Category: Value Investing

Book Review: The Value Investors

Book Review: The Value Investors

Posted on by David Merkel

Value investing shares several attributes which are mentioned in the final chapter of this fine book:

  • Humility in portfolio construction.
  • Valuation, though difficult, is important.
  • Good value investors read widely.
  • It’s not just math, but understanding competitive advantage.
  • Having a good sell discipline.
  • Having the right attitude in investing

This book examines 12 men in 10 organizations who are value investors.? As noted above there are common elements to value investing, but in the minor aspects, there are many different ways to pursue the topic.

Some diversify more; some less.? Some are more quantitative, some are more qualitative.

Now the fun of a book like this is that there are faces old and new, at least for me.? I knew of:

  • Walter Schloss
  • Irving Khan and his son Walter Khan
  • William Browne
  • Jean-Marie Eveillard
  • Mark Mobius
  • Shuhei Abe of SPARX Group (Japan)

But I did not know of:

  • Francisco Garcia Parames (Spain)
  • Anthony Nutt (England)
  • Teng Ngiek Lian (Singapore)
  • V-Nee Yeh & Cheah Cheng Hye (Hong Kong)

What impresses me is that among many different sub-approaches, approaching the stock market like an intelligent businessman works no matter where in the world you are, so long as it is subject to the rule of law.

I particularly enjoyed the biographical information about these men.? Many of them were good businessmen in onther industries before they began to do investing.? Their experiences in operating a business informed that way that they invest — think of stocks as fractional ownership in a business, and ask whether it is an attractive opportunity or not.

Quibbles

None.

Who would benefit from this book: ? All those exploring value investing would benefit from this work.? Those the know the topic well already can disregard it.? If you want to, you can buy it here: The Value Investors: Lessons from the World’s Top Fund Managers.

Full disclosure: The PR flack sent me a copy of the book after asking me if I wanted it.

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.

Industry Ranks September 2012

Industry Ranks September 2012

Posted on by David Merkel

My main industry model is illustrated in the graphic.? Green industries are cold.? Red industries are hot.? If you like to play momentum, look at the red zone, and ask the question, ?Where are trends under-discounted??? Price momentum tends to persist, but look for areas where it might be even better in the near term.

If you are a value player, look at the green zone, and ask where trends are over-discounted.? Yes, things are bad, but are they all that bad?? Perhaps the is room for mean reversion.

My candidates from both categories are in the column labeled ?Dig through.?

If you use any of this, choose what you use off of your own trading style.? If you trade frequently, stay in the red zone.? Trading infrequently, play in the green zone ? don?t look for momentum, look for mean reversion.

Whatever you do, be consistent in your methods regarding momentum/mean-reversion, and only change methods if your current method is working well.

Huh?? Why change if things are working well?? I?m not saying to change if things are working well.? I?m saying don?t change if things are working badly.? Price momentum and mean-reversion are cyclical, and we tend to make changes at the worst possible moments, just before the pattern changes.? Maximum pain drives changes for most people, which is why average investors don?t make much money.

Maximum pleasure when things are going right leaves investors fat, dumb, and happy ? no one thinks of changing then.? This is why a disciplined approach that forces changes on a portfolio is useful, as I do 3-4 times a year.? It forces me to be bloodless and sell stocks with less potential for those with more potential over the next 1-5 years.

I like some technology names here, some energy, some healthcare-related names, particularly those that are strongly capitalized.? I?m not concerned about the healthcare bill; necessary services will be delivered, and healthcare companies will get paid.

I?m looking for undervalued and stable industries.? I?m not saying that there is always a bull market out there, and I will find it for you.? But there are places that are relatively better, and I have done relatively well in finding them.

At present, I am trying to be defensive.? I don?t have a lot of faith in the market as a whole, so I am biased toward the green zone, looking for mean-reversion, rather than momentum persisting.? The red zone is pretty cyclical at present.? I will be very happy hanging out in dull stocks for a while.

That said, dull is hard to find these days.? Where will demand remain strong, or where will demand rebound are tough questions.

