Billionaire genius Mark Cuban at blogmaverick.com has been smart and full of good ideas, albeit with no sense of investment timing at all. All seem pretty sure our financial system isn't done with its turn in the spanking machine.

Rob Cornelius of Parkersburg follows energy and the markets for The State Journal.

Gurus falling down

2008-11-15T13:55:00.000-08:00

ROI
NOVEMBER 14, 2008, 9:34 A.M. ET

The Year of Wall Street's Fallen Idols

Chagrined, even ashamed, about your portfolio losses? Take heart: Even managers with some of the best reputations on Wall Street have seen their holdings savaged this year.

By BRETT ARENDS

Millions of Americans are reeling from investment losses this year.

For many, the financial cost of the red ink is only part of the misery. They're also kicking themselves for the losses.

Maybe you feel you invested too much. Maybe you feel you should have invested in different assets.

This may prove scant consolation, but it is worth noting: The best of the best have done no better. So go easy on yourself.

This has been Wall Street's year of the fallen idols.

Bill Miller

Marty Whitman, the legendary septuagenarian who co-manages Third Avenue Value, has seen crises come and go. There are few you could trust more in a panic. But his fund has almost halved this year. Bill Miller, the famous manager at Legg Mason Value, has fallen by nearly 60%. And that's not even the worst of it. Miller's more flexible, go-anywhere fund, Legg Mason Opportunity Trust, is down by two-thirds since the start of the year.

Ron Muhlenkamp at Muhlenkamp, Wally Weitz at Hickory, Manu Daftary at Quaker Strategic Growth, Richie Freeman at Legg Mason Partners Aggressive Growth, Ken Heebner at CGM Focus, Christopher Davis and Kenneth Feinberg at Davis New York Venture Fund, Will Danoff at Fidelity Contrafund, Saul Pannell at Hartford Capital Appreciation: They've all lost about 40% or more. Some have nearly halved.

It is a shocking bloodbath. These are managers with some of the highest reputations on Wall Street. They have beaten the Street over many years, even decades. And even they got shellacked.

What chance did you have?

Even most of those who anticipated a crash got pummeled. Bob Rodriguez at FPA Capital has been very bearish for years, and was holding large amounts of cash in the fund. But he's still down 36%.

The picture for Warren Buffett looks somewhat better, although he swung from $3 billion investment profits to $1.4 billion losses in the first nine months of the year, while net earnings more than halved. Shares in Berkshire Hathaway have fallen about 31% since Jan. 1.

Those who look good include John Hussman at Hussman Strategic Total Return, who is down just a few percent. And Jeremy Grantham at GMO, who predicted much of the meltdown. His GMO Benchmark-Free Allocation Fund, an institutional fund that has a pretty free rein on what to hold and what to avoid, has still lost 11% so far this year.

There are three long-term lessons here for ordinary investors.

The first is that if the smartest and best fund managers can't successfully anticipate a crash with any degree of confidence, you can't either. Time spent trying is time wasted.

The smart money rarely spends much time very bearish, and with good reason. In practice it is almost impossible to predict a crash. And even if you are right about the direction, you will probably get the timing wrong. That may end up compounding your losses instead of preventing them.

John Hussman is among very few who have gotten this one right. I know at least two superstar managers who correctly anticipated a blow out, and moved heavily into cash… in the fall of 2006, a year too soon. Markets soared instead.

I also know of at least one portfolio manager who's been predicting the U.S. credit implosion for at least seven years.

Prudent Bear has been betting on falling shares (and rising gold) for a long time. It's finally getting its reward: It's up about 37% so far this year. But investors actually lost money between 2003 and the end of 2007, while the rest of Wall Street rose 70%.

And remember that investing is a long-term game. This has been the worst financial bloodbath since 1929. Yet Ken Heebner is still up more than fivefold over the past ten years, even after factoring in this year's carnage. Mr. Daftary has more than doubled investor's money. Many others are up 50% or more over that time.

The best an investor can do is to look for value, prefer unfashionable assets over fashionable ones, and avoid chasing past performance.

As previously observed here, everything has now fallen. Inflation-protected government bonds. Munis. Gold stocks. The whole shebang. Eighteen months ago, every single asset class was expensive. Today it's possible that almost every single asset class – with the possible exception of regular Treasurys - is cheap.

Write to Brett Arends at brett.arends@wsj.com

This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit

www.djreprints.com

New stock to study: Mohawk Industries MHK

2008-11-10T16:34:00.000-08:00

Mohawk Industries is a producer and distributor of residential and commercial flooring including carpet, ceramic and porcelain tile, hardwood, laminate and home textiles including area rugs. They also distribute resilient (vinyl) and vinyl composition tile (VCT) flooring through a partnership with Congoleum.

Mohawk and Shaw (owned by Berkshire) are the 2 largest floor covering manufacturers in the world-- this represents a near duopoly: together they own 46% of market share.

MHK was founded 130 years ago. Its distribution system is much admired in the industry. It has over 30,000 regular customers (mostly specialty stores), none representing more than 5% of the total revenues. Market Cap approx. 2.5 B. Share price is down 53% from 52 week highs.

Bull Case:

duopoly and global footprint
boring business with a slow rate of change
very easy business to understand
Management is shareholder oriented and communicates very clearly in all reports
high insider ownership 18% of the company's outstanding shares are owned by the CEO
one director bought about $7 M worth of stock at $69/share in late Aug '08
value gurus have large stakes: Berkowitz, Ruane Cunniff and Wallace Weitz
meets criteria for Graham stock: P/E 4.1 P/B 0.5 Current Ratio > 2, 5y EPS Growth Rate > 3, EV/EBIDTA is only 5.
generated 371 M of cash flow in the first 9 months of 2008, actively paid down 271 M of a total of 2 B of debt. D:E is 0.47 well below industry average of 0.61.
no debt matures until 2011
Q3 results distorted by a quirky accounting rule that forced the company to write down a large non-cash charge v.s. goodwill (1.2 B) and tax deferral charges (0.25 B) triggered by the rapid and steep decline in MHK's share price.
60% of revenue is derived from renovations and remodelling, not new builds.
MHK has been able to raise prices recently despite lower input costs from the drop in petrochemical prices which should help boost margins in the intermediate term
Gurufocus backtested business predictability index rates MHK's 10 year financials at 4.5/5 stars.

Bear Case:

13.5% of outstanding shares have been sold short. The short sellers are probably right-- the share price is going to drop even further
there is a debt covenant on one of the LOCs that stipulates that the debt:equity ratio must stay below 0.6 or the company will be forced to liquidate assets at less than favourable terms
nat gas/oil prices (2/3 of costs of goods sold) are likely to rise again with the economic recovery and impact margins adversely
there is no end in site for the housing bubble implosion. There is at least 8 months of new home inventory to clear before builders start to significantly increase demand for MHK's products and its very possible that the slowdown could drag on longer than expected.
no dividend despite great and predictable cash flows!

This company is definitely worth further study. It would clearly be a long term investment 18 months to 3 years+. It is fundamentally cheap now; however, it's clear that the share price has further to drop. I would be interested at <$30/share and I would buy in small increments over the next 18 months, watching the company's liquidity very carefully. Housing in NA and Europe will recover one day-- I'm not sure when. The stock will likely rocket up (if the company survives, that is) 6 months or so before the recovery is obvious just because that's how the market works. With these kind of investments you need to commit during the times of maximum uncertainty, unfortunately.

Bedtime reading for China bulls and Gold-bugs

2008-11-10T14:07:00.000-08:00

Globe and Mail's Avner Mandelman

A little brain damage might make you a better investor...

2008-11-09T14:22:00.000-08:00

I'm hopeful that this is true because just yesterday I got caught by a left hook in my MMA class straight in the nose.

This article describes the psychological underpinnings that hold us back from making asymmetrically rewarding bets after we have made recent losses (realized or not). Patients with traumatic brain injuries often have disordered limbic-cognitive function which prevents them from being fearful bettors, even when they probably should be.

l

BAM-- Technical Knock out from the G&M

2008-11-07T07:38:00.000-08:00

My confidence in the management and position of this company continues to grow. In an awful environment for financing and raising capital, they continue to outperform all their competitors.

I'll buy at <$20 with conviction. I'm also very interested in some of the preferred offerings.

The Canadian Press
November 7, 2008 at 9:53 AM EST
TORONTO — Brookfield Asset Management Inc., formerly known as Brascan, reported Friday a sharply higher net profit and rising revenue.
Its third-quarter net profit was $171-million (U.S.), or 27 cents a share, up from earnings of $93-million, or 13 cents for the same 2007 period.
Overall revenue jumped to just under $1.3-billion from $980-million, said the company, which reports in U.S. dollars.
In breaking down its quarterly results, Brookfield said increases in operating cash flows were offset by higher non-cash charges, including depreciation on assets bought since the 2007 second quarter.

“Our operating performance in the quarter reflected the durability of our cash flows, most of which are supported by long-term contractual arrangements with credit-worthy counterparties, the high quality of our asset base and operating platforms, and the stability of our long duration investment grade capitalization,” said Bruce Flatt, the company's senior managing partner.
“In the last few months we increased our overall cash holdings and liquidity to more than $3.5-billion, most of that at the Brookfield corporate level.”
“This is one of the highest levels of liquidity we have ever held, but given uncertainty in the markets we want to be prepared for the unknowns, and opportunities which may present themselves in this environment.”
Mr. Flatt said although Brookfield is “exercising caution during these turbulent times, and preserving a high level of liquidity, we are exploring a number of potential opportunities to expand our operating platforms and create additional shareholder value.”
Brookfield Asset Management is focused on property, power and infrastructure assets and has about $90-billion of assets under management.

Along the same lines

2008-11-02T18:05:00.000-08:00

Since Buffett is buying up a railroad--- he now owns 18% of Burlington North-- maybe you can too.

GSH Guangshen Railway serves the Pearl River Delta in mainland China. It has miniscule debt for a railroad (Debt to capital ratio 13%) and is a predominately commuter railroad (i.e. less sensitive to economic cycles). It has a wide economic moat simply because the Chinese government will not allow competition to arise. It owns the only railway connecting HK and mainland China to boot. EV/EBIDTA is 14, comparable to NA railways. Dividend is 3% yield. P/B x P/E is 10.

I would definitely not buy GSH now. Morningstar has calculated a FMV of $28/share. I would be interested in buying shares if it dropped during a market scare to $15/share or less.

Another analysis here.

Asia rising

2008-11-02T12:06:00.000-08:00

I've become much more interested in the Asia investment arena lately, precisely because almost everyone else is running away from it.

As I've mentioned before, I still believe that the best way to invest in overseas markets is to buy global companies based in the US. Many of the components of the DOW 30 get more than 50% of their revenue offshore. With that you get access to a lot of information and at least some accountability (yes, I know the banks and brokers have let us down, but compare it to the skulduggery that goes on in many other countries and it looks bland). My reservation about investing in these areas is that it is so difficult to do what Phil Fisher called "scuttlebutt" (getting as much information in addition to the financial reports as you can to give you an edge over other investors).

One approach to this problem is to see what the value gurus are buying and imitate them. They do have a lot more resources than you have and if you can buy the same stocks they do in these faraway places at a cheaper price than they did, you may have an edge. OTOH, I don't like blindly following gurus as their goals, time horizon and asset allocation model may be radically inappropriate for my relatively tiny portfolio.

That said, I think there are a few gems that can be got for pennies on the dollar these days.

This Forbes article gives some Japanese examples of companies that are trading at or below their net liquid asset value.

l

"Net-Net" bargains

2008-11-01T07:52:00.000-07:00

In a net-net situation, an investor estimates a liquidation value for a company, then tries to pay a fraction of that value in the market. Ben Graham loved these types of situations, defining the net-net value as:

Cash and short-term investments + (0.75 * accounts receivable) + (0.5 * inventory) - total liabilities

Graham looked for companies whose market values were less than two-thirds of that net-net value, for two reasons. First, he wasn't sure he would receive the full value for accounts receivable and inventory before paying off the creditors. Second, he wanted to make sure he had a margin of safety to fall back on, in case it didn't work out. After all, if the market valued the company this low, something was certainly wrong with it.

Graham's idea was to bet on a situation with asymmetrical odds. In such situations, the probability of losing money is fairly high, but the magnitude of any loss would be small. However, the potential payoff is large, despite having a lower probability of success. That's why these situations are special and worth looking for, even today.

For some current equities who meet this criteria read here

Contrarians hate it when the market moves up!

2008-10-31T17:57:00.000-07:00

...particularly when there isn't a valid reason for it to do so!!! Efficient market, my #@$@.

I realize that Wall and Bay Street try to be forward looking but this is nuts. All the fears that precipitated the panicked selling have not gone away. They were overblown to an extent but they are still there. Every level headed person realizes that the "great de-leveraging" still has to play out for some time longer-- probably until mid-2009 at the very least.

In the mean time, I'm accumulating as much cash on the sideline as I can for entry into up to 4 new position and adding to some old ones:

New ones:

LUK: mentioned in the previous post, LUK came within a few dollars of my bid of $19/share and then leaped up to $27. Very frustrating. There is a cult-like following of this holding company so a lot of regular people (and gurus like Bruce Berkowitz) understand the quality of its management and the balance sheet despite the detractor: short term uncertainty of the highly assets Leucadia is so adept at acquiring (i.e. 70% of the portfolio is in JEF, a boutique investment bank!). I'm hoping that these people will go away soon and there will be some sort of macro-economic scare to knock them out of the stock so I can buy it real cheap. I'd hold this 3-10 years+.

HHULF.PK: Hamburger Hafen und Logistik reviewed several times. Knocked down to the low 20's euros. Short term outlook for this high margin, highly profitable company isn't good but long term is excellent. I think that it is very well managed. I'd buy in the high teens-- only because Europe is so out of fashion right now (like PHG) and I think I can get that price. I think the FMV of HHLA should be 50-60 Euros/share based on comparable ports EV/EBIDTA valuations. Being traded OTC makes this a thinly traded stock-- another reason it shouldn't be traded but bought for the 5 year+ horizon.

Old ones:

PHG-- because of the dividend, great balance sheet and the "green" play with the LED lighting market share. It's also very, very cheap, even after the rally. I don't think it's a GREAT company like LUK or has potential to be great like Hamburger. I think it's dirt cheap for a profitable company with 3 B of cash in the bank, trading at 0.7 book value, P/E of 5, P/S 0.5 and 15% ROE. Hard to resist at < $16/share

BBSI-- one of my favourite small caps. In a deeply cyclical business and still making money. Has no debt, high insider ownership and very strong management. The CEO has been sick lately and required some sort of major surgery-- this has me mildly concerned. The company ran well and maintained their + cash flows despite a terrible environment for staffing/PEO services with him being absent so that's reassuring. Dividend is being maintained and the share buyback proceeding as planned. They still have 50 M in the bank for acquisition etc. I'd buy at $9 or less without hesitating.

Others:

SEB

AXP

HOG

SNY

NVS

Pzena's view of value opportunities

2008-10-29T11:54:00.000-07:00

Read it here.

Don't fight the drug dealers--- buy them!

2008-10-29T07:54:00.000-07:00

My favourites: SNY, NVS, BMY, SGP

Invest in the Investors: LUK Leucadia National Corporation

2008-10-28T11:58:00.001-07:00

I'm attracted to holding companies that are:

trading below book value
have management with "skin in the game" (significant insider ownership) and a long term track record
little or manageable debt

I've admired Leucadia for a long time but much like BAM, held off actually owning shares because of inflated valuations. This clearly is no longer the case.

Run by gifted mavericks Ian Cumming and Joseph Steinberg, Leucadia National corp is an eclectic, diversifed holding company that was founded over 150 years ago. Its investment portfolio is quite focused and includes small cap biotechs, wineries, copper mines and boutique investment banks. They are deep value investors with a penchant for the "cigar butt" approach. To quote the duo in a shareholder's letter:

“We tend to be buyers of assets and companies that are troubled or out of favor and as a result are selling substantially below the values which we believe are there. From time to time, we sell parts of these operations when prices available in the market reach what we believe to be advantageous levels.”

