Code Red

This is a tough book to review.  It is correct in analysis of what went wrong, but overpromises in what its main goal is — protecting assets before the next financial crisis.

Let me take a step back, and describe the structure of the book.  A major goal of neoclassical macroeconomics is to try to eliminate the business cycle, and end up with smooth growth that minimizes unemployment.

As a result, central bankers, since they have a freer hand than politicians, as they are appointed, not elected, act to try to stimulate demand by lower interest rates.  They did that from 1982 to 2008, until they came to the bottom rung of their ladder, and realized they could go no further.

Thus “Code Red” — a situation that is an emergency.  Many central banks felt they needed to act in an emergency to create liquidity to pump up economies with significant financial bankruptcies.

Would it work?  When the central bankers started, all they had was theory, and  Japan.  Japan had tried out their theory, and it did them no good.

The academics argued that Japan did not do it right, and sadly, one was the Chairman of the Fed.  Would that Bernanke had done his Ph.D. dissertation on another unrelated topic.  Some historical accidents are real killers, and this was one.  (As an aside: always be wary of academic researchers that have a lot invested in an idea.  They cease to be neutral, and cause contrary data to be ignored, because you can always find a method to twist the data.)

Anyway, that is the first and longer part of the book explaining how bankrupt. untested theories led us to a situation where debt levels are high with governments, and central banks are ultra-loose.  In such a situation, nations will try to weaken their currencies to gain a nominal advantage over other nations, so that they can export more.  Eventually, it could lead to a currency war of competitive devaluations, or worse, a trade war of competing tariffs.

If central banks cooperate with their governments, they can repress people financially, making the rate that they can invest in with safety to be lower than the inflation rate.  The authors believe that governments will try to do that and eventually fail, because credit creation will eventually lead to significant inflation.

One virtue of the book is that it shows that economists with influence over policy don’t know what they are doing, but make a bold show of it.  Particularly telling is Bernanke on page 135 saying the Fed can mop up excess liquidity at the right time, and he is 100% confident of that.  The Fed has never succeeded at that before, so who is he kidding?

The second half of the book deals with how to protect your assets — half is generous here, because it is 25% of the book.  It goes over the permanent portfolio idea of Harry Browne, and then a series of non-solutions in Chapter 10, essentially arguing that diversification is called for.

Chapter 11 argues for inflation protection through buying shares of companies that have moats, such as:

  • Valuable Intellectual Property
  • Benefit from strong network effects
  • Are low cost producers
  • Have lock-in, and customers can’t switch easily
  • Natural monopolies and monopolies of market niches

These are good ideas, in my opinion, but difficult to continually implement.  The book gives companies that presently fit the ideas of the authors, but updating it, and knowing how to trade it is tough.  We’ve been through eras like the early ’70s, where companies like this have cratered, so this strategy does not come without the possibility where it becomes too popular, and gets abandoned.

Chapter 12 goes through commodities and gold, and is bearish on them, arguing that the commodities supercycle is dead, and that gold is tied to real interest rates.

In short, the second half of the book is thin.  If you are looking for protection, maybe the book should have said, there aren’t a lot of great ways to seek protection against the monstrous economic policies of the developed world and China, but that wouldn’t have sold many books.


I disagree with the first chapter that we had to have bailouts.  The government could have protected regulated subsidiaries of the banks, and derivative counterparties, and let the holding companies fail.  I also disagree that we had to have abnormal monetary policy to stem the crisis — so long as there is a positive yield curve, there is stimulus, but once you get down near zero, perverse effects kick in.

The rest of my disagreements are already expressed.  To summarize: the first half of the book is good, but the second half is thin gruel if you want to protect your assets.

Who would benefit from this book: If you want to understand the causes of the crisis this is a great book to buy.  For protection of your assets, it will give you a few ideas, but no solution.  If you want to, you can buy it here: Code Red: How to Protect Your Savings From the Coming Crisis.

Full disclosure: I asked the publisher for a copy of the book, and he sent one.

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.

Rest of the World


  • Morgan Stanley Leads Japan M&A for 1st Time Since 1997 Global expertise is @ a premium w/many deals across borders $$ Nov 30, 2013
  • Can Phone-Charging Stove Cut Wood Pollution and Save Lives? Cook food w/less fuel & pollution; make electricity $$ Nov 30, 2013
  • Carney’s Housing Alarm Bell Nudges BOE Toward Stimulus Exit But will he really do it? Economic growth isn’t fast $$ Nov 30, 2013
  • In Thailand, It’s Crippling Déjà vu All Over Again Democracy does not fit the cultures of some nations well $$ Nov 29, 2013
  • OPEC Rift Emerging Over Iraq Output, Possible Return of Iran OPEC? Forgot about them. Iraq oil production grows $$ Nov 29, 2013
  • Aussie Set for Longest Drop Since 1997 After Takeover Rejected A currency is less valuable when use is restricted $$ Nov 29, 2013
  • Rice Bond Flop Adds to Yingluck Protest Misfortune Feels a little like 1997, could b messy in emerging markets $$ Nov 29, 2013
  • How Poland Became Europe’s Most Dynamic Economy Great, but just watch the outsized entitlement liabilities $$ $SPY Nov 29, 2013
  • Paul Krugman’s Blind Spot The countries that did not increase their deficits have done better than those that did $$ Nov 29, 2013
  • Zeppelins Seen Hauling Caterpillars to Mine Siberia Fascinating way 2 move heavy machines 2 mines in Siberia $$ Nov 27, 2013
  • Rich Russians Sparring With Putin Over $48B Olympics Bet Cloudy view of who pays 4 & benefits from building Sochi $$ Nov 27, 2013
  • Pope Urges Countries Regulate Markets in Poverty Battle Jorge Bergoglio doesn’t understand the Bible; thus he errs $$ Nov 27, 2013
  • In Iran, Obama Achieves 50% of His Goals If everyone is unhappy, it might be a good deal; looks like Iran is happy $$ Nov 25, 2013
  • Europe’s Easy-Money Policy Snubs German Savers Germans should take vacations in Portugal, Italy, Greece, & Spain $$ Nov 25, 2013
  • Islamists Settle on Turkey-Syria Border as War Blurs Lines Multiple player wars r inherently unstable & risky $$ Nov 25, 2013
  • Extremist Tide Poses Growing Threat to Europe, Katainen Says Euro puts nations in a straitjacket, fuels extremists $$ Nov 25, 2013
  • All for One: Xi Jinping and China’s New Deal Argues that the Chinese govt continues to centralize, not so sure $$ Nov 24, 2013
  • The Weekend Interview with Saudi Prince Alwaleed bin Talal Policies that favor Israel & Saudi Arabia r the same $$ Nov 24, 2013