The Red Zone has a Lot of Noncyclicals

What I find fascinating about the red momentum zone now, is that it is laden with noncyclical companies.? That said, it has been recently noted in a few places how cyclicals are trading at a discount to noncyclicals at present.

So, as I considered the green and red zones, I chose areas that I thought would be interesting.? In the red zone, I picked energy services, and very basic goods.

In the green zone, I picked more than half of the industries.? If the companies are sufficiently well-capitalized, and the valuation is low, it can still be an rewarding place to do due diligence.

That said, it is tough when noncyclical companies are relatively expensive to cyclicals in a weak economy. Choose your poison: high valuations, or growth that may disappoint.

But what would the model suggest?

Ah, there I have something for you, and so long as Value Line does not object, I will provide that for you.? I looked for companies in the? industries listed, but in the top 4 of 9 financial strength categories, an with returns estimated over 15%/year over the next 3-5 years.? The latter category does the value/growth tradeoff automatically.? I don?t care if returns come from mean reversion or growth.

But anyway, as a bonus here are the names that are candidates for purchase given this screen.? Remember, this is a launching pad for due diligence.


Full disclosure: long for me and clients: HPQ, INTC, CSCO, TEL

 

On Low Volatility Investing

On Low Volatility Investing

Posted on by David Merkel

Recently a friend of mine sent me an e-mail after my review of Eric Falkenstein’s latest book.? Here it is:

David, I?ve been reading a decent amount of the academic literature on low vol investing and it?s certainly got my attention.? I?ll definitely be purchasing his book to read thru it, but I think he and Mebane Faber have had quite a bit of this stuff on their respective blogs.? Frankly I liked the research enough that I decided to part ways with some gifted Verizon stock that the in-laws gave us and bought a global low-vol ETF (ACWV). ?

http://us.ishares.com/product_info/fund/overview/ACWV.htm

I wish it had a bit more international tilt, but there is a sister international ETF that I can buy, so I might add that at some point to balance out the geographic exposure.? The one thing that really surprised me the most was that I figured this thing would have huge weights in Utes/Telecom.? Not so–actually the industry diversification looks very attractive.? And for 35bps of fees vs nearly 4% yield, hard to go wrong with this product for a nice LT buy and hold.? Kinda funny when I find myself, as a stock guy, actually liking a highly diversified index-type product? I just needed a bit more balance in the portfolio from all my very idiosyncratic idea.

Some of your readers might be interested in some of these ETFs if you think they are worth talking about.

For raw quantitative index investing, funds like these are good ideas, at least for now.? But with all new strategies, I ask the question, what will happen when a lot of people do this?? It is possible for stocks that minimize volatility as a group to become overpriced.

Think about what a minimum volatility portfolio looks like.? The companies pay decent dividends, are mostly not in cyclical industries… the portfolio looks like growth at a reasonable price.? Company financial & operating leverage is relatively low.? When I think of all of these together, it sounds like high free cash flow, and/or high growth of free cash flow.? This would be similar to high-quality growing companies that don’t take on a lot of debt.

A minimum variance portfolio, should the portfolio characteristics continue over the rebalancing horizon, will behave somewhat like a high yielding bond, but noisier.

The fund that my friend mentioned has an above average P/E ratio, an above average dividend yield, and an above average Price-to-Book ratio.? It tends to choose stable, eclectic companies within each economic sector.? For example, when I looked at financials, I saw a disproportionate amount of REITs, Insurers, and obscure Japanese and Asian banks.

This is a little quirky, but the stable elements of a variety of different sectors seem to do well over time as a portfolio.? But just as “value stocks” as a group can become overvalued, the same can happen for the stocks in the minimum volatility portfolio.? It would be good to track the average E/P & B/P (trailing twelve months) for the portfolio.? If the valuation metrics get too high, it could be a sign that low volatility is becoming a crowded trade.

That said, given the dynamism inherent in re-estimating a minimum variance portfolio, it might not be so obvious when low volatility is over-invested.? Maybe watching when the ratio of the Morgan Stanley Cyclicals index versus the S&P 500 might give us a negative clue. It was less attractive to invest in stable stocks in August of 2000 and February 2009.? These are two very different dates.? The former showed stable stocks peaking, while the latter was cyclical stocks troughing.