Bull Case for LUK

masterful capital allocation has produced a 21.4% CAGR increase in book value/share since 1979!
average ROE is 21% over 29 years
being mid cap (5 B) has allowed it to outperform Berkshire Hathaway's stock over the last 20 yrs
high insider ownership. Steinberg and Cumming each own 13% of the outstanding shares.
high degree of guru ownership, with many recently increasing their stakes including Bruce Berkowitz, Tom Gayner and David Winters.
Mr. Steinberg and Mr. Cumming have signed a 10 year contract to stay with the company and in the last AGM they said they would work there as long as they physically could. Apparently they are both in excellent health.
historically trades at 2 x book value, currently trading at 0.7
plenty of liquidity current ratio> 3
mostly long term debt with a low D:E ratio v.s. peers of 0.29 and leverage ratio of 1.38.
currently P/E ratio 10 x P/B 0.7 = 7 (far below Ben Graham's 22 criteria)
using an aggregate sum-of-the-parts, P/B value analysis and DCF analysis, they came up with a FMV of about $40/share roughly double what the shares are currently trading at.

Bear Case for LUK

shareholders need to rely on the expertise of only 2 aging individuals as the company is a specialist in picking unprofitable and troubled investments and fixing them up as opposed to Buffett's strategy of picking wonderful businesses that essentially run themselves, with or without him
heavy exposure to commodities and overseas ones to boot. These will suffer in the global slowdown and may well not survive
a concentrated portfolio magnifies bad investment decisions as well as good ones
recent heavy investment in JEF, a small investment bank they bailed out of trouble. It may have a rough run before the credit squeeze runs its course.
LUK's assets under management has shrunk by almost half (9 B-->5.3B) since Jan 2008 due to dwindling valuations
as the company grows, it will likely grow more slowly due to more competition for distressed potential investments and the law of large numbers
dividend yield is very modest at 1%; however, the managers are considering increasing this

IMHO, this is an excellent long term opportunity to own a company with a superb track record at an affordable price. It would be appropriate for a 3+ year time horizon in an RRSP.

I've put in a low ball bid at $19/share and hope it gets filled on a really nasty day in the stockmarket!

when a dollar goes for $0.60

2008-10-28T07:55:00.001-07:00

Stocks trading for less than the company's cash in the bank

More comments and stocks ideas to exploit the panicked selling

2008-10-24T11:06:00.001-07:00

Unwinding hedge funds, mutual funds and some silly retail investors with margin accounts have been forced to sell their favourite holdings of late. Those of us who have some cash on the sidelines may well have the opportunity of a lifetime.

Read First Eagle's view on this matter.

I've been concentrating on accumulating shares in companies with an established history of creating shareholder value (i.e. ROE >20% over 5 years), strong balance sheets, dividend yield over 2.5% and compelling valuations. The Grahamian simple valuation measure of focusing on companies that have a price-to-book ratio multiplied by the price-to-earnings ratio of less than or equal to 22 is helpful. I also prefer companies that have hard assets so I can focus on tangible book value that exclude such nebulous items as goodwill.

If you can ignore the macro-economic view for a moment (and I agree that it is hard to), you can choose wide economic moat companies with household names trading at amazing discounts to FMV. Most of them are in the DOW: AXP, MMM, GE, JNJ just to mention a few. DIA (the DOW Diamond ETF) is yielding about 3% now which isn't too shabby.

If you haven't read it already

2008-10-19T12:55:00.001-07:00

Warren Buffett's New York Times Opinion Piece

Grumpy old man = brilliant investor

2008-10-19T12:38:00.001-07:00

Marty Whitman's Value Picks

I'm intrigued by the ADR Henderson Land Development. It has extensive commercial and residential properties in HK and mainland China. It is trading at a deep discount to NAV (as Whitman suggests....> 50% discount on shares as they currently trade) and only has a D:E ratio of 0.15. Read the latest annual report presentation here.

I need to delve into this company's financial reports much more extensively before taking the plunge; however, if the LONG term growth story for China is intact and one believes in investing in hard assets then buying a company like this at bargain basement prices is compelling.

Note dividend yield is 2.7%. IMHO this would be a very long term investment >3 years +. Real estate is illiquid and one needs to be patient to allow the market to recognize hidden value.

Also: you may be confused by the currency denominations. 1 US dollar = about 8 HK dollars (7.7 today)

The greatest challenge now: Allocation of Capital

2008-10-16T17:51:00.000-07:00

The short and intermediate term outlook for both the domestic and global economy has probably never been more uncertain in my lifetime.

Companies with superb track records, strong management, excellent liquidity and minimal debt are available at valuation ratios not seen for many years. Benjamin Graham criteria for stock selection is so rigorous that most years since I started investing either no stocks in North America qualified or only a couple. Today there are 270 stocks that meet his criteria on the US exchanges alone! Interesting times, eh? BTW, to review those criteria:

Benjamin Graham's Criteria for the Defensive Investor

P/E Ratio less than 15
P/Book Ratio less than 1.5
Book Value over 0
Current Ratio over 2
Earnings growth of 33% over 10 years
Uninterrupted dividends over 20 years
Some earnings in each of the past 10 years
Annual revenue of more than $100 Million (1950).
Source: The Intelligent Investor, 4th Revised Edition (pages 184-185).

I belong the school of thought that the macro economic picture is inherently unpredictable. Those few who successfully perceive the future are really only guessing and statistically some of them are going to be right, sometimes even several times in a row. It's similar to slot machines. The danger is that after going on a statistically inevitable winning streak you start to believe that you have a special skill or insight that others do not. Of course, you don't and the casino walks away with all your winnings (eventually) and more. The stock market is really no different.

The vast majority of successful investors with a long term track record of profitable investment decisions (i.e. Buffett, Klarman, Berkowitz, Schwartz) take only a faint and detached interest in the macro economic picture and/or what the stock market is "doing". He/she is doing that for one reason only-- to find high quality companies on sale for pennies on the dollar.

I've been spending a lot of time reading through SEC filings and conference call transcripts, trying to find companies that have at least a narrow moat and the financial health to survive a downturn in the global economy, even a protracted one. I have quite a few prospects, many of which I already own and have analyzed on this blog and intend to buy more of. A few new ones I'm intently interested in and will review when I have time:

ISCA
FSTR
NTRI
POW.to

Vitaliy Katnelson is an offkey but insightful value analyst/money manager. He comments on his favourite stocks here.

l

Time to buy the survivors

2008-10-10T10:51:00.000-07:00

I'm buying businesses today with the following "safe and cheap" characteristics:

ample liquidity
wide moat
manageable or no debt
trading at or less than tangible book value P/E <8
high insider ownership (15% or higher)

Wow-- never in my life has there been so many opportunities. Rather than reel with the sheer number of them I've chosen to concentrate on a few:

BAM-- on sale like it never has been. I don't use conventional metrics to value this company.
SEB-- same
MKL
BBSI
PHG

I'm spending hours pouring over financial reports so I can decide the best way to allocate my limited capital. I may sell BPOP as its share price has been propped up by an improbable upgrade. I would love to own more CX, LYG, AXP and CKI.TO; however, these companies are being conspicuously quiet (well, other than Cemex) and there is a palpable opacity to their current liquidity situation that makes me nervous. All four have potential to be great investments and I'm monitoring them closely.

I'm putting in bids for some or all of them today and adding slowly over the next year to my stake in DIA, the diamonds of the DOW. I think the DOW has potential to drop into the 7000's and that would be great.

l

Seth Klarman's comments about today's opportunities and risks

2008-10-09T16:25:00.001-07:00

Posted by: sabonis (IP Logged)
Date: October 9, 2008 01:52PM

I called my boy Seth at Baupost and he gave me some details of what he talked about:

Seth Klarman at CIMA Conference 10/2/08

1. Biggest fear was buying too soon and on way down, from up in over-valued levels. Knew market collapse was possible and sometimes imagined I was back in 1930. Surely there were tempting bargains and just as surely would have been crushed after decline of next 3 years. A fall from 70 to 20 and fall from 100 to 20, would feel almost exactly the same. At some point being too early becomes indistinguishable from being wrong.

2. Getting in too soon brings risk to all investors. After a stock market has dropped 20% – 30% there is no way to tell when the tides will change. It would be silly to expect that every bear market will turn into a great depression. Yet fair value from under-valued can’t be predicted, and would be equally wrong.

3. As market descends you are tempted with purchasing companies. You will be bombarded with tempting opportunities. You never know how low things will go. When credit contracts and tide goes out on liquidity. At these times recall the wisdom of Graham and Dodd. At this time, you should not market time, but stick to your value convictions. You will see tempting bargains and value imposters. Ignore macro and look to buy cheap.

4. In a market like we have been experiencing. Most investors lose their rudders. They become unwilling to part with cash. They start working on macro economic level. Investors look to pull out of market and wait for a clear signal of change. Value investors should be able to keep their focus and remember Graham and Dodd of 1934.

5. If you can maintain your focus, resist business pressures and have a multifaceted tool kit, you can expect to prosper, even in difficult times.

A. Always recall road map of Graham and Dodd. Revisit this road map when times get difficult. Maintain discipline and value with a margin of safety. This doesn’t mean you won’t lose money. It means if there are drops in price, you have even more of a bargain.

B. Avoid highly leveraged stocks, junk bonds and shaky financials.

C. Look for bargains in various industries and nations.

D. Look at value, not great companies and great management.

E. Listen to Warren Buffett when he states you should buy a stock as if the market would close for a long period of time after you bought the stock.

6. Remain focused on the long run. Graham and Dodd motivate our diligence. They are like silent sentinels. Navigate the best you can and Graham and Dodd are the North Star for value investors.

7. Stand against the prevailing winds, selectively and resolutely. Yet for a while a value investor will under-perform. Interim price declines allow you to average down. Do not suffer the interim losses, relish and appreciate them.

8. Value investing at its core is the marriage between a contrarian streak and a calculator. Buying what is in favor is ensuring long-term under-performance.

9. It is critical to remind your clients, investment team and as often as necessary yourself, that you can only control your process and approach. Understand that you cannot control or forecast the vagaries of the market. Then you should invest in what you believe and what your research dictates. Be indifferent if you lose your short-term oriented clients, remembering that they are their own worst enemies.

10. Controlling your process is essential.

A. Be focused on process, not outcome.

B. Do not judge a decision based on its outcome.

C. During periods of under-performance it is easy to change your process.

D. When a firm is worried about tempers, second-guessing and fear, the process will fail. Look for long-term results; anything else will corrupt the process.

11. Value investing is an art and not a precise science. It is dealing with the fact that we do not work with perfect information.

12. Mechanical rules are dangerous. Graham and Dodd principles should serve as a screen.

Q&A

1. How do you see current investment climate?

A. James Grant - Look at some MBS and beaten down bonds. Some are priced to yield teens. They are priced for a further 25% decline. Also unsecured debentures of nations top retailers. These are priced at 5% to 7%. Hence, short the retailers at 6% and go long the beaten down mortgages.

B. Seth Klarman - Unusual amount of forced sellers, via margin calls. This could breed opportunity. Sees a lot of money managers staying on the sideline. He finds this as an opportunity to buy. Buy when others react to news or false news. His experience is when people give away stocks out of need, due to fear or margin calls, that sounds like a great buying opportunity. In this environment you are playing against very smart people.

C. Bruce Greenwald - Take a deep breath. All the doomsday talking is not being reflected in stock prices. Stocks are basically down 25%, but unemployment is not great like early 1940’s. You need to put this into perspective like 1991 or 1982.

2. Klarman discussed buying one security at a time. Not everything is a bargain out there. Be selective. Many of us have seen opportunities now, and history says to buy them. We bought knowing that banks are going to fail, that real estate would drop, but that certain mortgage backed securities were under-valued. Never leverage, where you can have an opportunity to buy and not be able to take advantage of it because of leverage.

3. James Grant - Treasuries are yielding less than expected future CPI. Treasuries are now being priced as a macro-economic play. Treasuries are not intrinsically safe. They are not safe based on valuation.

4. What factors do you look at in sizing a position?

Seth Klarman - He thinks this has been missed over the last 15 years. Most of the diversified risk is done via 20 to 25th position. We have had a 10% or so concentrated position about a dozen times over the last 20 years. Most of the time we have 3,5 and 6% position. We will take it higher if we see a catalyst for increased value. We would not own 10% position in a common stock, only because it seemed under-valued. We would have a greater than 10% position if there was a margin of safety. I see managers make mistakes with concentrated positions in similar industries. Small positions of say 1% are nonsensical. We do not use macro views, yet when we hedge, we will use a macro view. We think inflation could become out of control in 3 to 5 years. Yet, we might not wait for that position. Hence, perhaps early, we have a large inflation hedge. We don't own gold as a commodity. We won't disclose our inflation hedge, yet with enough work, you can find true inflation hedges.

insane P/E ratios from Bespoke

2008-10-09T10:57:00.000-07:00

The average 2009 estimated P/E ratio for stocks in the S&P 500 is 11.9. Currently, 48% of stocks in the index have an estimated P/E of less than ten. Below we highlight stocks with the lowest estimated P/E ratios in the S&P 500. Either earnings estimates are still way too high, or many of these stocks are trading at values of a lifetime. Just looking at the top three stocks on the list (GNW,X, CF), even if their '09 earnings come in at half of current estimates, at current prices their P/Es would still be less than five.

Tips for bargain hunting from Morningstar

2008-10-08T14:50:00.001-07:00

Value in Healthcare as well as safety

2008-10-08T12:58:00.000-07:00

read the brief review here.

My favourites: NVS, SNY, WLP and UNH for reasons detailed in previous posts.

UNH and WLP are cheaper (per PEG ratio) than the others because of real or perceived political risk they face from the incoming US administration's promised reforms. These reforms may well not be in the HMOs best interest.

If you believe that the more things change the more they stay the same, either company is a pretty good bet. Healthcare is on the back burner in the US as it is eclipsed by the economy, Iraq and Afghanistan.

l

Ponzio's view of today's situation

2008-10-07T13:51:00.001-07:00

Now What? The Great Market Meltdown.
October-7-2008

The US Government passes a $700 billion bailout (or rescue) package, and the markets continue their spiral down. Financial advisors across the country are shouting, "Stay the course!" (Usually from under their desks.)

This crisis is unlike anything we've seen in recent history (and perhaps not-so-recent history); so, what should we do now?

First, Stocks Stink. Consider Buying Bonds.

One year ago (actually, on October 11, 2007) the S&P 500 topped out at 1,576.09. Today, it hit 1,007.97 — a 36% loss. From top to bottom, the Dow lost 32% over the past year. While the news is reporting that we closed at 2004 levels, I think a much more sobering reality needs to be addressed: Over the past ten years — from October 8, 1998 through today's close —[b] the Dow has grown just 2.6% on average for ten straight years.[/b]

Add in dividends, take out some management fees and commissions, and you're lucky to have a 4% or so return for a decade.

(And I won't say anything about how irresponsible, foolish, or downright fraudulent some of Wall Street's finest were over those ten years. Remember Lucent? WorldCom? Enron? Merrill Lynch? Bear Stears? Really — I don't want to beat a dead horse.)

(Morons.)

What can Joe and Jane American learn from all this volatility? First off, remember that stocks stink! A portfolio of solid bonds would have crushed the stock markets over the past ten years; and, while I don't necessarily advocate 100% bonds for everyone, I do think that most people should own them.

Wall Street doesn't talk about bonds except to the extent that they try to get you to buy bonds funds. Individual bonds are not very profitable to Wall Street; bond funds will pay your broker the quarterly kickbacks and allow you to be put on the back burner. (What adviser wants to track all those individual maturities or have to actually do some research?)

That leads me to my first point: Beware of bond funds.