Financial Sector


  • San Jose Pension Crush Spurs Bid to Ease California Pacts State laws will change 2allow cuts 2 nonaccrued benefits $$ Nov 30, 2013
  • Foreclosed Sales at US Auctions Double as Prices Gain This is a good sign; B careful 2get a clean title if buying $$ Nov 27, 2013
  • Wall Street Props CLO Boom as Rules Lift Costs Get them out the door b4 new regulations require risk retention $$ Nov 27, 2013
  • Banks may pay $105B more to settle mortgage tab Did the banks even *make* $150B from 2005-8? Who gets the fine $$ ? Nov 27, 2013
  • Could banks charge fees for deposits? Yes they could if the Fed tries to loosen policy further $$ Nov 27, 2013
  • How Regulators Will Toughen the Volcker Rule This is an impossible task & will result in lawsuits galore $$ #fail Nov 27, 2013
  • Speed Traders Meet Nightmare on Elm Street With Nanex Slanted article downplays Nanex’s insights on the markets $$ Nov 27, 2013
  • London Gold Fix Calls Draw Scrutiny Amid Heavy Trading Very difficult to eliminate all unfairness in benchmarks $$ Nov 27, 2013
  • Wall Street May Take Derivatives Regulator to Court Arbitrariness in issuing regulations leads 2 pushback $$ $SPY Nov 25, 2013
  • Tackling The Fed: Jeb Hensarling’s Promise At Cato After 100 yrs, it is time to review our $$ state of affairs Nov 25, 2013
  • Nonprofit that flipped homes to investors faces scrutiny Not necessarily illegal, perhaps unethical, sneaky $$ Nov 25, 2013


Companies  & Industries


  • Repsol Deal With Argentina Was Propelled by Pemex Pemex mediates/wins, $REP loses, gets $$, $YPF free, Argent wins Nov 29, 2013
  • How Alyssa Milano Created a Fan-Gear Fashion Empire for Women Create clothes women like in team colors, not pink $$ Nov 29, 2013
  • Judge Approves ResCap Settlement W/Housing Regulator Unsec debt recovers 35%; I remember when they were hot stuff $$ Nov 29, 2013
  • Maker of Nutella and Tic Tacs Confident in Family Hands Profitable organic growth &staying private. Smart strategy $$ Nov 29, 2013
  • Clean Wind Farms Catch Up to Dirty Big Oil The comments section is replete w/replies on the many ways birds die $$ Nov 27, 2013
  • Kobe Bryant’s $50M Shows Salary Cap Is Ruining NBA Easiest way 2ruin a professional sports team is pay star 2much $$ Nov 27, 2013
  • For-Profit Colleges Face Consumer Bureau Probe on Lending Roles Student debt is a lousy deal avoid it if u can $$ Nov 25, 2013
  • Western Digital unwraps hybrid-data-storage system Best of both worlds @ reasonable cost SSD&HDD $$ FD: + $WDC Nov 25, 2013
  • Monsanto vs. Mutant Crop Developers in Global Seed Market There r multiple ways of creating new strains, y fight? $$ Nov 24, 2013


Politics & Policy


  • Obama’s call to close Vatican embassy is ‘slap in the face’ to Roman Catholics True enough, but I don’t c the need $$ Nov 29, 2013
  • Stay Home, America Commentary on trying to turn Thanksgiving into a shopping day & what it costs us as a culture $$ Nov 29, 2013
  • What a Higher Minimum Wage Does for Workers and the Economy Democracy doomed if people vote 4 $$ from Treasury->them Nov 27, 2013
  • Should We Bail Out Cities? Answer: no, we shouldn’t. Most bailout r in areas we knew were high risk already $$ Nov 27, 2013
  • Not so sure: Democrats Give Up 2014 With the Filibuster It’s a long way to the 2014 & 2016 elections $$ $SPY $TLT Nov 25, 2013
  • Rebirth Eludes Baltimore as Camden Reality Lags Promises Professional sports arenas r economic idol 4 destruction $$ Nov 25, 2013
  • The Senate Goes Nuclear, Fallout to Come A discourse on protecting the rights of the minority, a la the Founders $$ Nov 24, 2013


Market Impact


  • Warren Buffett and Time-Horizon Arbitrage Buffett as a quality GARP manager; challenge is finding durable moats $$ Nov 27, 2013
  • Why Are Takeover Prices Plummeting? Interesting 2c a lack of fervor among acquirers during high valuations $$ Nov 27, 2013
  • Madness & Sanity It is flattering to be quoted at such great length; Good thing that I do not enforce copyright $$ Nov 27, 2013
  • Stock Market Trading: The 20 Rules Of Engagement Useful rules 4short-term traders from the estimable Todd Harrison $$ Nov 27, 2013


PPACA / Obamacare


  • Hit-and-Miss Obamacare Site Still Frustrating at Deadline It could never have been fully fixed by 11/30 $$ $TLT $SPY Nov 29, 2013
  • A Fight Over Contraception Won’t Help Obamacare Tie PPACA 2 abortion & the fight is unlikely 2 ever end $$ Nov 29, 2013
  • Even Subsidized Obamacare Plans Haven’t Found Takers Yet Particularly among the young & healthy it doesn’t help $$ Nov 27, 2013
  • Is Obamacare Challenging Enough for Obama? Astounding to hear an ideologue like Margaret Carlson criticize Obama $$ Nov 27, 2013
  • Manias, Panics and ObamaCare Crashes PPACA was fatally flawed, the work of ideologues who don’t get healthcare $$ Nov 24, 2013