My own investing methods rely on no one factor, but looks at what makes a stock valuable through multiple lenses.? But tonight I highlight low volatility, because I think that investors do occasionally overpay for quality, but in general a quality bias pays off over time, as does a value bias.

Sorted Weekly Tweets

Sorted Weekly Tweets

Posted on by David Merkel

Financial Markets

 

  • State court ruling deals blow to U.S. bank mortgage system http://t.co/QilYZQJZ Washington State Supreme court allows MERS 2b sued &more $$ Sep 14, 2012
  • Partial explanation for flash crash and HFT http://t.co/ylpBj6Bm http://t.co/ABsvytw9 AP http://t.co/7xH09jMn http://t.co/hyznU44r $$ Sep 14, 2012
  • Violation: Prop Feeds #1 and #2 sent data to proprietary customers before NYSE sent data to the public feed. http://t.co/skh2CaUW ouch $$ Sep 14, 2012
  • Equity Firms Like Bain Are Depicted as Colluding http://t.co/8KMIo1xy This could be significant, but some of the legal issues r squishy $$ Sep 14, 2012
  • A Conversation with Ray Dalio http://t.co/clEaTy9C Full transcript, which I like, because watching video is slow $$ Sep 14, 2012
  • Jeff Gundlach’s Eye-Opening Presentation ‘Mirror, Mirror On The Wall’ http://t.co/QE6PHUoP Be prepared for lots of informative charts $$ Sep 13, 2012
  • Fink Belies Being Boring Telling Customers to Buy Stocks http://t.co/MYdrW95h A feature article on $BLK and Larry Fink; next Tsy Sec? $$ Sep 13, 2012
  • Oddly, what Dalio is saying here is very close to Harry Browne’s idea of the Permanent Portfolio. $$ http://t.co/C0x37B3Y Sep 13, 2012
  • Mortgage REITs’ leverage poses significant risks to the overall mortgage market http://t.co/Ifje6AxB Public markets r mismatched/limited $$ Sep 12, 2012
  • Bill Gross Sees Higher Long-Term Yields Amid Reflation http://t.co/eYPeRZlt If that were true, rates would be high already. $$ #youlose Sep 12, 2012
  • Is BlackRock Kissing Individual Bonds Goodbye? http://t.co/s2RywmL3 Mmmm…. converting transaction revenues into an annuity… yes… $$ Sep 12, 2012
  • 361 Capital Weekly Research Briefing http://t.co/nd6akDbW Interesting briefing that makes a mostly bullish case $$ Sep 11, 2012
  • Is Everything We Know About Stock/Bond Allocations Wrong? http://t.co/85D2kUik Questions the wisdom of risk parity for asset allocation $$ Sep 11, 2012
  • Want to Buy a Private Stock? http://t.co/E3WojVi2 Listen to @jasonzweigwsj Do not buy private equity; you don’t have the expertise. $$ Sep 09, 2012

Federal Reserve

 