The Danger of Bond Funds

Simply put, when you invest in a bond fund, you give the manager $x to purchase bonds. The manager then takes your cash, pools it with cash from other investors, and buys bonds of varying maturities.

Sounds pretty harmless.

The problem with bond funds is not in the buying, but in the selling. When investors sell their bond funds, the manager must generally sell bonds to pay the investors. The problem is that bond prices change; so, the manager might have to sell some bonds that you personally would have held to maturity.

How does this affect you? Consider this: You want to hold bonds for income and stability; but, in bond funds, your income and stability is directly affected by the actions of other investors. If a ton of people are buying into your bond fund today, your manager will be forced to buy bonds for you in a low interest environment. Then, when those same investors want to get out of that bond fund in five years — and if interest rates are higher — your manager might have to sell those low interest, now low priced bonds at a loss.

At the end of the day, you got a raw deal.

Instead, focus on buying individual bonds with the goal of holding them until maturity. If you buy a high quality bond offering a 5.5% yield until June of 2009, you know exactly what to expect — a 5.5% return for two years, and a definite dollar amount upon maturity, regardless of how happy or scared other investors are.

In short, don't let the panic and fear of other investors determine your return if your goal is stability, income, and a defined return.

Second, Realize That Volatility Is Here To Stay.

I'll admit — 6% or 8% daily swings in the markets are out of line. Still, volatility is here to stay. If you recall from this earlier post, the average number of daily transactions in the markets have grown 562% over the past ten years. Every day, 4.4 billion transactions occur, each moving a stock price in a certain direction.

Over the past two weeks, this number has grown to more than 8 billion transactions. If you are waiting for things to calm down, you'll be waiting a long time. There is simply too much excited money floating around to ever return us to consistently small and "comfortable" movements.

If 36% losses make you sick to your stomach, it's time for a reality check and a new strategy. Diversification (ie. holding a bunch of investments) is not the key — asset allocation is what will help you sleep at night.

When you are putting money to work in stocks, you must have a completely iron constitution. If watching your portfolio drop 50% will make you nervous, you shouldn't be 100% invested in stocks. Nobody likes 50% drops and we'd love to avoid them whenever possible; but, if you're 100% invested and prices drop quickly with no fundamental change in your businesses, you'll suffer some big temporary losses in your portfolio.

Combating Volatility the Intelligent Way

Many advisors will tell you that "diversification" will help mitigate losses and maximize returns. Then, they sell you a mutual fund that holds hundreds or thousands of stocks.

It doesn't make sense.

If the key to growing and preserving wealth (as Buffett has said) is putting your money into great investments and great prices, how can it make sense to buy a basket of great, mediocre, and bad companies at great, mediocre, and bad prices?

[i]As of June 30, AllianceBernstein Holding LP; ClearBridge Advisors, a subsidiary of Legg Mason Inc.; Fidelity Management & Research LLC; Barclays PLC unit Barclays Global Investors NA; Wellington Management Co.; and State Street Global Advisors were the mutual-fund managers with the largest stakes in Lehman's stock, according to FactSet.[/i]

So said the Wall Street Journal on September 16, 2008. While most of the funds did not comment, Vanguard's Rebecca Cohen had this to say:

[i]If you look at the absolute number of shares, we end up as one of the larger holders of Lehman...but on a relative basis, it's a relatively small portion of our funds.[/i]

Oops. We lost hundreds of millions of dollars of your money; but hey, you were diversified. You only lost a little (even though you shouldn't have lost anything in Lehman).

The intelligent way to combat volatility is to realize how much volatility you can handle, and then invest the rest in bonds. If you take a step back and realize that 50% losses are possible, then you have a base for building your portfolio.

Comfortable with a 10% drop, but not a 15% drop? Invest 20% in stocks and 80% in bonds and cash. Okay with a 25% drop but not a 30% drop? Put half of your money in stocks and half in bonds.

Focus on intelligently allocating your portfolio, not on broadly diversifying into more and more mediocre and bad investments. After all, [b]those broadly diversified, armchair investor stock and index funds are down just as much — if not more — than the markets right now.[/b]

Don't Change a Darn Thing in Your Approach

It is times like these that many investors panic and change their investment strategy in stocks. The fact that the markets are down does not change the fact that:

1. stocks are pieces of businesses with intrinsic values;
2. the value is the amount of cash that can be taken out of the business during its remaining life; and,
3. price follows value, even if it takes a few years for that to occur.

Stock market volatility

When we bought Johnson & Johnson last year, we looked sheepish, as though JNJ was a boring buy at $62 or so. A few months later, we looked really smart as JNJ topped $72 a share. Today, it was down as much as 14% from its near-$73 high, and many people are kicking themselves thinking, "Boy, I wish I took my profits $10 ago."

Why did we buy Johnson & Johnson at $62? Because we saw more than $62 — and more than $72 — of value. As the company's value continues to grow, we have to sit back patiently until Mr. Market is ready to realize it.

It may take a few months; it may be years.

Finally, Realize That It Will Be Better In a Few Years

I wish the internet was around in the 1970s. From its peak on January 11, 1973, the Dow began a two year, 47% slide from 1,067 to its December 9, 1974 low of 570. With no internet or stock market channel, most people continued on saving and investing, cognizant of the losses but not completely panicked or terrified.

Today, the doomsday crowd is calling for the end of the world and a total and final financial collapse. If we were to drop 47% from our high, the Dow would be 2,300 points lower at 7,568. Possible? Absolutely. Anything is possible.

But, like we did after the Great Depression and the 47% drop in 1973 and 1974, and like after so many other times throughout history, we will get through this, great businesses will be more valuable five- and ten-years from now, and price will eventually follow value.

Believe me — there are some very attractive bargains developing in this market, and you should look for them the same way you looked for them when the Dow was at 14,000.

International Blue Chips on sale

2008-10-07T12:13:00.000-07:00

Wow

2008-10-06T12:13:00.001-07:00

the streets (Bay and Wall) are running with blood.

I put in a bid for more BAM.A shares at $20 after a prior bid was filled at $25.

I'm trying to shore up some capital to buy initial stakes in PKX and DEO, both excellent wide moat long term plays that will survive a severe and protracted global slowdown IMHO.

The Buffett Bailout + Plan

2008-10-05T15:27:00.001-07:00

read it here.

PHG: Phillips is too cheap to ignore

2008-10-04T14:14:00.000-07:00

As I mentioned in my summary last month, I'm not a big fan of huge conglomerates. Too complicated, too hard to understand and assign value to the business.

Royal Phillips Electronics NV (ADR) ticker PHG is such a beast but it attracted me for a number of reasons:

it was simplifying and focusing its portfolio
it was becoming a major player in the "green energy" high margin LED lighting consumer sphere and medical imaging sector (see the cardiac CT above-- cool, eh?)
it had an excellent balance sheet D:E 0.16 Current ratio > 1.5 interest coverage > 17x and they have $8/share of cash in the bank
a decent dividend of 3.3% yield and only 8% payout ratio (divi is sustainable & lots of room for increasing it)
a global footprint

Since then earnings have been a bit sluggish; however, it is respectably profitable with a ROE of 15% and decent cash flows of 1.7 B dollars/annum. Double digit net margins to date and management expects these to improve as the product mix changes over to the higher margin stuff they sell in their medical device and lighting portfolios.

Since I started buying it at $40 and $35 dollars/share the share price has slowly sunk down to $26/share.

Look at these eye popping valuations:

P/E ratio of 3 (!)
P/B of 0.8
P/Cash Flow of 4.8
PEG <1

It's being priced as if it were an investment bank sinking in massive debt and begging for a bail out! That's craziness. After it's acquisition of Genlyte, it has the vast majority of the market share for lighting in North America. With a great balance sheet, it deserves better and it will be revalued closer to $40/share down the line IMHO.

PHG is not a great company. It's management's execution is mediocre to above average at this point. It's just massively undervalued right now considering it has the resources to withstand a prolonged recession and perhaps even a depression if that's in the offing for us.

I'd buy at <$30 (it's $26 today!) and hold for up to 3 years. Unless I'm impressed that PHG becomes a great company, I intend to sell at $55 or greater and not hold for the very long term.

l

A notorious bear who has done very well recently

2008-10-03T15:44:00.000-07:00

Prem Watsa's FP interview. He is very bright and always has had extreme and mostly negative views on the global economy and stock markets i.e. he predicted 10 out of the last 3 bear markets.

"The Bear argument always sounds more intelligent." Charlie Munger

Read it but don't be too scared by it or make any hasty investment decisions. Nobody knows what is going to happen from here. Cheap and safe investments historically have paid off hugely when bought while there is blood running on Wall St.--- clearly the case right now. The toughest part right now is determining what is safe in such extreme conditions.

Prem Watsa's interview.

note: Mr. Watsa is a contemporary of Francis Chou, my favourite mutual fund manager. I don't believe Mr. Chou is completely in agreement with the apocalyptic viewpoint of Mr. Watsa; however, he is a perpetual pessimist and has invested in many of the same equities Mr. Watsa has in the past i.e. Torstar. Chou filed with the Ontario SEC to be allowed to purchase CDS but a bureaucratic delay prevented him from executing the trade (that made FFX several billion in one fell swoop!). Fairfax is also the largest holder of Chou Associates, Chou's main balanced fund. I suspect that they must have a collegial relationship and it shows in their investment decisions.

Disclaimer: my wife and I both own Chou's funds and they make up a large proportion of our portfolio. Chou performs best in bear markets and I intend to hold these for the very long term.

Bogle wisdom

2008-10-03T08:06:00.000-07:00

Ponzio's notes on Monish Pabrai's presentation

2008-10-02T15:27:00.000-07:00

Notes from the Pabrai Funds 2008 Annual Meeting

by Joe Ponzio

On September 13th, I attended the 2008 Pabrai Funds annual meeting held here in Chicago. I met a few F Wall Street visitors and, unfortunately, missed meeting up with a few others. I must say that I am amazed at how many "Early Buffett" partnerships are out there.

For the explosive growth of these types of partnerships, I give 100% of the credit to Mohnish Pabrai for structuring his partnerships like the early Buffett ones and bringing them to the public eye. (If that's Greek to you, or if you're Greek and that's Chinese, stay tuned because I'll explain "Early Buffett Partnerships" in a subsequent post.) Before Pabrai, few people knew what an "Early Buffett" partnership was.

But I digress (and I'll get back to these partnerships later). For now, let's look at the Pabrai Funds 2008 annual meeting.

A Look at Performance

Pabrai's funds are all about long-term performance; so, looking at his one-year or year-to-date performance is downright silly. Sure, he'd love to show positive gains every year; still, even Charlie Munger himself couldn't pull off that feat, and Munger's not too shabby of an investor!

You didn't know? Like Buffett, Munger ran a partnership in the 1960s and 1970s. And like Buffett, he killed the Dow — except in 1973 and 1974, when Munger's partners lost about 53% over those two years. By comparison, Pabrai is doing quite well.

(How did Uncle Charlie's story end? In 1975, Munger's partnership earned a 73% return. When Munger liquidated the partnership, he had compounded money at just over 24% for fourteen years, even through the 53% two year decline.)

Pabrai's Presentation

Mohnish Pabrai talked for about 30 minutes or so (could have been longer...I wasn't watching the clock) and then opened the floor up for questions. (He won't discuss current or prospective holdings; so, I couldn't ask some of your questions.)

Pinnacle Airlines. Mohnish admitted that he would have been better off spending $20 on a book than $20 million (or whatever the real loss was) on Pinnacle. Airlines are tough, and Pabrai admitted that he should have learned from Buffett's lesson (or "beating") on US Air.

The takeaway lesson on Pinnacle. Airlines are typically bad businesses to invest in. Like auto makers, airlines have thin profit margins, suffer from high capital expenditures, and have to compete on price. Most investors should stay away from airlines entirely.

Investing in China. I'll give you the "short short version" of Pabrai on investing in China:

It is said that they maintain three books: one for running the business, one for the government...and one for the owner's wife.

Pabrai does not plan on making any investments in Chinese companies (though I don't think he'd rule the right opportunity out just because it's in China). Instead, he continues to believe that there are plenty of opportunities in the US.

Delta Financial (and other financials). Pabrai said that the big mistake he made on this one was not figuring out the "lifeline" for Delta. That is, he didn't properly assess the outs for the company and his investment. He then had this to say about Delta and the financial crisis (as well as all debt):

If you depend on borrowed money, you have to worry about what world thinks of you everyday.

(This was actually a quote ripped from Buffett at the Berkshire annual meeting on May 3, 2008. I give an example of this "borrowed money" danger in this post.)

Think about it personally — until your house is paid off, you have to worry about what the banks think of you. If you carry credit card debt, you have to worry that your interest rate will shoot up because the credit card company's opinion of you and your "creditworthiness" has changed.

Back to Delta: Mohnish said very simply that he did not consider the fact that the credit/securitization markets would completely freeze up. In short, he was "unprepared for a 1 in 50 year event."

Berkshire Hathaway. Over the years, Pabrai has been using Berkshire as a "placeholder" of sorts for up to 10% of his portfolio's cash. He'll hold it for a few days to a few months, and figures that he's averaged about 12% a year on it. (Beats the heck out of cash!)

He also talked about Buffett and Munger's amazing ability to compound money, "adding a zero every ten years." That is to say, every ten years or so, they added another zero to Berkshire's price ($40 to $400 to $4,000 to $40,000).

A Change in Strategy

Pabrai did talk about making a change in his strategy over the past year or so. He is now focusing more on the jockey (management) than the horse (cold financials). I took it this way: Up until a year ago, Pabrai was more than happy to "cigar butt" invest — find underpriced assets regardless of their quality.

Today, he is shifting to a more 1980s Buffett-style approach — find strong businesses run by highly talented, shareholder-focused managers.

Pabrai's Current Portfolio

Looking at his portfolio, Pabrai sees the widest discount to intrinsic value today than at any other point in the history of his partnerships. Some positions are trading at just 25% of his estimation of intrinsic value.

What will cause convergence of price and value? Pabrai talked about two types of assets in the portfolio:

hard assets and book value;

future earnings streams and cash flows.

Hard Assets — the Frontline Example

When Pabrai purchased frontline, the market value was less than one half of the liquidation value — a situation that cannot persist forever. Eventually, that price must correct because:

Wall Street will recognize its mistake in improperly pricing the business; or,

Someone will also recognize that value and begin buying, pushing the price upwards.

If the business is generated positive cash flow every month, that gap between price and intrinsic value widens every month. The widening of that gap puts tremendous pressure for the price to move up.

As Mohnish put it, "It's Ben Graham 101." Eventually market value (price) and intrinsic value will converge.

Future Earnings Stream as a Value Driver

In this case, Mohnish used IPSCO as an example. He bought the company at less than three times free cash flow. Thus, if the price did not change in three years, the market cap would be less than the cash on the books of the business.

What does that mean?

Plants, Inventory, Future Earnings Streams, Growth, Management, Permits, Licenses, Talented Employees — all free!

That "obvious" value caused tremendous pressure for upward movement in price. Pabrai bought for $45 and sold for over $155.

(As an aside, Pabrai said many of his holdings are trading at low single-digit multiples of free cash flow.)

The Pabrai Meeting Summary

All in all, it was a wonderful meeting and evening. You might think that Pabrai would be sheepish or cautious considering his recent performance; but, seeing the man in person, you can easily see that he believes his recent performance is not a problem in strategy (a strategy with a long, successful history with many mangers throughout history) but a problem with market prices and action.

Regrettably, I missed the Warren roundtable. At the end of the evening, Mohnish sat at a table with ten or twelve other attendees (whoever wanted to) and discussed his experiences at lunch with Buffett. But, I'll end with some points Mohnish had thrown out about Buffett earlier in the evening:

1. Buffett is a very reasonable person — full of energy and passion. As Mohnish put it, he's the type of person that comes along once in a century, like Einstein or Ben Franklin.
2. Warren Buffett posited: In investing, you have to make tough choices. As a non-investment example...would you want to be the best lover in the world, but have the world think you're the worst? Or, would you rather be the worst lover in the world, but have the world think you're the best?
3. Finally, do what you love.