  • Startup Scrambles to Replace the Egg Intriguing idea 2try 2replace eggs w/ingredients commonly fed 2 chickens $$ $TSN Nov 25, 2013
  • When Marketing Is Strategy Adapt your products & services 2 meet needs of consumers 4 convenience & effectiveness $$ Nov 25, 2013
  • Magnus Carlsen’s Win in Chess Championship Shows Powerful Role of Computers Computers improve the abilities of men $$ Nov 24, 2013

I had two more good questions in response to my piece Why I Resist Trends.  Here we go:

I think you have some idea which ones are the best by the discount to intrinsic value. If you were running a business (which you are when you are investing) and you had 10 projects with lets say a minimum return of 5% but a spread of 20% to 5% wouldn’t you first invest in the 20% return project and fund each project in descending order of return. By equally weighing aren’t you equally investing in the 5% and 20% projects? If you were a CEO shouldn’t the shareholders fire you? I know the markets have more volatility than projects due to the behavioral aspects of investing but in my view equally weighting is more important when you do not know much about your investment and less important when you do. I think you know a lot about the companies you invest in. Why not try an experiment. Either in real time or historically take a look at what would have happened overtime if you would have weighed you selections by discount from intrinsic value. I think you will be pleasantly surprised. I and John Maynard Keynes have been pleasantly surprised.

I do this in a limited way.  In the corporate bond market we have the technical term “cheap.”  We also have the more unusual technical term “stupid cheap” for bonds that are very undervalued.

When I have a stock that is “stupid cheap” I make it a double weight, if it passes margin of safety and other criteria.  On one rare occasion I had a triple weight.

But I meant what I said  in Portfolio Rule Seven — “Run a largely equal-weighted portfolio because it is genuinely difficult to tell what idea is the best.”  I have been surprised on multiple occasions as to what would do best.  Investing is not as simple as assessing likely return.  We have to assess downside risks, and possibilities that some things might go better than the baseline scenario.

I don’t use a dividend discount model, or anything like it.  I don’t think you can get that precise with the likely return on a stock.  My investing is based on the idea of getting very good ideas, as opposed to getting the best ideas.  I don’t think one can get the best ideas on any reliable basis.  But can you find assets with a better than average chance of success?  My experience has been that I can do that.

So, I am happy running a largely (but not entirely) equal-weight portfolio.  It is an admission of humility, which tends to get rewarded in investing.  Bold approaches fail more frequently than they succeed.

By the way, though Keynes was eventually successful, he cratered a couple times.  I have never cratered on a portfolio level, because of my focus on margin of safety.

On to the next question:

What are the tests you use to check if accounting is fair?

Start with my portfolio rule 5, here’s a quick summary:

Over time, I have developed four broadbrush rules that help me detect overstated earnings. Here they are:

  1. For nonfinancials, review the difference between cash flow from operations and earnings.  Companies where cash flow from operations does not grow and  earnings grows are red flags.  Also review cash flow from financing, if it is growing more rapidly than earnings, that is a red flag.  The latter portion of that rule can be applied to financials.

  2. For nonfinancials, review net operating accruals.  Net operating accruals measures the total amount of asset accrual items on the balance sheet, net of debt and equity.    The values of assets on the balance sheet are squishier than most believe.  The accruals there are not entirely trustworthy in general.

  3. Review taxable income versus GAAP income.  Taxable income being less than GAAP income can mean two possible things: a) management is clever in managing their tax liabilities.  b) management is clever in manipulating GAAP earnings.  It is the job of the analyst to figure out which it is.

  4. Review my article “Cram and Jam.”  Does management show greater earnings than the increase in book value plus dividends?  Bad sign, usually.  Also, does management buy back stock aggressively — again, that’s a bad sign.

Then add in my portfolio rule 6, here’s a quick summary:

Cash flow is the lifeblood of business.  In analyzing management teams, there are few exercises more valuable than analyzing how management teams use their free cash flow.

With this rule, there are many things that I like to avoid:

  • I want to avoid companies that do big scale acquisitions.  Large acquisitions tend to waste money.

  • I also want to avoid companies that do acquisitions that are totally unrelated to their existing business.  Those also waste money.

  • I want to avoid companies that buy back stock at all costs.  They waste money by paying more for the stock than the company is worth.

  • This was common in the 50s and 60s but not common today, but who can tell what the future will hold?  I want to avoid companies that pay dividends that they cannot support.

Portfolio rule 6 does not deal with accounting per se, but management behavior with free cash flow.  Rules 5 and 6 reveal large aspects of the management character — how conservative are they?  How honest are they?  Do they use corporate resources wisely?

On Ethics in Business and Investing

I would add in one more thing on ethics of the management team — be wary of a company that frequently plays things up to the line ethically and legally, or is always engaged in a wide number of lawsuits relative to its size.

I know, we live in a litigious society — even good companies will get sued.  But they won’t get sued so much.  I realize also that some laws and regulations are difficult to observe, and interpretations may vary.  But companies that are always in trouble with their regulator usually have a flaw in management.

A management team that plats it “fast and loose” with suppliers, labor, regulators, etc., will eventually do the same to shareholders.  Doing what is right is good for its own reasons, but for investors, it is also a protection.  A management that cheats is in a certain sense less profitable than they seems to be, and eventually that reality will manifest.

All for now, and to all my readers, I hope you had a great Thanksgiving.

Portfolio Rule Seven says:

Rebalance the portfolio whenever a stock gets more than 20% away from its target weight. Run a largely equal-weighted portfolio because it is genuinely difficult to tell what idea is the best. Keep about 30-40 names for diversification purposes.

Rarely is a stock a better idea after it has risen 20%, thus, sell some off in case of mean reversion.  When a stock falls 20%, it is usually a better idea, but to make sure, a review should be done to make sure that nothing has been missed.  Since instituting this rule, I have only had two bad failures over the last 13 years.  One was a painful loss on a mortgage REIT, Deerfield Triarc, and the other was Scottish Re.

But still I resist trends.  Human opinion is fickle, and most of the time, there is overreaction.  As a guard, on the downside, I review new purchases to make sure I am not catching a falling knife.

Much of it comes down to time horizons — my average holding period is three years.  If the asset has enough of a margin of safety, the management team will take action to fix the problems.  That is why I analyze management, their use of cash, and margin of safety.  A stock may seem like a lottery ticket in the short run, but in the long run it is a share in a business, so understanding that business better than most is an edge.  How big that edge is, is open to question, but it is an edge.