  • New round of quantitative easing biggest yet? http://t.co/ANA3MX2y Potentially. Problems will come as Fed corners low-rate GSE Resdl MBS $$ Sep 14, 2012
  • FOMC Central Tendencies: Target Fed Funds Rate at Year-End 2012-5, long-run 0.26 0.38 0.80 1.72 4.07 Chg: -0.04 -0.12 -0.30 NA -0.13 $$ Sep 13, 2012
  • FOMC Central Tendencies: Appropriate Timing of Policy Firming extends 7.6 months from June to 2.8 years Sep 13, 2012
  • FOMC Central Tendencies 2012-2015, long-run PCE inf 1.75 1.84 1.82 1.97 2.00 PCE inf 2012-2014 long-run +0.27 +0.08 +0.05 0.00 $$ Sep 13, 2012
  • FOMC Central Tendencies 2012-2015, long-run Unemp 8.11 7.70 6.98 6.38 5.60 Uemp change 2012-2014 long-run +0.01-0.01-0.30 0.00 $$ Sep 13, 2012
  • FOMC Central Tendencies 2012-2015, long-run GDP 1.84 2.78 3.4 3.39 2.44 GDP change 2012-2014 long-run -0.29 +0.210 +0.12, 0.00 $$ Sep 13, 2012
  • Budeeah, budeeah, budeeah, That’s all folks! Sep 13, 2012
  • Something happened around 2:30, but what? Sep 13, 2012
  • Press seems feistier than usual at the Bernanke Presser $$ Sep 13, 2012
  • Wow, a 2% move in gold qualifies as “explodes?” Wow #verbinflation http://t.co/8hodDxcp Sep 13, 2012
  • Extends low FF to mid-2015, ~9 months Sep 13, 2012
  • Fed’s web server is paralyzed, overwhelmed Sep 13, 2012
  • Ding! It’s SHOWTIME, Ben! $$ Sep 13, 2012
  • Bernanke Proves Like No Other Fed Chairman on Joblessness http://t.co/qHWtJv7W Bernanke imagines that he is fighting recession $$ Sep 12, 2012
  • Fed Stuck at Zero Into 2015 Seen in Swaps, QE Odds Reach 99% http://t.co/IM6HBDQR Given that fixed income mkts anticipate: no QE effect $$ Sep 10, 2012
  • An idea better kept in reserve http://t.co/ujKFy1Vc When u r playing around near the zero bound, all sorts crazy things could happen $$ Sep 10, 2012

 

US Politics and Economics

 

  • US Consumer Price Index Increases by Most Since 2009 http://t.co/6u2Di5r4 Given the unlimited QE, hard to see why prices should be weak $$ Sep 14, 2012
  • Airbrushed History and Dusted-Off Promises http://t.co/gMetXbgi Obama promised much more in 2008-9 than he is owning up to now. $$ Sep 13, 2012
  • Household Income Sinks to ’95 Level http://t.co/LA6pnEC3 R U better off than 4 years ago? Mean, yes. Median, no. $$ Sep 13, 2012
  • In Chicago, the Teachers’ Last Stand http://t.co/3uAcUJZT Bad news for the teachers, given underfunded DB plan, $$ struggles will worsen Sep 13, 2012
  • This is Illinois after all…corruption & bad mgmt r normal. Teachers fear 4 their unfunded pensions & high $$ jobs. http://t.co/KVWIURuV Sep 13, 2012
  • About Those Policies That Got Us Into This Mess http://t.co/cUDmsUJy Interesting: many of the critical laws were signed by Democrats $$ Sep 13, 2012
  • White House pushes back on claims from Woodward book http://t.co/IPpUUGXg The fiscal crisis was Obama’s fault as well as Congress’ fault $$ Sep 12, 2012
  • Strike Puts Spotlight on Teacher Evaluation, Pay http://t.co/MJ0A4pCt Break the union and hire non-union teachers who r motivated $$ Sep 12, 2012
  • Stagnant Incomes Signal Restraint in Spending by U.S. Consumers http://t.co/uiBxYBzM Y b aggressive spending when policy is uncertain $$ Sep 10, 2012
  • Why Health Care Matters and the Current Debt Does Not http://t.co/yw4MLv6o Because the healthcare unfunded liabilities r a LOT BIGGER $$ Sep 10, 2012

 

Other

 