And I'll add some wisdom to that last one — wisdom that Buffett surely implied and that my father always told me:

To be the best at what you do, you have to do what you love. And if you're the best, the money will follow. And that's true whether you're saving lives or digging ditches.

Buffett's comments about the bailout and more

2008-10-02T15:20:00.000-07:00

read the transcript here.

Buffett pulls the trigger again.

2008-10-02T08:06:00.000-07:00

one may view it as material proof of his belief that the global economy will improve. It looks like the bail package will be finally voted in on Friday (with a little pork being passed around as usual). Doomsday may be averted, this time. lol.

IMHO, there are a few opportunities developing that "bear" close observation if you have capital on the sideline:

American Express-- heading to the low 30's. a guru favourite with a great business plan that will almost certainly survive to fight another day.
Brookfield Asset Management BAM-- a personal favourite. Still hasn't hit my target entry price of $25 CDN or lower (for the BAM.A.TO equity traded on the TSX, anyway). I have a standing bid at this level and am waiting patiently.
Diageo DEO-- has hit my target entry of $69 or below, but my capital evaporated in that account (tax bill). I think this is a very safe long term investment with an excellent upside. I agree with Morningstar that it is trading at a 30-40% discount to FMV.
Conocophillips COP-- I'm not as bullish on oil as many others but the fundamentals, management, Buffett stake and exposure to nat gas makes this company compelling. It is approaching my original entry price over 2 years ago!
Seaboard Corp SEA-- if it were to drop below $1200, it would be irresistible.
Hamburger Hafen HHULF.PK-- still hanging in there about 40 euros/$57 USD. I'm holding out for an entry stake at $55.
Lloyds TSB Bank LYG-- the very large acquisition of HBOS and apparently opaque back room deals with the UK gov't is making the risk assessment of this investment a bit tough. I'm holding tight on my stake and considering add a bit when and if I get enough information about the bank's financial situation/liquidity status.

Clarke Inc. CKI: new presentation and review of current portfolio

2008-09-30T14:48:00.000-07:00

see the presentation here: Sept 2008 update

Cheap ETFs

2008-09-28T13:29:00.001-07:00

My preference is for DIA but if you want to hunt for value in sectors see below.

Cheap ETFs

The investing world's "Great One" makes his moves

2008-09-26T13:52:00.001-07:00

Exactly how much we've fallen

2008-09-21T19:10:00.001-07:00

Watch BAM closely over the next week

2008-09-20T11:17:00.000-07:00

As you're probably aware, in the USA and Europe short selling has been banned by the SEC for 799 financial sector companies. This is a temporary measure due to expire in 10 days.

Let's ignore the wisdom or folly of this move for a moment. Who are we to question the thoughts of giants? lol.

Brookfield Asset Management BAM and Brookfield Properties BPO are conspicuously absent from this list. I've written quite a few blog posts about BAM in the past and it remains one of my favourite long term holdings. Marty Whitman has described BAM as a company that he is "extremely bullish on". Tom Gayner, Chris Davis and recently Ken Fisher are adding to their stakes. Insider buying is steady and the insiders own about 17% of the company. Most of BAM's investments are not attributable back to the parent company so it is very well capitalized. It's a bit curious that BPO is not covered by the SEC edict as it doesn't even trade on the TSX. BAM owns 40% of BPO's shares (last time I read the financial report anyway). BPO owns premium Manhattan real estate (i.e. part of the World Financial centre) amongst other stuff. Its share price has been hammered as traders worry about leaseholders such as Merrill Lynch who may default/terminate the juicy payments.

Unfortunately, BAM has not been cheap and I've been looking for an opportunity to add to my position. The long term survival of this company is not in question here-- it's the contraction of the capital markets reducing opportunities for the type of investments BAM specializes in and a reduction in value of their considerable real estate and lumber stand holdings eating into their intermediate term profitablity. I wonder that if the short interest rises in the next few days (bored traders?) it might create an opportunity to own more of one the best managed companies in the world.

For the best presentation of the bull case for BAM, take a look at the Sept 08 webcast for Investor's Day.

For a sense of important balance, I need to include some of the bear concerns, well summarized here.

I'd buy below $25 enthusiastically and hold for the very long term.

l

The markets are boring these days, eh?

2008-09-19T10:21:00.000-07:00

9 industrial sectors (not just financials) are demonstrating volatility comparable to a roller coaster ride.

The credit crisis, housing slump, bank liquidity crisis/deleveraging phenomenon seemed to be an isolated domestic US problem a year ago and time has proven that rot is global in scope. It's ironic that the US is one of the few developed countries in the world that has shown GDP growth recently despite the trifecta of grief.

When the markets move, opportunities arise that come along only once or twice in a generation. IMHO, the key principles to invest wisely when blood is still fresh on Wall St. and Bay St are:

think like a business owner. If you wouldn't want to be the owner of the whole company (if you could afford it and had the ability to manage it), why would you want a partial share?
buy what you understand. Particularly with respect to the quarterly and annual financial reports and with special attention to the "Notes" section at the back of the report . They are usually confusing for a reason. Put these shadowy companies in the "Too hard" pile like I should have done with AIG. Read BBSI's reports and you will follow them easily. Even a very complicated company like BAM can be methodically worked through, section by section, by almost anyone even if they are not a CFA. HHULF.PK (Hamburger Hafen Logistik) is extraordinarily simple and clearly laid out in their publications--- and these have been translated into english from german!!
make sure the management has "skin in the game" (i.e. significant insider ownership >10% IMO) to assure that their decisions are aligned with your interests. The management's behaviour should be rational and independent of the "institutional imperative". One of the advantages of owning a business with a high degree of insider ownership is that most insiders cannot (due to company or SEC rules) or will not trade their stock for short term gains and this builds a bottom into the share price. It also acts as a partial protective shield against "bear raids" like what happened recently to Bear Stearns, Lehman and AIG. It's hard to manipulate the stock when you can't buy a large portion of the float. Examples: SEB, COLM, BRK, BBSI, BAM.
try to buy the best balance sheet in the business v.s. competitors. It's easy to say you want companies with no debt and lots of cash on hand; however, in many cyclical industries this is not an efficient use of working capital. Just make sure that when the unexpected happens, your company will be the last one (or one of the last) standing and positioned to wrest away market share from the much weakened competition when the dust settles.
focus on boring businesses in slowly changing industries with predictable cash flows and high barriers to entry for potential future competition i.e. insurance companies like Markel MKL, booze manufacturers like Diageo DEO.
do your scuttlebutt (non-quantitiative research)-- go to the mall, talk to customers and to salesmen. My wife and I have done this with AEO: watching the stores full of teenagers, buying up their products while the rest of the mall is barren.
watch for companies that have great fundamentals but a poor short term outlook or are irrationally hated by investors i.e. Cemex CX is currently priced as if another highway, bridge or apartment block will never be built in North America or Europe. Everyone hates DELL and simply won't hear any of the upside now that it is a different company than when it was a growth stock.
when looking at such metrics as ROE, use 5 year averages as these numbers can easily be distorted by short term, non-repeatable events in one quarter or two. i.e. LYG, AXP have astounding 5 yr ROEs in the 30's.
buy the asset managers not the mutual funds themselves. i.e. AGF, BAM, LM
holding companies often have unlocked value, high insider ownership and are managed for the long term i.e. IVSBF.PK, POW.TO, TYIDF.PK
choose to delve into the areas where hundreds of thousands of brilliant minds are not. I don't invest in oil or gold stocks because a lot of very smart people with far greater resources than I are spending 24/7 trying to figure out what the catalyst will be that will push commodity prices such as these up or down. What's the chance you'll get an edge on these guys? Pretty nominal, IMHO. The way the market works is that once the "smart money" has it figured out, the market follows seconds later and becomes priced into the stock ahead of time through the influence of futures/forwards/warrants exchanges. Instead of competing with these guys, take it easy on yourself and choose stocks that are extraordinarily boring, not traded on the NA exchanges, thinly traded and/or not covered much by NA analysts. These equities are conveniently often the same ones that have high insider ownership. Examples: Seaboard Corp SEB, Hamburger Hafen Und Logistik HHULF.PK, Investor AB IVSBF.PK, Toyota Industries TYIDF.PK
Watch for consensus and bargain guru stocks for new ideas. Don't blindly follow them-- instead consider them an elite stock filter. My favourite (free) resource for this is gurufocus.com.
Watch what the insiders are doing. Selling is of uncertain circumstance but large scale insider buying should be noticed and factored into your buying decision making. I use Yahoo's financial page for the US stocks and canadianinsider.com for the Canadian equities.

Happy hunting and enjoy the process. If you don't, buy ETFs, using dollar cost averaging, rebalancing once or twice and year and then forget about it. My favourite undervalued ETF is DIA "The DOW Diamonds" at <$110/share.

This too, will pass

2008-09-18T10:55:00.001-07:00

Whitman's glass-half-full take on market:
'There are great values out there now,' says octogenarian founder of Third Avenue Management
Article
Comments

SHIRLEY WON
From Thursday's Globe and Mail
September 18, 2008 at 8:46 AM EDT
TORONTO — Marty Whitman, the octogenarian dean of deep-value investing, sees great bargains to be snapped up from the current stock market meltdown.
"It's a great time," enthused the 83-year-old founder of New York-based Third Avenue Management LLC before speaking yesterday at a conference organized by AIC Ltd.
"We can't try to pick the bottom, but it seems to me that there are great values out there now, just like in 1974," the firm's co-chief investment officer said in an interview.
The stock market crash of 1973-74, which affected all the major stock markets around the world, lasted 694 days before bottoming out.
"Everything went down every day, and if you bought, you hit a lot of 10-baggers," recalled Mr. Whitman. "I hope that we do it with a lot of what we are doing now."
Mr. Whitman, who buys stocks he considers to be "safe and cheap," still oversees the firm's flagship mutual fund, Third Avenue Value, in the United States.
The former Wall Street analyst with a background in distressed investments didn't start his fund company until 1990 at 65, an age when most people retire. As of Aug. 31, his global fund has posted an average annual return of 14.4 per cent since inception.
His colleague, Ian Lapey, who is in his early 40s and is the designated successor to Mr. Whitman, runs the similarly managed AIC Global Focused Fund sold in Canada.
With the U.S. government bailing out American International Group Inc., and Lehman Brothers Holdings Inc. filing for bankruptcy protection this week, Mr. Whitman described the unfolding events as "the most severe financial crisis" that he has seen.
It's worse than the U.S. savings and loans crisis in the 1980s, Asian currency crisis of 1997 and the collapse of hedge fund Long-Term Capital Management and the Russian default crisis in 1998, he said.
But, he said: "This too shall pass."
Mr. Whitman buys companies that are very well financed; whose stocks are priced at a substantial discount to net asset value (NAV), and where the businesses can grow their NAV by at least 10 per cent compounded a year over the next five to 10 years.
"If the value is compelling enough and the businesses have staying power, we just buy and don't worry about the market," Mr. Whitman said.
"Our turnover is about 10 to 15 per cent a year at most, and the majority of our exits are companies that get taken over rather than a sale."
Some financials he has been buying lately include Power Corp. of Canada, caught in the downdraft, and U.S. securities like bond insurer Ambac Financial Group Inc., Bank of New York Mellon, and MBIA Insurance Corp.'s 14-per-cent surplus notes.
"We are extremely big on Brookfield Asset Management," he added. "It's very well financed, brilliantly managed by Bruce Flatt and his team. We are also big on the oil sands. We like Suncor, EnCana and Nabors Industries, whose subsidiary Nabors Canada is the largest land drilling company in the world."
He has also been picking up more shares of Toyota Industries Corp., a long-time favourite. And he has been accumulating more stock in Hong Kong-based Henderson Land Development Corp. Ltd., Hang Lung Group Ltd. and Hutchison Whampoa Ltd.
"All of these [Hong Kong] companies have a huge presence in mainland China," he said. "If we are going to be wrong about these investments, it's going to be for political - not economic - reasons."
While legendary value investor John Templeton - who died in July at age 95 - retired from the mutual fund business by age 80, Mr. Whitman intends to keep working.
"If I can't be a tennis pro - and I can't - I might as well just keep doing this as long as I am able to," quipped Mr. Whitman, an avid tennis player. "Just show me the door when I really get too old. So far, there is no sign."

Another look at AIG

2008-09-14T13:45:00.001-07:00

A taste of the mind boggling complexity here. Still "too hard" for me. I've sold 80% of my stake.

AIG is in the spotlight of the market right now and all the best and brightest analysts/investors are trying to figure it out. What's the chance that you and I can beat them? Pretty slim. I prefer to focus on neglected issues where it's easier (possible) to get an edge over the crowd. 20 analysts follow AIG and put every public minuscule bit of information under a microscope. In stark contrast, Seaboard SEB has 1 lonely analyst following it, mostly because it's mid cap, 70% insider owned and has extremely opaque governance. Scuttlebutt can pay off in the Seaboards of the investing world.

Guru focus: Should you pay attention to the Value Gurus?

2008-09-11T16:02:00.000-07:00

Short answer: Yes, with a caveat or two. Don't fly blindly-- try to buy companies at lower price than your guru did and make sure you understand why he/she recognized what the market was missing such that it mispriced the stock. Unfortunately, this requires a lot of homework... I spend quite a bit of time focusing on the gurus that I admire and seem to think like me (I guess I think like them, lol). I can't get my head around the machinations of Ken Heebner, George Soros and Bill Ackman, for example. OTOH, Seth Klarman, Bruce Berkowitz, WEB, Dodge and Cox, Marty Whitman, Ron Baron, Mason Hawkins, Jean-Marie Eveillard, Ian Cumming, John Rogers, Chris Davis and Monish Pabrai all capture my interest immediately.

I think that Guru stock picks are an excellent starting point for your research. If the gurus you respect are almost all buying a company and the insiders are buying it too then it sure is compelling to scour the financial reports to find what they have seen that Wall St. has overlooked.

Model Portfolios Performance Review: How should you follow the Gurus?

September-11-2008

It has been a very tough year in the market. The S&P500 is down about 15% as of Sept. 10. Here we like to review the performances of our model portfolios. Each model portfolio consists of the top 25 stocks top ranked with its criteria. How did the model portfolios do in such a market?

All four model portfolios were rebalanced on Jan. 2, based on the close prices of Dec. 31, 2007 . Although all four model portfolios are down for this year, but they all outperformanced the S&P500.

The Most Weighted Portfolio consists of the 25 stocks with the highest combined weightings from the portfolios of the 25 selected Gurus. This portfolio gained 22% in 2006, without counting dividend. It lost 2% in 2007, compared with S&P500’s gain of about 3%. So far this year it is down 11.55%, compared with S&P500’s 16.09%. Since inception in Jan. 2006, the portfolio gained about 6%, while the S&P500 lost 3% during the same period. All numbers do not include dividends.

This portfolio had 40% of turnover at the 2007 rebalance.

It has been widely reported that Gurus are underperforming. However, buying the stocks with the highest combined weightings outperformed the market by about 9% so far in less than 3 years. The portfolio of 25 stocks shows similar volatility as the S&P500.

The Broadest Owned Portfolio consists of stocks that are most popular among Gurus. The rank is based on the number of the gurus that hold the stock. If this number is the same, the stocks that the gurus hold in higher positions (percentage to portfolio) are ranked higher. The portfolio is updated every 12 months.

This portfolio gained 15.8% in price in 2006, outperforming S&P500 by more than 4%. However, like the Most Weighted Portfolio, it lagged the market in 2007 by losing 6%. So far in 2008, it made up the bigger loss, and outperformed the market by 7%. Overall since inception in Jan. 2006, it did better than the market by about 1%.

The Consensus Picks Portfolio consists of the consensus picks by the 25 selected Gurus. The rank is based on the number of the gurus that have bought the stock over the past 6 months. If this number is the same, the stocks that the gurus bought in higher positions (percentage to portfolio) are ranked higher.