Another reason I resist trends is that industry pricing cycles tend to reverse every three years or so, offering opportunities to firms that possess a margin of safety in industries that are not in terminal decline, like most newspapers, bricks-and-mortar bookstores, record stores, video rental stores, etc.  (The internet changes almost everything.)

The second last reason why I resist trends is practical — experience.  Most of my best purchases have suffered some form of setback while holding them — were they bad stocks?  No, time and chance happen to all, but a good management team can bounce back.  It offers me an opportunity to add to my position.  I made a great deal of money buying fundamentally strong insurers and other companies during the crisis, sometimes with double weights.

The last reason is an odd one — the tax code.  Short-term gains are disfavored, and also cannot be used for charitable giving.

So why not take a longer view?  I can tell you what you would need to do:

  • Focus on margin of safety (debt, competitive boundaries, etc.)
  • Analyze how management uses free cash (acquisitions, dividends, capital investments, buybacks)
  • Analyze industry pricing trends, at least implicitly.
  • Look at the accounting to see if it is likely to be fair (there are a few tests)
  • Look for cheap valuations, which may have ugly charts.  People have to be at least a little scared.

That takes effort.  I am by no means the best at it, but I do reasonably well.  I avoid large losses without having any sort of automatic “sell trigger.”  Most of my initial losses bounce back, to a high degree.

With that, I wish you well.  Have a great Thanksgiving!

My last post, On Investment Ideas, Redux, received two good questions.  Here they are, with my answers:

When using your quantitative factors, do your normally compare an investment idea relative to its sector, industry, or a custom comp group? I have dabbled in quantitative factor models in the past, and normally I start with an index, group by sector, and then compare each company relative to its sector (I use valuation metrics, liquidity, technical factors such as relative strength and price relative to moving averages, earnings volatility, earnings estimates revisions, balance sheet metrics, beta, and a proprietary risk/reward metric). How do you go about making the data relevant?

I try to look at what is overplayed and underplayed among factors and industries, and adjust my weightings accordingly.  I look for companies that add to economic value relative to price  I look for companies that may benefit from an industry turnaround or a corporate turnaround.  I look for pricing power, and how that is changing.

My industry and factor models are not integrated.  I use industries as a screen, but I look for value via valuations and factors.  Consult my eight rules for more on this.

I make the data relevant by letting my scoring model highlight promising ideas, and then killing those that are qualitatively bad ideas.

The second question:

Do you think the insurance company meme, while historically profitable, has now been over-exposed by yourself, AIG, Berkshire, etc?

Seems like the barriers to entry throughout the financial industry have collapsed (dis-intermediation by whatever name), and the trade looks pretty crowded. Every industrial concern has a financial arm as widely reported.

I have noticed a lot of de-mutualization of insurance companies, a lot of M&A / consolidation activity, and obviously asset management (new competitors) has grown all over the place. The financial sector (as a percent of the S&P) is back near all time highs.

Is the insurance meme now a crowded trade?

There have been others talking about this idea long before me, notably Tom Gaynor of Markel, a few of the CEOs in Bermuda, Eddy Elfenbein, etc.  There are significant barriers to entry on this trade:

  1. Insurance is not a fast growth industry.  As such, many investors ignore it.
  2. Insurance is not sexy.  Few buy insurance companies as a result.
  3. Insurance is the most complex industry from an accounting standpoint, if you exclude investment banks.  Few follow it in detail.
  4. Insurance profits are volatile in the short-run, but consistent in the long-run, for conservatively run insurers.  People get scared out of insurance stocks from the volatility.

Demutualization is a plus for the publicly traded insurance industry, because it makes the more industry more economic.  That said, there are few large mutuals likely to demutualize anytime soon.  They know that they have got it good.  Good pay. Little oversight.  Why change a good thing?

I would look at it this way.  Since capital easily flows into insurers, be skeptical when insurers with short liabilities have price-to-book over 1.5x.  For life insurers, and those with long liabilities, get skeptical when the price-to-book is over 2.0x.

We’re not there yet, but we are getting closer.  My exposure to the insurance industry is still significant, but well below my peak, where buying discounted insurance shares was easy money, and with far less risk than buying banks.  Banks were the better choice in this scenario, but insurers would have made it through uglier scenarios.  Less leverage and credit risk.

I have not always been a fan of insurance stocks.  In the 90s, I never owned them, because many took too much risk in investing.  Today, those bad old days are gone, and underwriting is designed to make a profit, on average.  And in an environment where many stock valuations are stretched, the valuations of insurers are reasonable.  The only question is whether capital levels are so high that competition on premium levels will be brutal.

My view is this: it will be difficult for the general public, and even institutional investors to warm up to insurance stocks to the degree that they make relative valuations unreasonable.  But if they do, I will be gone.  Somebody give me a spank on the seat if we get another era like the mid-2000s where insurers trade well above their book value, some above 2.0x, and I don’t sell.

I failed to sell as much as I should in 2007.  This time, I will be more measured.  As for now, my overweight on insurers is still a reasonable and likely profitable trade.  But as valuations go up, I will lighten the boat.

Would I disclose proprietary ideas of mine?  I’ve done it before.  Why would I do it?  Because it would take a lot to make the ideas usable.  Remember my commentary from when I was a bond manager: I was far more open with my brokers than most managers, but I never gave them the critical bits.

So a reader asked me:

Any chance you could expand on what quantitative metrics you are using to compare potential investments? Could you also name a few of the 77 13fs you track? Thanks

I will go above and beyond here.  You will get the names of all 78 — here they are:

  • Abrams
  • Akre
  • Altai
  • Ancient Art
  • Appaloosa
  • Atlantic
  • Bares
  • Baupost
  • Blue Ridge
  • Brave Warrior
  • Bridgewater
  • BRK
  • Capital Growth
  • Centaur
  • Centerbridge
  • Chieftain
  • Chou
  • Coatue
  • Dodge & Cox
  • Dreman
  • Eagle Capital
  • Eagle Value
  • Edinburgh
  • Fairfax
  • Farallon
  • Fiduciary
  • Force
  • FPA
  • Gates
  • Glenview
  • Goldentree
  • Greenhaven
  • Greenlight
  • H Partners
  • Hawkshaw
  • Hayman
  • Hodges
  • Hound
  • Hovde
  • Icahn
  • Intl Value
  • Invesco
  • Jana
  • JAT
  • Jensen
  • Joho
  • Lane Five
  • Leucadia
  • Lone Pine
  • M3F
  • Markel
  • Matrix
  • Maverick
  • MHR
  • Montag
  • MSD
  • Pabrai
  • Parnassus
  • Passport
  • Pennant
  • Perry
  • Pershing Square
  • Pickens
  • Price
  • Sageview
  • Scout
  • Soros
  • Southeastern
  • SQ Advisors
  • Third Point
  • Tiger Global
  • Tweedy Browne
  • ValueAct
  • Viking Global
  • Weitz
  • West Coast
  • Wintergreen
  • Yacktman

What I won’t tell you is what I do with their data, because it is different from what most do.  But you can play with it.