  • #FF @TALENTEDBLONDE @prieur @rcwhalen @AmyResnick @AnnieLowrey @brucekrasting @derekhernquist @fundmyfund @ftalpha @BloombergNews $$ Sep 14, 2012
  • Children of Single Parents Much More Likely in Poverty http://t.co/PbaJuoGU “Dog Bites Man” Two parents r normally stronger than one $$ Sep 13, 2012
  • The Manhattan Project to End Fad Diets http://t.co/NvkkihYt Sounds promising, but there is 2 much $$ & wishful thinking w/fad diets Sep 13, 2012
  • Michael Pettis publishes! It’s a great night! $$ Sep 13, 2012
  • Charities Deceive Donors Unaware Money Goes to a Telemarketer http://t.co/vKXjfU7K Don’t ever give money to a charity over the phone $$ Sep 12, 2012
  • Medics Being All They Can Be Find Civilian Job Barriers http://t.co/p7gZbgNT Vets have to have a way to transist to civilian work $$ Sep 12, 2012
  • Is College a Lousy Investment? http://t.co/GoKcgrLB It depends. If u r in the top 20%, no. If u r in next 20%, maybe. Otherwise, yes $$ Sep 12, 2012
  • 13 Tools To Tame Social Media Overload http://t.co/UYXZUMAt A variety of programs that can stiffen your resolve to avoid wasting time $$ Sep 11, 2012
  • Why the New Marketing-Driven Corporate Research Lab Needs the CIO http://t.co/d8wWCDJc Research, Development & Marketing belong together Sep 10, 2012
  • Letting Babies Cry a Bit Is OK http://t.co/UmqwwLbl Babies stop crying (leave aside pain/sickness) when crying does not get rewarded $$ Sep 10, 2012

 

Energy

 

  • Wind is intermittent, advances in batteries that can store energy are also needed. http://t.co/eBsqqW5y Sep 13, 2012
  • Asian Water Scarcity Risked as Coal-Fired Power Embraced http://t.co/C4QQXAQm The need for water is forcing tough choices in India $$ Sep 11, 2012
  • Gamechanging Natural Gas Tech Gets Green Light http://t.co/tiI2hiu2 Methane hydrates r recoverable; triples existing oil & NG reserves $$ Sep 10, 2012
  • Saudi Arabia Concerned About Rising Crude Prices http://t.co/f3eUmId0 High quality problem, but how much can the Saudis a4d 2cut back $$ Sep 10, 2012

 

Rest of the World

 

  • Swiss Farmers Clash With Traders as Bubble Builds in Town of Zug http://t.co/EjPUX0Pa Another report from the Bubble caused by the SNB $$ Sep 13, 2012
  • Skip College Is Top Advice for World-Beating Koreans http://t.co/YQ9DKAZO Any strategy to improve your lot can be overused, even college $$ Sep 12, 2012
  • Less-Rosy Reality http://t.co/HfidgmGM This current round of euro-optimism will wear badly with time. Cash flows will dictate reality $$ Sep 11, 2012
  • Can Asia avoid the middle-income trap? http://t.co/PLB8ER7i How technology is killing the Asian growth miracle http://t.co/ue15U4sd $$ Sep 10, 2012
  • Hollande Challenges Unions on Labor Law as Stagnation Sets In http://t.co/xRBJdqdt Pretty tough to start fighting w/base w/low poll #s $$ Sep 10, 2012
  • Why Merkel Wants To Keep Greece in Euro Zone http://t.co/b3cTiHfq It is cheaper in the short run than bailing out the banks $$ Sep 10, 2012

 

Companies

 

  • Why Ruane Cunniff & Weitz Funds Like Valeant Pharmaceuticals (VRX) http://t.co/QBLd8SGV Combination of Pharma co, & asset-stripper $$ Sep 14, 2012
  • Andrew Ross Sorkin?s Bad Math on AIG http://t.co/pHdsYWRV Notes tax favors $AIG received, could have mentioned forgiven bailout terms $$ Sep 13, 2012
  • Legg Mason CEO to Leave Amid Pressure http://t.co/PB4ZxKCj $LM was better in the past, when they did not rely on fund mgmt as much $$ Sep 12, 2012
  • David Merkel: Why You Will Never Be Buffett http://t.co/iPfn9Gxo @reformedbroker features two of my articles on Buffett. Thanks, Josh $$ Sep 12, 2012
  • Ship Magnate Uses Gut in $11 Billion Bet Worst Since ?70s Ending http://t.co/f5BGyDoZ Long article on the gamblin’ head of $FRO & $SDRL $$ Sep 10, 2012

 

On Bailouts

 

  • Two notes on the bailouts: first, those saying the US Govt made $$ on the bailouts are not counting in Fannie & Freddie Sep 11, 2012
  • Second: they aren’t counting the cost of capital: had they invested $$ at the same time in a 50/50 mix stocks/bonds would’ve made much more Sep 11, 2012
  • So, aside from encouraging future moral hazard, the bailouts lost $$. Strictly on a moral basis, the govt should not play favorites. Sep 11, 2012