The Consensus Picks portfolio gained about 10% during 2007, outperforming the SP500 by more than 6%. Again so far it did better than the market by 7% this year. Since inception in May 2006, it gained 4.37%, relative to the loss of 1.95% by the S&P500. Maybe the Gurus are not doing very well, but their consensus picks are doing ok.

Guru Bargains 25 is the best performing portfolio in 2007, it gained 15.4%, beating SP500 by wide margins. This portfolio consists of stocks that have declined since Gurus bought. Is it telling us that buying stocks at lower prices that Gurus have paid has great rewards? If we believe in value, it should.

The Guru Bargain portfolio did poorly in 2006. We did things differently for 2007. First of all, we did not use the portfolios of all the Gurus in our database to make the portfolios. We selected a subgroup of 25 Gurus who have very conservative approach and the lowest turnovers. Then we limit the market cap of the stocks to be above $4 billion. These requirements made the portfolio much less volatile, and changed the results dramatically.

The rebalance of this year replaced almost all of the stocks but AMD. So far in 2008, it is about even with the market. This portfolio is more volatile than the market. If you see the current Guru Bargains here: http://www.gurufocus.com/Guru_bargins.php

G&M: Canadian insider buying spikes

2008-09-11T13:56:00.001-07:00

Read Globe and Mail Report on Biz here.

Brief Contrarian Portfolio review and a Shopping LIst

2008-08-24T08:50:00.001-07:00

Just a few comments and observations regarding the businesses and their associated stocks. The majority have been reviewed in detail earlier in this blog. I have a penchant for wide moat stocks in unloved sectors so you will see an over-representation of insurance companies, holding companies, asset managers, consumer discretionary niche businesses and wide moat financials. I am a physician so pharmaceutical and medical device companies are somewhat in my "circle of competence", so you'll see some of them listed here as well.

If you're interested, use the search function in the upper left corner of the screen to find these posts.

Equities currently held:

MCO Moody's: much hated and blamed for the credit crisis (with some merit). Lawsuits and red tape type legislation are inevitable but Moody's has been through this before and will likely thrive when the debt markets recover. Extra-US revenue is increasing and likely to accelerate with financial markets eventual recovery. I'm holding on this one long term (3 years +) unless it drops into the 20's/share without a material change in the business plan and I'll buy more. I'm a bit more cautious with this investment as I find this business to be very complex and the reports tough to follow which raises red flags for me. Buffett is holding on to his stake which offers some reassurance. Hold for now. Target price $70/share.

COLM Columbia Sportswear: good valuation, high insider ownership (66% of outstanding float), no debt whatsoever (!) and a global footprint have me holding on to my stake for another 18-24 months. Shaky inventory management, lack of any moat whatsoever and lack of a tangible business plan to take market share from the prodigious competition (i.e. North Face, Underarmour) may undermine margins and downstream profits. If emerging markets (i.e. NOT Europe) take to the brand, it may do better than I expect. I believe that there is an excellent margin of safety on the downside; however, my expectation is a maximum 50% upside over the next 1-2 years. Hold for now. Target price $60

SPLS Staples : superior management demonstrated by increasing ROE and a competition-crushing increase in market share wrested from OfficeMax and Office Depot. SPLS has double the net margins of its weakened competitors. The company's delivery business is thriving, particularly outside North America. International exposure improved by the well timed and executed Corporate Express acquisition. Minimal debt, modest dividend (1.8% yield), a newly developing moat, and moderate growth make this holding an intermediate to long term one: 3-10 years. Target price $40+

CMH.TO Carmanah Technologies: A locally based, globally represented solar LED manufacturer/distributor. I bought this early in my investing career--- when it was the bright and rising star of the TSX Venture exchange and trading between $3.60 and $4.20/share. However, with time the inexperienced management fumbled, CMH's earnings vaporized and predictably, the balance sheet bled red ink. Carmanah rapidly became a penny stock. A new CEO, CFO and then a new board was brought in last fall to turn things around. CEO Ted Lattimore, a Vodafone turn-around specialist veteran, has sold off all the low margin product lines and concentrated on the LED biz. They've pared back the head count, out sourced the manufacturing component and cleaned up the balance sheet: no bank debt and a current ratio > 3.1. Last 2 quarters EBIDTA has turned positive and would have been (the dreaded "pro-forma" statement) profitable discounting the restructuring charges. Management expects to turn a profit by early 2009 and 10% top line growth thereafter. I think this is a reasonable entry point for a speculative investment, keeping in mind that there is absolutely no moat protection whatsoever and it may never become profitable. It is not a value stock now and may never be.

CKI.TO Clarke Inc. this activist catalyst holding company is trading at approximately 30% discount to its NAV. Recent aggressive investments in various income trusts including Granby IT, Art In Motion (which CKI plans to take private this fall), Avenir Diversified IT, Supremex IT and others along with recent NCI bids for share/debenture buy-backs have depleted cash from 44 M to 1.5 M and reduced the current ratio from 5.5 to 4.4. Although the balance sheet remains strong, I'm closely monitoring Clarke's liquidity risk. It's still paying a very modest dividend (1.1% yield). Mr. Armoyan's investments are holding up better than I expected considering the current economic environment: only 1 M writedown and 17 M non-realized loss in a 266 M portfolio. I intend to hold as long as the balance sheet remains reassuring. I think that the downside (further national/global economic weakness, strong loonie etc) is priced into the shares currently and that the upside will be rewarding. I find that Clarke's financial reports extremely easy to understand, even the notes section which is usually designed to confuse you. If I get a report that I can't understand down the line, I'll follow my usual sell displine and dump the stock.

COP Conocophillips: I sold 66% of my stake for a nice profit a few months ago despite very compelling valuations. Political risks (even in the USA!) along with an expected multi-segment margin squeeze make me leary. I'm finding this area too difficult to gauge as it is exposed to too many external forces to get an "edge". I prefer lower profile, boring businesses.

AEO American Eagle Outfitters: update recently posted on this well managed, no-moat company in a rapidly changing business with very fickle (read: not loyal) customer base. Great balance sheet, no debt and will likely appreciate rapidly with the turnaround in the retail sector, whenever that happens. I would buy more at $13/share and sell in the high $20's with a horizon of 1-2 years.

CX Cemex ADR: another extremely well managed narrow moat company in a hated industry, as it is tied in with housing/construction markets. It is also a major player in the infrastructure refurbishment worldwide which most analysts feel will be a multi-trillion dollar industry over the next few decades. Extremely compelling fundamentals==> trading at book value and P/E (both trailing and projected) about 7, PEG 0.85. Although the 20 Billion long term debt obligation is concerning post the Rinker acquisition, management is committed to debt reduction, aided by a 20% operating cash flow yield. Buying below $20 and intend to hold for 5 years+. Short term target is $30/share. This is one of my favourite investment ideas currently.

LYG Lloyds TSB Bank ADR: UK financial institutions are amongst the most despised in the world these days. This is the most conservatively managed and boring bank in the UK (and perhaps the world) with the stated goal of paying out 75% of earnings to shareholders in the form of dividends. The company's staunch conservatism is serving it well, propping up its reputation for safety. LYG has recently sold off its foreign operations and due to its strong brand in the UK it has a wide moat. Dividend yield of about 9% and ROE historically in the mid 20's. P/B 1.6 P/E 5.6 PEG

SEB Seaboard: shipping/food processing company with high insider ownership (70%) and great valuations. Margins being nailed by commodity prices, particularly grain for the hogs in their pork segment. A recent pull back in share price to a 52 week low presents a good entry opportunity for the long term. This was prompted by a 50% reduction in EPS yoy despite higher revenue (higher costs). Management communication with shareholders is opaque (no conference calls and minimal/no guidance) and analyst/Wall St. coverage is nominal---this can be both an advantage and disadvantage to the long term investor. P/E 9 P/S .43 trading around book value. It grows revenues 15%/yr over the past 5 years and increased it's tangible book value 23%/yr each year over the same period. Great balance sheet and liquidity with current ratio 2.7. Dividend negligible at 0.2% yield. Buy at <$1200/share and hold for the very long term or >$3000/share.

COV Covidien: "crown jewel" medical device manufacturer spin off from the old Tyco monster conglomerate. Although I think that it has excellent long term potential, the share price has appreciated 50% over the last year, within shooting distance of its Morningstar FMV of $65/share. Insider buying is impressive (one officer bought $1 M worth of stock at $51/share so he obviously still thinks it's undervalued) as is the product pipeline. I'd be interested in buying more shares in the low 40's and holding for the long term (3 years +) or until the shares hit the mid 80's. Hold for now.

NYX Euronext-NYSE: despite the inevitable emergence of competition on the horizon (narrowing the competitive moat), this global leader stock exchange is trading at 9% cash flow yield. Sellers have overlooked the fact that only 10% of revenue comes from domestically traded equity fees. I will buy below $40/share with an intermediate holding horizon of 18 months to 3 years and/or a target price of $90-100/share.

HOG Harley Davidson: undeniably wide moat niche manufacturer/retailer overly punished of late for its troubled loans division. Current ratio > 2.5 and strong overseas growth. 15% cash flow yield, 33% ROE, 3.2% dividend yield. Well managed and very strong brand with excellent overseas growth in revenues . Inventory management widely praised. Recent bump up in debt from virtually nil to $3 Billion for the Italian motorcycle maker MV Augusta acquisition has raised eyebrows. Margin compression (increased costs, decreased US revenues) recently and concern re: demographic shift in customer base continues to hammer at the share price. I intend to buy at prices in the low 30's and sell in the 70's as a long term hold (3+ years).

BMY Bristol-Myers Squibb: has been a disappointing long term holding for me, despite the generous dividend. The intermediate term drug pipeline thins out markedly between 2011 and 2014 although looks promising beyond. The reasonably leveraged balance sheet is be endangered by overpaying for the in-progress Imclone acquisition. The company is also joing its peers by being bogged down with lawsuits including the Apotex suit. Some of my favourite gurus have sold their stake in BMY in June as well including Bruce Berkowitz. Some large scale insider buys in May have followed by serial dispositions. I think that Bristol will turn itself around over the next 3-5 years for brighter days and that the pessimism I express is priced into the stock price. It may not be a bad entry for a very long term investor-- after all, BMY has been around almost 1.5 centuries and the nearly 6% dividend more than offsets inflation. I suspect there are better opportunies in this sector (like SNY). I am considering selling on any short term strength for a capital loss but I'm not in any rush.

BBSI Barrett Business Services: I've written frequently about this favourite small cap of mine. Short term uncertainty in the sector coupled with a superb balance sheet, superb management and high insider ownership and insider buying if late, plus a dividend (2-3%) makes this a long term hold. I would add to my position (and have several times over the past 6 months) as the share price moves towards $12 and below. I would pare down my stake in the mid $20's unless the great valuations are also maintained. The share price ramped up 40% after the last conference call. I will hold my shares for now and intend to do so for 3+ years.

BPOP Banco Popular: the last 12 months have been tough for Popular-- the share price dropped to $5 from $16 after 3 consecutive quarters of writedowns for bad loans. Management has responded appropriately by selling off their US mainland operations and focusing on their virtual stranglehold monopoly in Puerto Rico. They managed to pull in half a billion dollars of operating free cash flow despite reporting negative income for that period which bodes well for 2009 or 2010. Dividend is about 4% yield. Shares have rebounded to about $9 on a recent sale to Goldman-Sachs of more dodgy domestic mainland mortgages. It is over capitalized at 10.5%, providing a margin of safety in such tough times. I plan to hold with my stake for up to 3 years or a target price of about $20/share. I don't intend to acquire more shares because I have a large stake and find wider moat financials such as AXP more attractive as well has less risky.

PHG Royal Phillips Electronics: I was originally attracted to PHG because of its global footprint and very strong balance sheet (primarily due to the big cash reward from the Taiwan Semicondunctor divesture). I liked the way management was selling off the low margin, cyclical businesses (like flat screen TVs) and instead concentrating on the more profitable health care/medical device, "green" LED and personal care products. It has become a simpler company and easier to understand how they make money. Great fundamentals with P/E of 8 EV/EBIDTA of 9, PEG 1.06 P/S 0.79. ROE double digits. The downside I've come to appreciate is the expensive acquisition driven strategy (i.e. Respironics) focus instead of emphasizing organic growth. The share prices is slowly dwindling away from $41 down to $31/share. Certain gurus with large positions are selling as of June 08. I intend to hold for another 18 months as I'm not convinced that this is a great company worth sticking with through thick and thin. I would sell in the mid 50's.
Over time I've become more of a fan of the spin-off spawn (i.e. COV) of these big, bloated conglomerates rather than their parents. Recent legislation mandating LED use may be the near term catalyst to push up the share price.

MKL Markel Corp: an extremely well managed specialty insurance company that I've admired for a long time and has only recently become cheap enough to interest me. Pricing pressure on underwriting profits has squeezed the share price to 2005 levels. One of the most respected gurus, Tom Gayner (a potential replacement for Warren Buffet, according to rumour) is the chief investment officer. Short term outlook is weak, long term is excellent as its competition is crushed in the current adverse environment and its long term investments pay off. This is a long term RRSP type hold for me (3 years +++) that I intend to add to if the shares drop in the low 300's and consider selling some if they hit double that (and maybe not even then). The nice thing about insurance companies is that: 1. they are in a slowly changing industry with predictable cash flows (mostly) 2. product obsolescence doesn't affect them much 3. inventory management is moot. When they are cheap and well run, they are amongst the safest long term investments. This is why there are so many insurance companies that hang around for > 100 years.

Y Alleghany Corp: Another favourite of mine- an investment holding company with insurance subsidiaries and a very long term focus, currently trading at levels just above 2006 prices. High (35%) insider ownership but not so high that shareholders can be ignored. Debt = 0 and good fundamentals. This is a safe investment for very long term investors as most of the investments the company makes is in distressed companies---- an endeavour for the most patient. They bought Burlington North before Buffett did. I hold in my RRSP and will add at $300 and below, hold for 3 years++ and consider selling some at $550 and up.

Dell Computer DELL: over the last 5 months, Michael Dell has personally bought 200 Million dollars worth of common stock on the open market, half purchased last week after the stock plunged 18% due to a disappointing quarter. HP has been eclipsing Dell on the international stage, narrowing Dell's moat markedly. Dell hasn't brought its expenses into line fast enough to impress investors. This includes many long term value guru investors like Dodge and Cox, Bill Miller and Bill Nygren. It's true that top line growth was impressive in this hostile economic environment but this has been achieved at the expense of slimmer margins. The thrust of its business plan is to focus on the higher margin server, storage and peripherals segment of their revenue mix and they have executed in that regard. There is concern about conflicting efforts from their direct and indirect sales forces. One also wonders why they are delving so aggressively in the poorly rewarding area of low end notebooks. Despite all these worries, as the revenue mix improves and cost cutting measures finally show up in the bottom line, there is good potential for margins to turn around over the next 3 or so years. The other facts that should not be easily discounted is that Dell is a cash generating monster: virtually no debt, 10 billion dollars of cash in the bank and it generates $3 billion dollars of annual free cash flow (!). I would be happier if a dividend was being paid by this more slowly growing company during the protracted turn around and I think Dell should pay one. I have arbitrarily decided to wait another 4-6 quarters or until the share price hits the high 30's-- whichever comes first.

LM Legg Mason: a best of breed asset manager having hit hard times. SIV vehicles held in their income funds had to be supported by cash from the company's balance sheet in order to prevent LM from having to sell them under duress at pennies on the dollar. Certain managers have badly underperformed the market, particularly value guru Bill Miller and this has lead to prodigious outlows of the giant pile of AUM (assets under management). Few doubt that LM will survive though, with more than sufficient liquidity (current ratio > 2) 3.5 Billion dollars of unrestricted cash in the bank and considerable FCF generation and 3.4 B in long term debt. Management is seasoned and there is considerable insider buying. It is the most widely held security of the value gurus who have been aggressively adding to their stake of late. (One exception is Richard Perry who sold his stake in June). The stock has appreciated from about $28/share to about $44/share and I'm currently holding for the long term (3+ years). A 2% dividend helps offset the inflationary bite of the wait. I would add more shares to my portfolio if it dropped into the low 30's again. I would be tempted to sell some > $100/share.