Then you asked about factors.  Here are my factors:

  • Price change over the last year
  • Price change over the last three years
  • Insider buying
  • Price-to-earnings, both current and forward
  • Price-to-book
  • Price-to-sales
  • Price-to-free cash flow
  • Price-to-sales
  • Dividend yield
  • Neglect (Market cap / Trading volume)
  • Net Operating Assets
  • Stock price volatility over the last three years
  • Asset growth over the last three years
  • Sales growth over the last three years
  • Quality (gross margins / assets)

Now that I have “bared all,” I haven’t really bared all, because there is a lot that goes into the preparation and analysis of the data that can’t be grasped from what I have revealed here.  To go into that would take more time than I can spend.  That’s one reason why as a corporate bond manager, I would share more data with my brokers than most would do, because I knew that the last 20% that I reserved was the real gold.  That I would not share.

Beyond that, there are my industry rotation models, which I share 4-6x per year, and then my qualitative reasoning, which makes me reject a lot of ideas that pass my quantitative screens.

That’s what I do.  It’s not perfect, and my qualitative reasoning has its faults as well.  I encourage you to develop your own theories of value, as Ken Fisher encouraged me to do back in early 2000.  Develop your edge, with knowledge that you have that few others do.  I’ll give you an example.

I understand most areas in insurance.  I don’t get everything right, but it does give me an edge, because insurance accounting and competition is a “black box” to most investors.  Insurance has been one of the best performing industries over time, but many avoid it because of its complexity and stodginess.

Behind the hard to understand earnings volatility, there is sometimes a generally profitable franchise that will make decent money in the long run.  But few get that, and that is an “edge” of mine.  Develop your own edge.

That’s all for now.  Invest wisely, and be wary, because the market for risk assets is high, and what if the Fed stops supporting it?  Make sure your portfolio has a margin of safety.

Sometimes I think regulators are in over their heads.  They aren’t talented enough to run a company, but they think they can control the excesses of financial companies.  Then there’s the Fed.  They think they can control an entire economy through the weak policy lever of affecting the views of people have for calculating what interest rates they should use to capitalize the values of assets.

Think of assets as a stream of future cash flows.  But what are those cash flows worth today, to buy or sell them?  The interest rate that makes the price and the cash flows equal is the capitalization rate, or, “cap rate.”

For years, at least in the Greenspan era, lowering the cap rate via Fed funds was the rule when times were weak.  He was the anti-Martin, bringing back the punchbowl rapidly when the party was getting a little dull.  Because of that, the economy grew more aggressively for a time, but at a price of growing unproductive debts.

The Problem

You can lower the interest rates as low as you want, but it doesn’t change the underlying productivity of the economy.  You might push asset or goods prices higher — it depends whether saving or spending is more important.  At present, actions of the Fed push asset prices higher, which doesn’t do much for the economy as a whole.  Rising asset prices do not stimulate the economy much.  Though it would be dishonest to do it, it would stimulate the economy more if Ben would rev up the “Helicopter of Happiness” and rain dollars from “Heaven.”

The Fed created the housing bubble with their policies 2001-2007.  They did that to stimulate the economy.  You can only use strong sectors of the economy to transmit monetary policy, because they can absorb more debt.

That’s true when not in a liquidity trap. We are in such a trap now, given the profligate prior Fed policy.  They did not let recessions destroy bad debts leading to a reduction in the marginal productivity of capital.  That value is so low now, that companies pay higher dividends and buy back shares.  Relatively little goes into growth via new investment.

My point is that monetary policy has some potency if central bankers are willing to inflict pain in the bear phase of the credit cycle.  With Greenspan and Bernanke, that was absent.  As such, we suffer in a liquidity trap, and one that current Fed policy will not remedy.  Far better to raise short-term interest rates and let some bad businesses fail, and grow from there.

The following was published at RealMoney on April 20th, 2007:

The Changing Business Environment

What do you think is the most important change happening in the competitive environment at present?

This query can highlight emerging issues and demonstrate how the company is adjusting to the changes. Again, you need to compare the answers of various managers against each other; an odd answer could either be ahead of the pack or out of touch. If you think the answer makes sense, it can open up new questions that further enhance your understanding of the industry and the role that the company you are interviewing plays in it.

After Hurricane Katrina and other storms in 2005, ratings agencies toughened up their risk models, and catastrophe modeling companies increased their frequency and severity estimates. This created an even greater squeeze in the 2006 property reinsurance markets than what the losses of capital alone would have caused, as happened to the 2005 property reinsurance market from losses suffered in 2004. New entrants in the reinsuring property risk space found that they could write only half of the premium that their more seasoned competitors from the class of 2001 could. Further, property-centric writers found the capital required went up more for them than for their more diversified competitors.

There was less effective capital in property reinsurance at the end of 2005 than at the end of 2004, even though surplus levels were higher on net. Those who recognized the change in the rules of the game caught the rally in the stock prices as the price for reinsurance went up more rapidly than most expected for the 2006 renewal season.

What laws, regulations, or pseudo-regulations (such as debt ratings criteria) would you most like to see changed?

This is another attempt to understand what most constrains the growth of the enterprise (see Part 1 for a different angle on the question). The answer should be something that is reasonably probable, or else the management is just dreaming.

For an investment bank like Goldman Sachs (GS), an answer could be, “We want the ratings agencies to agree with our view of our risk management models, so that we can get a ratings upgrade and lower our funding costs.”