AXP American Express: another badly wounded "Best of Breed", wide moat, minimal Capex, slowly changing and highly profitable (historical average ROE > 30%) business. Wall St. sold it off because of concerns regarding increasing default rates, even among prime cardholders. With 20 Billion in cash and a current ratio of 3.5, liquidity isn't an issue-- yet. 6.1 Billion dollars of annual free cash flow doesn't hurt either. AXP has not traded at such favourable valuations since that dark day on September 11, 2001. Berkshire is the largest shareholder. 15 value oriented gurus hold this stock in their portfolio, most of whom have added to their stake in the past 6 months. Some largeish insider purchases in February but not much since. The securitization used to fund the credit card business is a source of worry as well to analysts: dislocation in similar markets may impact earnings. Decreased prime and super-prime consumer spending will cause the discount rate charged to merchants to be squeezed and adversely affect margins. I think that these are short term concerns and I would happily buy more AXP in the mid 30's and hold for the very long term (3++ years) as it is a great company. Depending on the fundamentals at the time, I might be tempted to sell some at >$85/share. A modest dividend yield of 1.8% helps offset the effect of inflation.

UNH United Health: hated HMO (with good reason) with recent change in governance (a good one). Black clouds hanging over the whole managed care sector due to political risk (new president coming.... will there finally be reform down South--- doubt it), deteriorating medical cost ratios and the stink of the backdated options scandal lead by the former CEO. Wide moat with economy of scale. Knocked down by the market to unrealistically low valuations (<50% style="FONT-WEIGHT: bold">BAM.A Brookfield Asset Management (TSX version): a great company that I have blogged abundantly about; however, it hasn't been cheap lately. Worth holding for the long term or indefinitely. I would buy in the mid-20's and sell portions (possibly) in the 40's.

AIG American International Group: another famed Warren Buffet quote:

"I have three boxes on my desk: In, Out, and Too Hard."

this is an example of an investment assessment that has become "too hard". AIG had potential to become a great company but it has become too big and too complex. The corporate governance has reflected this fact and it seems clear to me that they are just as baffled as I am about the liquidity status of the whole as well as the risk assessment of the credit default swap portfolio and subprime mortgages they hold, particularly in Europe. I can't make heads or tails of their reports-- this should have been a red flag for me. I was (and still am) to their excellent reputation and footprint in emerging markets; however, it appears the horse is out of the barn in Europe and North America. Morningstar has laid out 5 different recovery scenarios and 4/5 aren't great for shareholders. The market is anticipating that AIG will need to do a secondary dilutive offering of stock to shore up their balance sheet and that's why the share price is in free fall recently. My plan is to wait until the Lehman panic boils off and then sell half of my stake on any strength and hold the other half for the intermediate term or until the share price (or if it does) increases into the 30's and beyond.

KMX Carmax: best of breed used auto retailer with an excellent business plan (described in a previous post) and superb management. Will likely take even more market share during the sector recovery. Good liquidity current ratio 2.8-- it's not going anywhere, unlike a lot of competition. Downside is slim net margins and competition may replicate their business plan (although they've failed so far). Lots of short interest (23% of outstanding shares are short!)-- subject to "short squeeze" when the shorts rush to cover during a turn around. I plan to hold my stake unless tempted to buy more at $12/share or less and sell if it hits the 30's+. Intermediate term hold due to narrow moat and tight margins-- 18 months-3 years.

NVS Novartis SGP Schering-Plough SNY Sanofi-Aventis: these are my "best of breed" favourite big pharma basket of companies. NVS is a leader in the vaccine market and has no debt. SNY is a Buffet stock with a great pipeline. SGP is well managed and overly punished for the Vytorin surrogate outcome studies and a data dredging phenomenon that suggests an increased cancer risk-- the significance of the findings that has been exaggerated by some silly academic doctors who still don't realize that a LOT of people will never tolerate statins and still need to be on a cholesterol drug for their entire lives. All are wide moat companies with excellent long term potential suitable for an RRSP.

Shopping List with entry target prices.

Note: I don't intend to buy all of these or even most of them-- being on this list means that I'm actively researching the companies and closely monitoring the share prices for a possible entry position

POW.TO Power Corp: < $30/share. One of the best of breed holding companies with high insider ownership, astutely managed by the Desmarais family.

IVSBF.PK Investor AB: <$19/share. One of the best of breed holding companies with high insider ownership, astutely managed by the Wallenberg family.

TYIDF.PK Toyota Industries Corp.: <$25/share-- a Marty Whitman favourite holding company to buy Toyota Motors on the cheap.

PKX Posco: arguably the best managed steel company in the world and may well have the best balance sheet. Buffet stock. I couldn't resist if it fell below $75/share.

DEO Diageo: This article summarizes the bull case better than I could. This is also one of my favourite investment ideas currently. Another excellent analysis here. Wide moat stock with growth and a dividend to boot. Definite RRSP material. Buy at <$70/share

ZMH Zimmer Corp: wide moat orthopedic device company. Great balance sheet and free cash flow. An excellent long term holding if you can get it cheap enough-- <$65/share

ATD.B.TO Alimentation-Couchetard: undervalued and a buy at <$11/share

HHULF.PK HAMBURGER HAFEN UND LOGISTIK: This virtual monopoly was reviewed earlier this year under post "Hamburger, anyone?", the first 1/2 2008 results are summarized in this investor presentation here. Strong results across the board with increasing ROE, gross margins, net profit (up 43%) and decreasing capex. The slowdown in emerging market's trade with the European hinterlands due to moderating global economic conditions is partially offset by anticipated further cost controls and the anticipated corporate tax cut for German corps. The stock took a huge hit this week-- dropping from about 55 Euros a month ago to hovering around it's all time low of 40 euros today. I assume that global recession concerns are the main driver of the sell off but I'll keep hunting. My entry point will be in the mid to high 30's. This is also one of my favourite investment ideas currently.

Insight on AEO by Ponzio

2008-08-23T13:28:00.001-07:00

Seekingalpha.com article here.

Previous articles and comments on AEO here.

I'm anticipating more fall out from the US consumer this fall and will likely buy more AEO at hopefully less than $10/share. My target price is $25/share ((assuming operating margins of 20% and 10% top line sales growth over the next 5 years) with a 18 month investment horizon. I'm not interested in a long term hold for this company because:

it has no economic moat (durable competitive advantage)
it is a fairly rapidly changing biz (fashion) known for fickle consumer behaviour
only a modest dividend to keep me entertained while I wait

SOX and Executives busting rocks : an Editorial

2008-08-21T11:32:00.000-07:00

‘Sunlight Is the Best Disinfectant’

U.S. Supreme Court Justice Louis Brandeis

The Sarbanes-Oxley legislation (SOX) was signed by George Bush July 30, 2002 in response to an increasingly skeptical public's view of corporate governance. Enron's fall in 2001 was followed by wave after wave of exposed executive kleptocracy. The point of the law was to dramatically increase corporate financial internal monitoring, auditing and reporting to achieve better transparency for current and potential investors.

Since then a backlash from Main Street (the HQ for many large cap companies in NYC) gathered momentum, suggesting that the reporting requirements were too expensive (particularly for small companies), resource intensive and was driving away foreign investment and domestic IPO listing on American exchanges. There's little debate that SOX is expensive to comply with; however, more recent papers describe lower borrowing costs and relatively increased share prices over time with compliant companies who show no material weakness in their financial reports.

The hue and cry over the "draconian" regulation has subsided since the credit crisis has exposed the results of extremely poor stewardship in the financial sector-- particularly amongst the investment banks (Bear Stearns, Merrill-Lynch etc) who had opaque balance sheets stacked with complex derivatives. Few can argue that less regulation would have prevented this disaster although one can surmise that badly designed legislation could easily do more harm than good. I agree that more is not always better and I do believe in the general principle of free markets--- within reason.

Quarterly and annual financial reports are signed by the CEO and the CFO. If a material misrepresentation is eventually found in that report, these executives can and will go to prison for up to 20 years. Despite what SOX critics say, they actually do go to prison for ---- ask Dennis Kozlowski and Mark Swartz of Tyco infamy, Kirk Shelton of Cendant, and of course Lord Black of Hollinger International. These white collar thieves were caught and put in jail for sentences that exceed that given to serial rapists here in Canada.

Whether you agree with that or not, it cannot be argued that this is a VERY strong disincentive to commit fraud.

When is the last time you can remember a Canadian executive going to jail for approving or actively participating in such obvious fleecing of the common shareholders? Remember Bre-X? No one spent a single day in jail for that one. It should be interesting to see if anyone actually gets materially punished for the Livent debacle. There are many more examples.

The reason I worry about investing in specific companies based in emerging markets (particularly Russia and China) is that standards of corporate governance simply do not exist by the oligopolistic nature of their governments. Security laws are antiquated and rarely invoked-- that is, unless you are an enemy of the current Czar (read the story of Mr. Khodorkovsky).

Most humans behave in a largely predictable manner due to internal and external incentives and disincentives. It shouldn't be surprising that the Chinese and Russian populaces have embraced their recently unencumbered markets. Whether we recognize it or not, we are all wired to be capitalists. We can choose to be a socially responsible capitalist like Warren Buffett or a ruthless backstabbing superficial ass like Mr. Trump. Without sensible regulation, history suggests that more Trumps and Lord Blacks emerge.

I maintain that despite several ugly blemishes that are in plain view (unlike many other countries in the world where the dirty laundry never sees the light of day), the large cap, wide moat, multi-national businesses based in the United States and subject to SEC scrutiny and US law are the easiest to analyze from the available information to the average investor. Their internal workings are the most transparent and their executives and corporate boards are the most accountable. I would suggest that the best way to invest in India and China is to buy companies like Caterpillar (CAT), 3M (MMM), Kimberly-Clark (KMB) or Harley-Davidson (HOG).

l

BAM revisited

2008-08-20T08:51:00.000-07:00

This article presents a rare (for seekingalpha.com, anyway) balanced view of the current investment status of Brookfield Asset Management.

I agree with the poster that the long term view for BAM is excellent. I'm hoping for the share price to drop back to 52 week lows (around $25/share) and then I intend to double my position.

Read the article here.

l

Mandatory Reading: Brandes on Value v.s. Glamour investing in Emerging markets

2008-08-17T16:21:00.000-07:00

A quantitative argument for using fundamental analysis for these companies.

My comment:

Can you trust the numbers derived from the financial reports of these largely corrupt nations? I think not. Consider an ETF if you want to dip your toe in these dangerous waters.

l

WEB makes moves

2008-08-17T13:48:00.000-07:00

see gurufocus summary here

l

4 oil service stocks

2008-08-17T11:53:00.001-07:00

I'm most interested in RIG of the four (due to valuation and the strength of management). I plan to wait until the late fall or until oil drops into double digit territory (if it does), whichever comes first.

4 oil service stocks

History Lesson about Value Investing from Ponzio

2008-08-17T11:45:00.000-07:00

Value Investing vs. Value Pretending

by: Joe Ponzio posted on: August 16, 2008 | about stocks: BRK.A

For more than 50 years, great "value" investors — Warren Buffett, Benjamin Graham, Charlie Munger, Seth Klarman, to name a few — have been touting the benefits of investing when there is blood in the streets, buying businesses when they are on sale. At each turn, somebody would ask them: Aren't you concerned that, by constantly talking about how you became so successful, you'll create a following that will, in turn, increase competition and reduce your potential investment returns?

It is said that value investing is more popular today than ever before. I tend to disagree.

Investing ... 50 Years Ago

I am going to journey back to a time before I was born: 1958. The Dow Jones Industrial Average [DJIA] averaged about 10% a year from 1948 through 1957 (when looking at the average closing prices during that time). Stock prices were quoted in eighths and quarters, but most regular people only saw those quotes once a day — in the morning paper.

This was a time when you had to call a broker for a stock quote, who would in turn call a floor broker, who would then get the quote and update your broker. Assuming you didn't wait on the phone, your broker would call you back with a quote — sometimes several minutes later. Real time quotes and information? Not even a pipe dream yet.

It is said that Buffett never even had a tickertape machine in his office. And even if he did, how quickly could he really get price quotes? I mean — look at these things (right).

What chance did you have as a trader? Were you hand-plotting charts as they came across the tape? Then what? John Bollinger wouldn't be around to draw Bollinger Bands for another twenty-some years, Gerald Appel's MACD was still ten years away, and by the time you figured out your moving averages...they moved.

For the most part, regular people had absolutely no chance at being successful traders, speculators, or "growth" investors. To invest in stocks, you had one choice — buy stock in businesses that you would be comfortable holding for (i) at least an entire day, and (ii) regardless of the short-term swings.

There was no access to quick information; so, regular people had to buy knowing, and comfortable with the fact, that the price might be a few eighths or a few quarters higher or lower the next day. And when it was, you couldn't get too excited or too panicky because it took time for your broker to get an updated price — a price that could change rapidly in the few minutes it took for your broker to get the price, phone you back, take your order, and place and fill the order.

Investing Versus Speculating ... 50 Years Ago

Unless you were down on the floor of the exchanges every day, you had one of two choices: Buy great businesses when they were on sale (or down) or Buy random stocks, close your eyes, and hope for the best. In my dealings with people who had been saving and investing in the 1950s, I have found that most people opted for the first strategy. Even the most unsophisticated of investors invested soundly — buy great businesses, particularly when their prices were falling, and stay away from everything else.

What differentiated Warren Buffett from Aunt Bea and Grandpa Earl? One simple, yet often overlooked, thing: the breadth and scope of their respective Spheres of Confidence and Competence. Buffett was comfortable investing in a Sanborn Map — buying the business for less than the value of its stock and bond portfolio. Aunt Bea and Grandpa Earl didn't look for Sanborn Map; and, had they seen it, they didn't have the business and financial sophistication to buy and profit from it. Sanborn Map was outside their Sphere.

You know what else Aunt Bea and Grandpa Earl didn't do? They didn't see Buffett buying Sanborn Map and think, "Hey, we can do that too. Let's break up some businesses." Instead, they plodded along, buying stock in AT&T (T), Texaco, and other companies that seemed to have a big, sustainable presence in their area.

To Aunt Bea and Grandpa Earl, Sanborn Map was pure speculation. You know what? They were right! If they invested in Sanborn Map — without having Buffett's eye or ability — they would have been speculating. To them, speculating was uncomfortable and was to be avoided at all costs. After all, their goal was to invest so that they could one day be comfortable, and being uncomfortable throughout the process didn't make a whole lot of sense.

Along Came Wall Street

The 1950s began the Golden Age for Wall Street. Prior to that, brokers traveled the country, knocking on doors and selling stock. They would get checks from customers, finish their sales route, and then place the orders together — sometimes weeks after the customer first wrote the check. Remember: This was long before ACH, cell phones, and laptops. For crying out loud, Elvis Presley was just getting into the Army and it would be another year before Alaska would even become a state.

Technology. Advertising. Profits. By 1958, 83% of US homes had televisions — up from less than 1% in 1948, half of which were in or around New York City. And with television came...Wall Street commercials. It didn't happen overnight; but, eventually, the stock market became an exciting place where fortunes could be made...quickly.

The Schism on the Street

Aunt Bea and Grandpa Earl were not profit centers for Wall Street. They were boring, buy-and-hold investors — the type of clients a broker could go broke with. So, Wall Street had to "educate" them — teach them the difference between growth and value investing.

Sure, value investing is safe...but it's slow. Who wants 10% or 12% a year? These other stocks are ready to explode. They're gonna grow. They're...they're...they're growth stocks. Investing in growth stocks can get you to your goals two, no three, no...ten times faster.