For a steel company in the early 2000s, the answer could have been, “The government needs to enforce the antidumping duties better.”

A media or branded goods company today might say, “Better efforts by the government to reduce piracy both here and abroad.”

For companies under cost pressure, such as General Motors (GM) and Ford (F), the answer could be, “A better labor agreement that includes changes in the union rules, so that we can improve productivity.”

What technological changes are most driving your business now?

Technology often benefits its users more than its creators. Prior to computers, it took a lot more people to run banks and insurance companies. Now financial companies are a lot more efficient and hire fewer people than they used to as a result of the change. You as the analyst want to know about the next technological change that will lower costs or create new products in order to forecast increases in growth of profitability.

There are other technological changes, but the biggest one recently in business terms is the Internet. The creation of the Internet has changed the way people search for information. World Book Encyclopedia was owned by Berkshire Hathaway (BRK.A), which thought it had a pretty good franchise until Microsoft (MSFT) and others came out with their own cheaper encyclopedias on a CD-ROM. Now even these are getting competed away by Wikipedia.

Who else is being harmed by the Internet? Newspapers are under threat from all sides. Classified ads have been marginalized by eBay (EBAY), Craigslist, Monster (MNST), etc. Regular advertising has been siphoned off by Google (GOOG), Yahoo! (YHOO) and others.

What cultural changes are most driving your business now?

Cultural changes affect demand for products. As more and more women entered the workforce, demand increased for prepared foods and dining out options. Demand decreased for Tupperware parties and things sold door-to-door.

Cultural changes can also lower the costs of an operation. Outsourcing has lowered costs and improved time coverage for call centers, computer programming and many other service functions. The willingness of nations to embrace the cultural change of capitalism creates new markets that previously did not exist.

One more example, again from insurance: Insurance became a growth product when extended family ties weakened and nuclear families became the standard. Now as nuclear families break down and are replaced by a greater proportion of singles without children, some insurance markets are weakening (life) and others are strengthening (annuities, personal lines, individual heath and disability).

What regulatory changes are most driving your business now?

Before you talk to management, you should know the answer to this one. But what matters here is that you know that they know, too, and more importantly, are building that into the plans for the business.

To get you started, consider the possible impacts of some changes on a few industries. For a pharmaceutical company such as Merck (MRK) or Pfizer (PFE), this could be a change in the way that drugs get approved. It might be a larger political change, such as the recent election of the Democrats, which is expected to produce a change in Medicare reimbursement rates.

Increases in environmental regulation can affect the profits of extraction businesses significantly, whether agriculture, mining, silviculture, energy exploration and production and more. If it becomes easier to unionize, that can affect wage rates and productivity even more as work rules bite into effectiveness and flexibility of work; both of these can lower profits in labor-intensive businesses.

Now, these are pretty obvious examples, and most examples here will be obvious, because most regulation is done openly. The answers that a management gives can be a test as to whether they themselves know what is going on.

Sometimes the answers get a little more subtle. In personal lines insurance, it took analysts a long time to catch up with the safety trends that were bringing down the frequency and severity of losses, particularly graduated licensing for young drivers. Internally, the companies had figured it out long before they told the analyst community. The analysts who asked why severity and frequency of loss were so good and got an answer that allowed them to “connect the dots” to the regulatory change realized that there was a secular, not cyclical, change going on. Thus they were able to make money buying personal auto insurers, because the trend was likely to extend to more states.

Mergers and Acquisitions

Without naming names, what types of business alliances do you think could be most valuable in the future?

This helps flesh out competitive strategy. Managements will be reluctant to part with details, but usually are willing to explain their approach to supplier agreements, joint ventures and so on.

The answer to this question can also highlight the “missing pieces” for the current business, and how the management team is trying to source them. It can also shine a light on new products and services that management is considering.

Is it cheaper at present to grow organically or through acquisitions?

The right answer is almost always organic growth. Acquirers usually overpay, particularly in acquiring scale. Intelligent acquisitions are usually small and often private firms, where the sale is negotiated and not an auction. The goal is to gain new core competencies or markets that can grow profits in concert with the capital and other resources that the company can add to their new acquisition.

If a company answers “through acquisitions,” there had better be a reason it has an advantage in acquiring companies that its competitors don’t, which is rare. If it’s the only public company rolling up a sector (again rare), there should be some logic as to what discipline the company exercises in not overpaying for acquisitions.

In the early phase of a roll-up, prices are typically reasonable for the small firms being purchased. As the roll-up proceeds, the acquisitions that are easy, logical and cheap get done first. In later phases, if there is a mania, the hard, illogical and more expensive acquisitions get done.

It’s rare to have a roll-up in which some party doesn’t start overpaying badly at the end. Sometimes that signals the end of the roll-up phase, with a decline in the share price of the overpayer, destroying the value of the currency that it is using to acquire small entities; namely, its stock price.

How important is scale when you consider acquisitions?

Again, acquirers usually overpay for scale. The right answer is usually that it is not important, unless it is a commodity business and the acquirer is the low-cost competitor, and will wrench expenses out of the target company to make the target as efficient as the acquirer.


The difference between my approach and the approach of most analysts is that I think about the business and its strategy rather than the next quarter or year’s earnings. My methods probably won’t help you make money in the short run but will help you make money in the long run as you identify intelligent management teams that understand how to compete for the long term, rather than those that can manage only next quarter’s GAAP earnings.

Two additional side benefits to doing it my way: First, the management teams will like talking with you. I can’t tell you how many times managers have said they appreciated my businesslike approach to analyzing their companies. Second, it will translate back into an improved understanding of the business you presently work in, as you think about strategic issues there.