Perhaps Aunt Bea and Grandpa Earl don't buy it. But their kids do. Born in the 1950s and 1960s, they started working and thinking about saving in the late 1970s and 1980s. Throughout the 1980s, young investors were growing more confused than their parents had ever been. On the one hand, the stock market was soaring and hostile takeovers, leveraged buyouts, and mega-mergers spawned a new class of billionaires. On the other hand, inflation and interest rates were out of control, banks were failing left and right, and the stock market was growing ever more volatile.

Aunt Bea and Grandpa Earl knew virtually nothing about the activities on Wall Street. All they knew was that Coca-Cola tasted great and everyone was talking about it.

The explosion in news, information, and selling the dream/showcasing the nightmare were the perfect recipe to create a new breed of investor: the short-term, growth-oriented trader.

"Old School" Investing Gets Murky

As "growth" and "value" became investment strategies, Wall Street built mutual funds and portfolio allocations around them. In time, "value investing" began to drift from its original meaning of "buying a sustainable business when it is on sale" to today's Wall Street definition of "investing in stocks that have low price to earnings ratios."

The Value Pretender

That fundamental shift in the definition of "value investing" leads us to Seth Klarman's Margin of Safety:

Value investing" is one of the most overused and inconsistently applied terms in the investment business. A broad range of strategies make use of value investing as a pseudonym. Many have little or nothing to do with the philosophy of investing originally espoused by Graham. The misuse of the value label accelerated in the mid-1980s in the wake of increasing publicity given to the long-term successes of true value investors such as Buffett at Berkshire Hathaway, Inc. (BRK.A, BRK.B), Michael Price and the late Max L. Heine at Mutual Series Fund, Inc., among others. Their results attracted a great many "value pretenders," investment chameleons who frequently change strategies in order to attract funds to manage.

These value pretenders are not true value investors, disciplined craftspeople who understand and accept the wisdom of the value approach. Rather they are charlatans who violate the conservative dictates of value investing, using inflated business valuations, overpaying for securities, and failing to achieve a margin of safety for their clients.

In short, Klarman is making the point that today's so-called value investments and value investors are, by and large, not true value investors in the old-fashioned sense of the word. To paraphrase Klarman: Value pretenders tend to buy what is down, without looking at whether or not it is cheap. They look at the PE ratio versus past PE ratios; they buy if the stock is trading near its 52-week low or wait until it pulls back from its 52-week high.

Investing...Today

Last month I wrote this post about business investing, and how it differs from "value investing" in the now traditional sense of the word. I guess I'm trying to start a revolution — a change in terms to help separate true value investors from value pretenders.

Answering the Question

Aren't you concerned that, by constantly talking about how [the gurus] became so successful, you'll create a following that will, in turn, increase competition and reduce your potential investment returns?

One thing that history has shown us is that most people are never really introduced to business investing, just growth and value investing/investments. And that makes a heck of a lot of sense. If you look at the expense ratio of the F Wall Street portfolio, you'll see that we effected just nine (now ten with the purchase of LNY) transactions in fourteen months. Any broker handling that account would starve to death having us as clients. Last year, four of the largest publicly held Wall Street firms generated more than $425 billion in revenue. To maintain that level of revenue on the backs of business investors, they would need more than 4.5 billion clients — roughly 70% of all individuals in the world.

But, if they can get you to double the number of transactions, they would need half as many clients to achieve the same level of revenue. If, on your own or (more likely) through their mutual funds, they could get you to do 100 transactions a year, they would need just 45 million clients — 99% fewer clients for the same revenue.

Thus, where is Wall Street's incentive to promote business investing?

The unintended result of these discussions about investing — growth investing, value investing/pretending, business investing — is that more people become interested, engaged, and intrigued. Sadly, many of these people don't have Aunt Bea and Grandpa Earl's patience and understanding (or the ability to recognize their lack of understanding) of investing, or the desire to learn how they should invest; so, they will jump from ship to ship in search of fast profits.

(Many people are so disgusted or disheartened with Wall Street and investing that they simply put it on the back burner, choosing to do nothing rather than risk making a mistake.)

This continued and growing trend will add more and more volatility which, in turn, can actually increase the potential for profits for true value investors but reduce the overall expected return for most "traditional" investors as they continue to trade and invest on emotion and lack of coherent, intelligent strategy.

Is value investing/pretending dead? It will have its moments in the sun. But mark my words: Business investing (Old-Fashioned Value Investing) will only get better.

(By the way: I don't have an Aunt Bea or Grandpa Earl. With a name like Ponzio? Think about it.)

The resurrection of value

2008-08-11T14:08:00.000-07:00

Read the Bloomberg article here.

For those of you who like to piggy-back: from Gurufocus.com

2008-08-10T20:10:00.001-07:00

Disclaimer: my family owns USB and GSK.

High Dividend Yield Stocks in Warren Buffett Portfolio: Gannet Co. Inc., Bank of America Corp., SunTrust Banks, GlaxoSmithKline, and U.S. Bancorp

August-10-2008

At this time of uncertainty, above average stock dividends may give investors some comfort. However, the risk of owning high dividend yield stocks is that the dividends may be cut. Buying the high dividend stocks Warren Buffett owns may be a safer way to go.

Here are some high yield stocks that have been recently owned by Warren Buffett and other gurus.

Gannet Co. Inc. (GCI)

Gannet Co. Inc. (“GCI”) operates as a news and information company in the United States and the United Kingdom . It operates in two segments, newspaper publishing and broadcasting and has a newly developed digital strategy segment that was started after several business acquisitions. GCI has a market cap of $4.12 billion; its shares were traded at around $18.02 with a P/E ratio of 4.60 and P/S ratio of 0.58. The dividend yield of Gannett Co. Inc. stocks sits at 9.18 percent.

In recent headlines, Gannet Co. Inc. has experienced a 36 percent net loss of income for the second quarter. A subsidiary of Gannet, The Cincinnati Enquirer, has also begun offering optional severance packages to its employees in light of declining economic conditions that have sapped its ad revenues. Total revenue for Gannet Co. Inc. has dropped 10 percent, with publishing advertising suffering the most.

Warren Buffet has owned over 3 million shares of GCI since before the second quarter of 2000 at a share price of $59.81 and witnessed its decline after a peak at $89.16 in 2003 to its recent all-time low of $29.05. This recent decline reflects the sentiment held by Warren Buffet that the era of newspapers has passed and that traditional news mediums are being interrupted by the internet.

Other gurus also have shares in GCI. As of the first quarter of 2008, John Rogers increased his shares in CGI 62 percent from the previous quarter while David Dreman decreased his shares 51.37 percent over the same period. Charles Brandes, Brian Rogers, NWQ Managers, Arnold Van Berg and Warren Buffet maintained their shares in the company despite the drop in share price. Guru Jean-Marie Eveillard, however, sold out his shares in the first quarter of 2008.

Director of GCI, Arthur H Harper, bought shares of stock recently, near the end of the second quarter of 2008 and Senior Vice President and Chief Digital Officer Christopher D Saridakis also bought shares at the end of April 2008. The price per share has fallen an average 24.69 percent since April.

Bank of America Corp. (BAC)

Bank of America (“BAC”) is one of the world’s leading financial services and banking companies. It serves individual small businesses, commercial, corporate and institutional clients across the U.S. and around the world. Bank of America Corp. has a market cap of $148.42 billion; its shares were traded at around $33.33 with a P/E ratio of 18.35 and P/S ratio of 3.01. The dividend yield of Bank of America Corp. stocks is at 8.65 percent.

After picking up Countrywide, and enduring several volatile quarters, Bank of America has become the nation’s largest home lender. However, Bank of America has yet to record a quarterly loss through the current credit crunch. The secret to success? Bank of America has diverse business segments, including a sizeable credit card division and a flourishing wealth management division.

Warren Buffet has owned BAC stock since before the second quarter of 2007 and has witnessed the stock decline in value from $48.89 per share to $37.91 per share by the end of the first quarter of 2008. Along with Richard Pzena, David Dreman, Chris Davis, Kenneth Fisher, Dodge & Cox, NWQ Manager, Ruane Cunniff, and Tweedy Browne, Warren Buffet has maintained his shares in the company. His holdings currently stand at 9,100,000 shares.

On the other hand, Brian Rogers, Hotchkis & Wiley, and Richard Snow increased positions in the first quarter of 2008 in BAC by 200 percent, 27.82 percent and 19.18 percent respectively from the previous quarter while Irving Kahn reduced his position 30.66 percent from the last quarter in 2007.

Several Directors in the company bought shares recently as well, Jackie M Ward, Thomas M Ryan, and William Iii Barnet each bought shares in the last several months.

SunTrust Banks (STI)

SunTrust Banks (“STI”) is a commercial banking institution that provides a wide range of services to accommodate the financial needs of its clients. Its primary businesses include deposit and credit services as well as trust and investment services. STI has a market cap of $14.85 billion; its shares were traded at around $42.01 with a P/E ratio of 11.87 and P/S ratio of 2.13. The dividend yield of SunTrust Banks Inc. stocks is high at 8.04 percent.

As reported by Triangle Business Journal, SunTrust Banks recently acquired First Priority Bank for $214 million and the assets for $42 million. SunTrust is the third largest bank in the Bradenton , Florida area where Priority was based.

Warren Buffet has owned shares of STI since before the second quarter of 2000 and seen the price per share fluctuate from $45.69 to a peak of $85.74 back down to the first quarter price of $55.14, reporting an overall price increase of 18.49 percent. Although Warren Buffet began with 6.6 million shares of STI, he now owns 3.2 million shares after making sales after the second quarter of 2001 and again after the second quarter of 2004.

All the gurus who own the stock have maintained their number of shares, including David Dreman, Brian Rogers, Chris Davis, Kenneth Fisher, Dodge & Cox and Ruane Cuniff. However, recently, in April, STI’s CFO, Mark A Chancy bought 3,000 shares of stock in his company at $52.56 a share and the price has decreased 20.07 percent since. Directors David H Hughes, G Gilmer Iii Minor, and Alston D Correll all also recently bought 10,000, 4,000 and 75,000 shares of stock, respectively, in July.

GlaxoSmithKline (GSK)

GlaxoSmithKline (“GSK”) is one of the world's leading research-based pharmaceutical and healthcare companies and is committed to improving the quality of human life by enabling people to lead a fulfilled and active life. They also have leadership in four major therapeutic areas: anti-infectives, central nervous system (“CNS”), respiratory, and gastro-intestinal/metabolic therapy. GSK has a market cap of $119.49 billion; its shares were traded at around $46.34 with a P/E ratio of 12.80 and P/S ratio of 2.64. The dividend yield of GSK stocks is higher than average at 4.62 percent.

Boston Business Journal recently reported a $15 million milestone payment from GlaxoSmithKline to Tolerex Inc. in order to support a clinical trial for diabetes treatment. However, GSK also recently declined a lung cancer developmental treatment with collaborative partner Exelixis. Currently, GSK stocks have experienced rising fluctuating prices.

Warren Buffet has owned 1.5 million shares of GSK since about the fourth quarter of 2007 and seen a price decline of 15.79 percent from $50.39 to $42.43 in the first quarter of 2008. Two other gurus also initiated positions in GSK, Bill Nyguen and Bruce Berkowitz bought 2 million and 2.3 million shares respectively during the first quarter of 2008. Other gurus maintained their shares in GSK, such as Dodge & Cox, Richard Snow, Sarah Ketterer, Edward Owens, NWQ Managers, Kenneth Fisher, John Keeley, Charles Brandes, and Tweedy Browne.

U.S. Bancorp (USB)

U.S. Bancorp (“USB”) is a financial services holding company. They operate full-service branch offices and ATMs and provide a comprehensive line of banking, insurance, and investment services to consumers, businesses, and institutions. USB is also the parent company of Firstar Bank and U.S. Bank. U.S. Bancorp has a market cap of $53.05 billion and its shares were traded at around $30.47 with a P/E ratio of 13.28 and P/S ratio of 4.06. The dividend yield of USB stocks is higher than average at 5.52 percent.

Recently U.S. Bancorp has had many insider buys which indicates a healthier, rebounding market. It has held up in light of the credit crises however, according to Morningstar, it was changing hands at single-digit multiples of below-trend earnings as investors fled the sector, before the big bounce in financials a few weeks ago.

Warren Buffet has owned shares of USB since before the second quarter of 2001 and seen the price per share rise from $22.79 to its current end of first quarter price of $32.26. He has also increased his holdings from 6.2 million to 68.6 million in that time. Dodge & Cox just initiated shares in USB in the first quarter, while George Soros increased his shares 30.29 percent and Ruane Cunniff increased his shares 17.42 percent, both from the last quarter of 2007.

On the other hand, Bill Nygren and Ronald Muhlenkamp both decreased their shares by 23.19 percent and 53.93 respectively while David Dreman, Wallace Weitz, Tweedy Browne, Kenneth Fisher, Brian Rogers, and Jean-Marie Eveillard all maintained their shares in the company.

Chairman, President, and CEO Richard K Davis just sold 173,673 shares of USB stock in July, and the price has increased 6.13 percent since. Vice Chairman, Andrew Cecere sold 50,000 shares of stock in mid April at the price of $33.10 and the price has declined 7.95 percent since then. Finally, Directors Jerry W Levin , David B Omaley , Arthur D Jr Collins , Joel W Johnson , Craig D Schnuck , and Douglas M Jr Baker all recently bought shares of USB, while Directors Terrance R Dolan , Joseph C Hoesley , P.w. Parker , and Diane L Thormodsgard all recently sold their shares.

American Eagle Outfitters: fabulous fundamentals but no moat

2008-08-07T14:05:00.000-07:00

This article (from seekingalpha.com) describes the current favourable value assessment along with the downside risk extremely well:

American Eagle Outfitters: Impressive Company, Tough Market

by: Steve Alexander posted on: August 07, 2008 | about stocks: AEO / ANF / TGT

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Most Americans are familiar with American Eagle Outfitters (AEO). The company runs over 950 American Eagle mall-based clothing stores, primarily aiming for the teen and young adult market. More recently, the company has also started 3 new concepts: aerie (50 stores), which sells (as management says) "bras and undies", Martin + Osa, which focuses on sportswear for the 25-40 age range, and 77steps, a new concept aiming for the baby and youth market. AE only sells it's own proprietary brands instead of sourcing outside labels. Their niche is "affordable fashion". In shopping terms, this would be a step above Target (TGT) and a step below Abercrombie & Fitch (ANF).

First, the positives. American Eagle is an extremely well run company. MFI return on capital levels have averaged about 69% since 2004, which is superb efficiency. Cash flow generation is similarly impressive, with free cash flow margin showing a 5-year 16% average. The company has compounded earnings per share at a 32% clip over that period. The balance sheet sparkles, with 370 million in cash versus no debt. Finally, management has been quite shareholder friendly, especially when compared to peers. American Eagle boasts a 3% dividend at today's prices, and payout ratio of free cash flow is only about 22%. The current dividend is quite safe and there is plenty of room for more dividend hikes. Any way you slice it, this is an effective company.

Even more exciting, American Eagle stock today boasts statistics that would make any value investor raise an eyebrow. Earnings yield is nearly 22%, or for old fashioned types, a 7.1 enterprise value (EV) to price ratio - insanely cheap. EV to sales is under 1. Free cash yield, my favorite valuation statistic, is huge at 15% (EV/free cash flow is 6.7). These are fire sale prices based on past levels of earnings and cash flow.

There is certainly a large amount of pessimism built into this stock - way too much, in the opinion of MagicDiligence. American Eagle's flagship stores are nearing saturation, but the aerie concept could have the potential to grow into a several hundred store chain. Also, slower expansion improves free cash flow generation, allowing more stock buybacks and dividend increases. A quick look at the Magic Formula screen shows a whole slew of clothing retailers being cheap... a clear sign that it's the industry, and not the company, being discounted. And when something is cheap solely because of short term macro-economic factors, it could be a good time to buy. American Eagle is a pretty good bet to bounce back strongly, and that's why MagicDiligence has a buy opinion.