Market Impact


  • Banks Consider New Corporate-Bond Trading Network Maybe volume will pick up w/increased liquidity &reduced spreads $$ Nov 23, 2013
  • White House snubs Fannie-Freddie plan Agree w/Obama here; we need to discourage mortgage debt, delever economy $$ Nov 21, 2013
  • PIK Bond Offerings Surge Always a bad sign when borrowers can choose not to pay cash to lenders; market is frothy $$ Nov 21, 2013
  • Americans Recover Home Equity at Record Pace I wouldn’t b so optimistic; there r2 many investors relative 2 owners $$ Nov 21, 2013
  • J.P. Morgan Is Haunted by a 2006 Decision on Mortgages How underwriting was compromised at $JPM leading2bad mtges $$ Nov 21, 2013
  • Morgan Stanley Wins as Lynch Pays Up Remember margin of safety. Great past track record, won’t likely work forever $$ Nov 20, 2013
  • Why Banks Are Still Wary of Credit Risk Retention Plan Maybe do opposite: ban banks from owning securitized assets $$ Nov 20, 2013
  • Bank, Credit Union Defend Payday Products as Crackdown Looms Cheaper version of what exists outside banking $$ Nov 20, 2013
  • Why Bankers and Regulators See Very Different Future for Giant Banks Hand banking regulation back to the states $$ Nov 20, 2013
  • Student Loan Market Headed for Crisis, CFPB Warns Always avoid the debt class that has grown rapidly; losses loom $$ Nov 20, 2013
  • Buying Low Thwarted by Narrowest Stock Valuation Gap Ever I’m not finding many cheap stocks out there. $$ Nov 19, 2013
  • Why No Bankers Go to Jail Theory 5: Easier for the government to discipline corporations than prosecute felonies $$ Nov 18, 2013
  • Inherited Money To Manage? Overcoming Emotion Is Key To Big Returns This is essential to ALL money management $$ Nov 18, 2013


Central Banking


  • Fed Looks for Other Ways to Aid Economy You’ve done quite enough thank you. Go 2 the corner & play w/the fed funds $$ Nov 21, 2013
  • A Limited Central Bank John Mauldin republishes the notable speech by Charles Plosser at the Cato Institute $$ $SPY Nov 21, 2013
  • QE:Euthanasia of the economy? Japan & the US r examples; QE can’t revive an overindebted economy. Recession needed $$ Nov 20, 2013
  • Onions Bring Tears to RBI’s Rajan as Prices Surge The humble onion can make even a central banker cry $$ #agflation Nov 20, 2013
  • Junk Glistens Under ‘Bernankecare’ as Worst Stocks Win Fed encourages the foolish to take more risk at a bad time $$ Nov 20, 2013
  • Fed Ponders How to Temper Tapering Without Rate Increase The Fed wants the best of all worlds and at no cost $$ Nov 20, 2013
  • It’s Fed Versus Moody’s for ‘Most Wrong’ Crown Fed by a mile here; regulators should disallow unseasoned assets $$ Nov 18, 2013




  • This Market Is Going Higher, Warns Jeremy Grantham Momentum will carry it up until valuations can’t b sustained $$ Nov 20, 2013
  • Krugman and Summers Want to Keep Finance Fun Their policies promote bubbles and crises rather than stability $$ Nov 20, 2013
  • Is the Only Choice Bubbles or Recession? Recessions r needed to eliminate unproductive lending; they r necessary $$ Nov 20, 2013
  • Risk of a Stock Market Melt-Up? ​Federal Reserve Ultra-Dovishness, Technicals, the Economy and the TINA effect… $$ Nov 18, 2013




  • Pimco Sees $3.7T Reason for Adding Yuan FX reserves grew $166B in 3rd quarter 2a record; no rebalancing yet $$ $SPY Nov 23, 2013
  • China hard landing is likely: Andy Xie China today is like Japan in the late 1980s, an economy w/2many dead assets $$ Nov 21, 2013
  • Chinese Skeptics Deepen Biggest A-Share Discount in 3 Yrs Invest your $$ in Chinese stocks & watch it get Shanghaied Nov 20, 2013
  • Credit-Driven China Glut Threatens Surge Into Bank Crisis Forced industrialization leads to bad debts & depression $$ Nov 20, 2013
  • Gold No Slam-Dunk Sell in China as Aunties Buy Bullion Chinese know that gold cannot be printed, so they own it $$ Nov 20, 2013
  • Chinese Steer Billions Abroad in Quest for Safety Wealthy Chinese do not trust their government & so plan escape $$ Nov 20, 2013


Rest of the World


  • Iran Is Playing Obama, Says Savvy Saudi Prince Fascinating political calculus here, Saudi Arabia vs Iran $$ Nov 23, 2013
  • Very Well Aged: Archaeologists Say Ancient Wine Cellar Found 3700 yrs old found in what is now Israel $$ Nov 23, 2013
  • Aluminum Fees in Japan Seen Near Record in First Quarter on Abe Amazing how much Aluminum held off mkt 4 lending $$ Nov 23, 2013
  • Mobius Can’t Buy Enough Vietnam Equities on Foreign Limits They have bad loan problems too, like everyone else $$ Nov 21, 2013
  • Pirates Looting Cargoes With AK-47s Threaten African Oil Energy companies should pay military 4 services $$ Nov 21, 2013
  • Hollande’s Tax Rebels Underscore Mounting Opposition What u get for letting the govt get 2 big $$ $SPY $FXE Nov 20, 2013
  • Swiss Rage Against CEO Pay Provokes Vote on Salary Limits Interesting 2c if it passes & what happens if it does $$ Nov 20, 2013
  • Watch Greece – it may be the next Weimar Germany Cradle of democracy becomes its graveyard? Golden Dawn & murder $$ Nov 20, 2013
  • What Castro Knew About Lee Harvey Oswald Argues Cuba did not plan the assassination, but encouraged Oswald 2do it $$ Nov 18, 2013


Politics & Policy


  • Probe of How U.S. Agency’s Medicare Move Reached Investors Hits Wall Congress shields itself from insider trading $$ Nov 21, 2013
  • Illegal NYC Homes Thrive as De Blasio Tackles Housing Legalize alternative apartments in NYC; end rent control $$ Nov 21, 2013
  • Details of Private Mars Mission Given to House Science Panel Space era begins when private industry does it alone $$ Nov 20, 2013
  • Blame Rich, Overeducated Elites as Our Society Frays Long. Argues that elites can control if they r united $$ #maybe Nov 20, 2013
  • US Military Eyes Cut to Pay, Benefits Military is thinking much farther ahead than the politicians they serve $$ Nov 18, 2013