Still, AE is not Top Buy material. Clothing retail, especially to teenagers, is a classic no moat business. There is a TON of competition in this space. Aeropostale (ARO), Abercrombie & Fitch (ANF), Gap (GPS), and PacSun (PSUN) are just a few of the competitors, to say nothing of the specialty stores as well as larger retailers such as Kohl's (KSS). Most all of these are well run companies with strong financial health and cash flow. The teen and young adult set are notoriously fickle on fashion. Ask Gap or PacSun shareholders about the pain when a teen clothier messes up it's product offering, even for just a few months. Compare this to a wide moat firm like Microsoft (MSFT), who has blown billions of dollars on sinkholes like MSN and the Zune, only to remain ludicrously profitable. All AE has is it's management, and there is little room for error.

In a nutshell, MagicDiligence loves American Eagle the company, but really and truly hates the business it', s in. It's a good buy for the do-it-yourself Magic Formula investor. But there are too many other Magic Formula entries with strong, built-in competitive advantages to recommend AEO as a Top Buy.

A "Sin" Stock with growth and value characteristics

2008-08-06T19:44:00.000-07:00

Diageo DEO: is a 122 year old UK based liquor, beer and wine producer and distributor to 180 countries across the globe. It is the largest company in the world of its kind and has the majority market share, particularly in Asia. Its products are skewed toward premium brands. 8 of the top 20 brands in the world are owned by DEO including Guiness and Cuervo. Diageo has even put a foothold in "Second Life", the famous online multiplayer game (see picture above).

Bull Case for DEO:

secular product supposedly "recession-proof"
product obsolescence not an issue in an industry with a very slow rate of change
some inventory (i.e. Scotch which is the fastest growing product segment) actually increases in value over time!
double digit growth in Asia
predictable cash flows (almost $3 Billion/year!) and fat net margins exceeding 20%
distribution scale and efficiency (along with valuable brands) gives DEO a wide economic moat
being based in the UK, revenues (and the stock price) are measured in the British pound: historically one of the most stable world currencies
eye popping ROE > 35%
dividend 3.4%
Morningstar's fair market value = $112/share v.s. recently trading around $70/share--> a 38% discount
75% of executive compensation is performance based, helping to align their interests with shareholders
Enterprise value/EBIDTA = 12: cheap historically for a stable, highly profitable company that deserves a multiple premium

Bear Case:

subject to adverse legal/social exposure ("sin" product)
ethical funds and investors will generally avoid alcohol purveyors, narrowing the market exposure ever so slightly
subject to heavy tax burden that may increase in the future
European market has a been an exceptionally slow grower for the company. Europe has also seen more intense competition and subsequent margin compression
foreign exchange risk of British Pound v.s. loonie/USD
Not cheap by conventional valuations: P/E (trailing) 17 P/B 6 PEG 1.44

The recent run up in the market has spoiled my opportunity to enter a position in DEO. I'd be interested at any share price < $70/share and hold for the very long term. I think that this is an excellent investment with a considerable margin of safety.

l

The Value Gurus View of today's market

2008-08-01T11:50:00.001-07:00

OWCH!

Read Bill Miller's shareholder letter here.

With the longest unbroken record of beating the S&P 500 index ever recorded Mr. Miller has gone from a widely admired to highly reviled status: he has badly underperformed over the last 2 years. Investors are so fickle, eh?

Regardless whether you agree with his last 2 years' investment decisions or not, you have to appreciate the tremendous resolve and discipline it takes to invest in the contrarian/value grain-- particularly if you're using other people's money who are not necessarily as patient as you would like. It's pretty easy to be an "armchair asset manager".

I am researching the following opportunities with summaries to follow:

Legg Mason LM update
Terex TEX (both TEX and MTW are infrastructure plays with dirt cheap valuations)
Manitowoc MTW
Power Corporation of Canada POW.TO
Indigo Books etc. IDG.TO
Alimentation Couche-tard update ATD.B.TO
Diageo DEO

Vitaliy Katsenelson: HMOs, Heal thyself!

2008-07-29T17:28:00.000-07:00

Mr. K's insightful and methodical analysis is highly respected by contemporary value investors and that includes me.

My brief comments and disclaimer: I own UNH and plan to add to my position on dips hopefully in the low 20's and high teens as the US election looms. My target price is $60/share based on a DCF analysis similar to this one by Dr. Price. I don't think that this company is a "great" one and don't plan to hold it for the very long term: it is known for treating its employees and clients very poorly. I do think that it is extremely undervalued (due to the emotional reaction many investors have towards the company?), even considering worst case political outcomes.as Vitaliy elaborates on below. Don't forget that the "vital few" agree with recognition of this value: Warren Buffett, Chris Davis and Edward Owens are amongst 9 gurus who own substantial amounts of UNH stock (WE recently bought at $47/share, adding to a 6.4 Million share holding).

You Don’t Have to Be Sick To Own HMO Stocks: UnitedHealth Group, WellPoint and Aetna
July-29-2008
[b]Vitaliy N. Katsenelson column: [/b]You want to buy straw hats in the winter. This sums up an important kernel of successful value investing: making decisions (buying and selling) that are unpopular at the time. (Of course, one has to make sure that, due to global climate change, winter is not swiftly followed by an ice age. In the case of the stocks I am about to discuss, today is winter and the summer will come again.) Shares of [b]UnitedHealth Group (UNH)[/b] and those of its HMO comrades have declined significantly over last six months. UNH has taken down its earnings guidance twice in 2008 from $3.90 to about $3 per share. Competition among HMOs is intensifying; the weak economy is not helping, as employers are looking for ways to save money and downgrading their health care coverage. HMOs have underestimated their medical costs. Of course, the rising unemployment is hurting enrollments and adding more pressure to an already sobering situation. So that is the bad news. Everybody knows it. HMOs' current, ex- (and there are plenty of those) and future shareholders know it. The bad news is more than priced into these stocks. With single-digit price-earnings ratios, HMO stocks are priced as if the sun will never to shine again, as if a lunar eclipse became a permanent celestial feature for the industry. UNH, as well as [b]WellPoint (WLP), Aetna (AET)[/b] and others, are priced as if they were going out of business. They are not! The sun will shine again. The baby boomers are getting older and are consuming more and more medical services. For good or bad, the HMO's role in the health care industry is unlikely to diminish. The industry has changed dramatically over the past decade. It consolidated. Now the top five companies account for roughly 80% of industry revenues. With fewer players, the more rational their behavior should be (read: stable pricing). The price war that took place in late 1990s, when the industry was very fragmented, and was responsible for record low margins, is unlikely to take place, at least to the same degree, this time around. Also, instead of trying to fight ever-rising costs of health care and getting a bad rap from consumers, HMOs are focusing on two things: 1) exercising tremendous buying power by extracting lower prices from health care providers and 2) embracing the inflation in medical costs by taking a cost-plus approach to pricing; in other words, passing medical inflation on to consumers. In the short run, as is apparent from recent announcements, both the "cost" and the "plus" parts are going in the wrong direction. The industry underestimated the recent rise in medical costs, and the weak economy has been (temporarily) detrimental to pricing. The value of a company is the present value of its discounted future cash flows. Thus, a great way to judge a company's worth is through the discounted cash flow model, which projects future cash flows and discounts them back at particular rate. Even if we project significantly lower, declining future cash flows (an unlikely scenario), we will still get intrinsic values that are higher than today's depressed stock prices suggest. Finally, there is a political risk--the elephant in the room. We have a presidential election and a strong Democratic candidate with a social agenda. This is bad for the HMO stocks, right? Well, though HMO stocks may have starred as villains in Michael Moore's movie Sicko, they are not at the core of the health care crisis and are likely to be a part of the solution. Public health care companies have generated $250 billion in revenues and $13 billion in profits in 2007. This may sound like a lot of money, and it is, but that only represents a net margin of 5% and a return on capital of 5%. Neither number screams, "We're fleecing the public!" In fact, they are close to the economics of government- regulated electric utilities. Let's say politicians decide to go after HMOs. They only have $13 billion of profits to work with; even if they halve HMOs' profitability, $6.5 billion will not solve trillion-dollar health care problems. Also, 81% to 83% of these companies' revenues go to paying for health care services (doctors, hospitals, drugs) and another 3% to 4% of revenues fall into Uncle Sam's pockets. It is hard to milk this industry for political gain. At the same time, if the new head of government decides to fix the health care problem by insuring the 45 million uninsured Americans, government will call on--you guessed it--the private sector HMO industry. HMO stocks look ugly in the short term, and the news flow may get worse before it gets better. But these stocks are trading at incredibly attractive valuations, have strong financial positions and great cash flows. Though they don't pay meaningful dividends, they are using every ounce of tremendous free cash flow to buy back stock. At today's depressed prices this could make a meaningful difference. In the case of UNH, the company can buy roughly 17% of its outstanding shares a year from its free cash flows. The short-term negatives--and I believe they are short term in nature--may be a blessing in disguise.

You Don’t Have to Be Sick To Own HMO Stocks: UnitedHealth Group, WellPoint and Aetna
July-29-2008
[b]Vitaliy N. Katsenelson column: [/b]You want to buy straw hats in the winter. This sums up an important kernel of successful value investing: making decisions (buying and selling) that are unpopular at the time. (Of course, one has to make sure that, due to global climate change, winter is not swiftly followed by an ice age. In the case of the stocks I am about to discuss, today is winter and the summer will come again.) Shares of [b]UnitedHealth Group (UNH)[/b] and those of its HMO comrades have declined significantly over last six months. UNH has taken down its earnings guidance twice in 2008 from $3.90 to about $3 per share. Competition among HMOs is intensifying; the weak economy is not helping, as employers are looking for ways to save money and downgrading their health care coverage. HMOs have underestimated their medical costs. Of course, the rising unemployment is hurting enrollments and adding more pressure to an already sobering situation. So that is the bad news. Everybody knows it. HMOs' current, ex- (and there are plenty of those) and future shareholders know it. The bad news is more than priced into these stocks. With single-digit price-earnings ratios, HMO stocks are priced as if the sun will never to shine again, as if a lunar eclipse became a permanent celestial feature for the industry. UNH, as well as [b]WellPoint (WLP), Aetna (AET)[/b] and others, are priced as if they were going out of business. They are not! The sun will shine again. The baby boomers are getting older and are consuming more and more medical services. For good or bad, the HMO's role in the health care industry is unlikely to diminish. The industry has changed dramatically over the past decade. It consolidated. Now the top five companies account for roughly 80% of industry revenues. With fewer players, the more rational their behavior should be (read: stable pricing). The price war that took place in late 1990s, when the industry was very fragmented, and was responsible for record low margins, is unlikely to take place, at least to the same degree, this time around. Also, instead of trying to fight ever-rising costs of health care and getting a bad rap from consumers, HMOs are focusing on two things: 1) exercising tremendous buying power by extracting lower prices from health care providers and 2) embracing the inflation in medical costs by taking a cost-plus approach to pricing; in other words, passing medical inflation on to consumers. In the short run, as is apparent from recent announcements, both the "cost" and the "plus" parts are going in the wrong direction. The industry underestimated the recent rise in medical costs, and the weak economy has been (temporarily) detrimental to pricing. The value of a company is the present value of its discounted future cash flows. Thus, a great way to judge a company's worth is through the discounted cash flow model, which projects future cash flows and discounts them back at particular rate. Even if we project significantly lower, declining future cash flows (an unlikely scenario), we will still get intrinsic values that are higher than today's depressed stock prices suggest. Finally, there is a political risk--the elephant in the room. We have a presidential election and a strong Democratic candidate with a social agenda. This is bad for the HMO stocks, right? Well, though HMO stocks may have starred as villains in Michael Moore's movie Sicko, they are not at the core of the health care crisis and are likely to be a part of the solution. Public health care companies have generated $250 billion in revenues and $13 billion in profits in 2007. This may sound like a lot of money, and it is, but that only represents a net margin of 5% and a return on capital of 5%. Neither number screams, "We're fleecing the public!" In fact, they are close to the economics of government- regulated electric utilities. Let's say politicians decide to go after HMOs. They only have $13 billion of profits to work with; even if they halve HMOs' profitability, $6.5 billion will not solve trillion-dollar health care problems. Also, 81% to 83% of these companies' revenues go to paying for health care services (doctors, hospitals, drugs) and another 3% to 4% of revenues fall into Uncle Sam's pockets. It is hard to milk this industry for political gain. At the same time, if the new head of government decides to fix the health care problem by insuring the 45 million uninsured Americans, government will call on--you guessed it--the private sector HMO industry. HMO stocks look ugly in the short term, and the news flow may get worse before it gets better. But these stocks are trading at incredibly attractive valuations, have strong financial positions and great cash flows. Though they don't pay meaningful dividends, they are using every ounce of tremendous free cash flow to buy back stock. At today's depressed prices this could make a meaningful difference. In the case of UNH, the company can buy roughly 17% of its outstanding shares a year from its free cash flows. The short-term negatives--and I believe they are short term in nature--may be a blessing in disguise.

Stock Market Hangover: A hair of the dog

2008-07-26T11:29:00.000-07:00

An excellent prospect for a RRSP holding. I plan to buy at <$70.

Victoria Contrarian Investing

Victoria Contrarian Investing Club Google Groups

Insider Ownership helps... or does it?

When Pigs Fly

Watching the insiders

Age before beauty

Chou gets crushed

Priceless

A friendly 'bot: ISRG

Another old, wise man speaks--- you should pay attention

Positioning for a recovery---- whenever that will be

Interesting times and more mea culpa

A Silver-back Grizzly roars again

Bear Market Rallies and Opportunities

Mad about James J. Cramer

A billion here and a billion there... soon you'll be talking about REAL MONEY

The charges laid against us

Grantham Video gives excellent advice

Slightly less depressing reading material

Look at Nokia NOK

Feel a COP?

3 gurus to watch

Yet more reasons to ignore (most) analysts

Must watch

Studying Conocophillips... again

It's tough not getting depressed....

Why you should ignore experts and do your own research.

Victoria Contrarian Investing Club Launch

Sum of the parts analysis

P/B

Seth Klarman speaks on the value investor's perspective

Fortress Paper: a cheap, profitable microcap

SYK v.s. IHI

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

Risky business

A few pictures that tell an important story... click on the graphs to see the whole thing

Have a look at USG

Q&A with Buffet-- Part I, II and III

David Dreman's Forbes article

More BAM: cash flow analysis

A couple of opportunities to watch for...

Bill Miller's Q3 letter

Wait until Santa does his thing

Gurus falling down

The Year of Wall Street's Fallen Idols

Chagrined, even ashamed, about your portfolio losses? Take heart: Even managers with some of the best reputations on Wall Street have seen their holdings savaged this year.

By BRETT ARENDS

WSJ International

New stock to study: Mohawk Industries MHK

Bedtime reading for China bulls and Gold-bugs

A little brain damage might make you a better investor...

BAM-- Technical Knock out from the G&M

Along the same lines

Asia rising

"Net-Net" bargains

Contrarians hate it when the market moves up!

Pzena's view of value opportunities

Don't fight the drug dealers--- buy them!

Invest in the Investors: LUK Leucadia National Corporation

when a dollar goes for $0.60

More comments and stocks ideas to exploit the panicked selling

If you haven't read it already

Grumpy old man = brilliant investor

The greatest challenge now: Allocation of Capital

Time to buy the survivors

Seth Klarman's comments about today's opportunities and risks

insane P/E ratios from Bespoke

Tips for bargain hunting from Morningstar

Value in Healthcare as well as safety

Ponzio's view of today's situation

International Blue Chips on sale

Wow

The Buffett Bailout + Plan

PHG: Phillips is too cheap to ignore

A notorious bear who has done very well recently

Bogle wisdom

Ponzio's notes on Monish Pabrai's presentation

Notes from the Pabrai Funds 2008 Annual Meeting

Buffett's comments about the bailout and more

Buffett pulls the trigger again.