  • Obamacare Bailout Sought as Effort Planned to Bypass Site PPACA looks like a wrecking ball for what was good $$ Nov 21, 2013
  • ObamaCare Forced Mom Into Medicaid If it is important 2 preserve your Mother’s dignity, y aren’t u paying 4 it? $$ Nov 21, 2013
  • Obamacare Consultants Warned of Health Website Failure Wasn’t a surprise; officials knew in advance & ignored it $$ Nov 20, 2013
  • A Conservative Cure for Obamacare A challenge in 2017: fix PPACA or destroy it? Nothing big will change till then $$ Nov 18, 2013




  • Mainstream economics is in denial: the world has changed Correct, but the solution is more free markets, not less $$ Nov 21, 2013
  • It was not the free market that failed. It was the regulated market that refused to do what it promised; regulators acted pro-cyclically $$ Nov 21, 2013
  • Economics students need to be taught more than neoclassical theory Reasonable; let students hear other paradigms $$ Nov 21, 2013




  • Worried About That 787 You Ordered? Hire a Factory Babysitter Makes sense to do this when u r paying so much $$ Nov 21, 2013
  • A Second Life for Old Permian Oil Field in Texas Fascinating to see multiple levels of hydrocarbons, it goes deep $$ Nov 21, 2013
  • US Growth comes Mostly from Inventories Helps explain why the economy feels worse than the published numbers $$ Nov 20, 2013
  • Brookfield’s Looking-Glass World Foundation $BAM $BIP $BPO $BRP $INF $BEP $BOXC $BPY Be wary of opaque disclosures $$ Nov 19, 2013
  • A Sub-$1,000 3D Printer for Metal Not quite, you have to have your own kiln in order to process the clay/metal $$ Nov 18, 2013




  • Wrong: Orthodox economists have failed their own market test Krugman & Baker did not predict the crisis $$ Nov 21, 2013
  • Wrong: The college savings plan that beat the hedge funds anyone can promise a high fixed return, few can fund it $$ Nov 21, 2013
  • Wrong: Robert Shiller: is economics a science? See Robert Shiller incapably defend bankrupt neoclassical economics $$ Nov 21, 2013
  • Wrong: Has the Dollar Really Lost 97% of Its Value? It has.lost as a store of value, u should not b forced 2invest $$ Nov 20, 2013


Retweets, Replies & Comments


  • “Part of the solution is to define taxable income right, so that taxation cannot be deferred.” — David Merkel $$ $SPY Nov 21, 2013
  • “I don’t have an opinion on the Kennedy assassination. I do believe that old men like Castro like to…” — David Merkel Nov 21, 2013
  • “I lose. You lose. He, she & it loses. We lose. You all lose. They lose.” — David Merkel $$ Yellen confirmed. Nov 21, 2013
  • “Rating agencies are only capable of dealing with financial instruments that have gone through a…” — David Merkel $$ Nov 18, 2013
  • “Few banks bought insurers, and few insurers bought banks. By the time the meltdown hit, Citi had…” David Merkel $$ Nov 18, 2013
  • “Would be better if the male saved up gold to give to the woman in trust. It would help protect…” — David Merkel $$ Nov 18, 2013
  • “You can never eliminate all risk. Never, but let’s do our best.” — David Merkel $$ Article:  Nov 18, 2013

The following was published at RealMoney on April 19th, 2007:

Pricing and Products

Do you think you can pass through price increases in the next year?

Questions like this can highlight management’s competitive strategy and how much excess of demand over supply exists in the current environment. Answers that involve no price increases or price decreases should also explain the reason for that, e.g., technological change.

For example, if you asked this question of a disk-drive manufacturer, he’d probably blink and ask of you, “Where have you been? This business has been so cutthroat competitive that we have been forced to innovate in order to create drives that store more, retrieve faster and at lower cost for more than 20 years! We’ll never get price increases! This business is like Alice and the Red Queen. We have to run as hard as we can just to stay in the same place. Our only hope is volume growth, and thankfully, we have gotten that.”

Answers that boil down to “demand is eroding” or “competitors are irrational” should contain some idea of what management is doing to combat the problem. Sometimes giving up market share to an irrational competitor can be the brightest move; market share can only be rented, never owned.

I can give examples from many cyclical businesses. All mature businesses are inherently cyclical, and stock price performance follows the pricing cycle. At RealMoney, I have already written about this dynamic in insurance, steel and cement. To give one more example, consider the airlines. As so many of them slipped into bankruptcy early in the 2000s, most of the bankrupt carriers were forced to shed capacity. As they shed capacity, pricing got incrementally better and then a whole lot better, leading to the outperformance of airline shares.

What are your plans for dealing with emerging substitute products?

Sometimes a market comes under threat from a new competitor with a new business model. Usually threats like this begin with simple products with relatively low returns on equity.

For example, when the steel minimills came into existence, they provided only the lowest-quality steel products. Over time they expanded their products to capture more of the value chain in the steel business, and this placed increasing pressure on the integrated steel companies, many of which crumbled under competition from the minimills.

Had the competitive threat been met early, the integrated companies could have minimized the threat by adopting the tactics of the minimills.

Do you have any complementary products in the works that open up new markets for you?

Much of the time, growth happens through a willingness to explore offering products and services that are one step removed from existing offerings. This could be a new marketing channel, offering the product internationally, extending the brand, offering services that complement the product, etc. Often a move like this precedes growth in profitability; it means that executives are looking for low-risk ways to expand the franchise.

Going back to my favorite insurance company, Assurant (AIZ), it’s constantly looking for new ways to create new products and services that lever off an existing core competency. For example, it’s No. 1 by a large margin in force-placed homeowner’s insurance.

When a homeowner with a mortgage doesn’t make a payment on his or her homeowner’s insurance, the mortgage company is at risk if a disaster happens. After a grace period of two to three months expires, the mortgage company buys a homeowner’s policy from Assurant or another carrier and bills the homeowner at their next mortgage payment. The development of force-placed homeowner’s insurance led to new product lines in force-placed auto insurance and renter’s insurance.

The first business developed as a result of relationships with mortgage lenders that wanted their interests protected if property insurance slipped out of force (not a good sign for the creditworthiness of the loan). The same applies to auto lenders. It also applies to large multifamily unit management companies, which want the integrity of their apartments protected. Those who live in apartments are much more likely today to damage the units than in prior decades, and increasingly landlords require it.

Full Disclosure: still long AIZ