 

China

 

  • The Communist Party?s Big Problem? It?s Not Bo Xilai http://t.co/BXRshBNQ Publication of a long, critical commentary of CCP direction $$ Sep 13, 2012
  • Shadow Bankers Vanishing Leave China Victims Seeing Scams http://t.co/4RmbjG8d When bankers flee, go B/K, commit suicide: not good sign $$ Sep 13, 2012
  • China’s Revolution Risk http://t.co/lzs5k5ll One has to remember that not all risks are simple and economically rational. $$ Sep 12, 2012

 

Replies

  • @BarbarianCap @derekhernquist Thanks much. Don’t know what to say. 🙂 $$ Sep 15, 2012
  • @derekhernquist You’re welcome, Derek. I appreciate following you, & you following me. Why did I start the blog? To give something back $$ Sep 15, 2012
  • @moorehn Yeah, I know. I just Googled a few phrases from your show to see what would come up. Sorry that that did. Sep 15, 2012
  • @moorehn Rush Limbaugh also used “It’s like a sugar high.” 4 QE yesterday on his radio show http://t.co/BhS48hxN No, I don’t listen 2 him $$ Sep 15, 2012
  • @ritholtz Yes. First time but there are other cases in the works $$ Sep 14, 2012
  • @LaMonicaBuzz Definitely the latter. Full disclosure: long $SPLS $$ Sep 13, 2012
  • @JamesGRickards Confidence comes from a strong balance sheet & sustainable economic policies Sep 13, 2012
  • @XQuickFixX That figure is for average over a lifetime. Sep 13, 2012
  • @XQuickFixX “average BA college degree makes ($52,200)” Link? Sounds too high Sep 13, 2012
  • @wsquared58 Good for you Sep 13, 2012
  • @TheStalwart Cool, well, we will watch and see to the EOD Sep 13, 2012
  • @TheStalwart Are you forecasting the immediate move, say, 15 minutes, or to the end of the day? Sep 13, 2012
  • . @Nonrelatedsense Browne’s system is simple, like a VW bug. Bridgewater is like a Maserati in comparison. Both are elegant AA ideas $$ Sep 13, 2012
  • @waughkd I have been to SD once in my life; my brother lived on an Indian reservation there 4 years. The physics of wind power is tough $$ Sep 13, 2012
  • @XQuickFixX It used to be that that earned below median incomes; now they earn above median; it’s the pensions that r really high Sep 13, 2012
  • @munilass Thanks for tweeting that; I have had a lifelong interest in prime numbers, though the math here is beyond me. Sep 13, 2012
  • @GaelicTorus I’ve debated that; I sometimes do negative book reviews. More often it doesn’t get a review. Sep 13, 2012
  • @GaelicTorus Book isn’t out yet, not seeking a copy. Sometimes I get books I did not request, e.g., Hank Paulson’s book & didn’t review $$ Sep 13, 2012
  • @GaelicTorus former employee of $GS who left, purportedly because his ideals were shattered as $GS changed 2b more mercenary $$ Sep 13, 2012
  • @JacobWolinsky thanks 4 that data point. traded away most of my commodity stocks a while ago. Did not want to be a hog. $$ Sep 13, 2012
  • @JacobWolinsky If China’s growth materially reduces, many commodities will have a hard time. Sep 13, 2012
  • @groditi I could convert it to a PDF and send it to you just e-mail me at david.merkel@gmail.com Sep 13, 2012
  • Commented on StockTwits: I never use stops. Never. I just buy, hold, and sell after a few years. I you choose well,… http://t.co/HXgjGxic Sep 12, 2012
  • @TheStalwart Car chases go on a lot longer because other cars pull over for the police $$ Sep 12, 2012
  • @MarkDampier I’m skeptical too… $BLK is big enough to be able to get good executions for clients. They shouldn’t have to use ETFs $$ Sep 12, 2012
  • @BradErvin1 You can’t do that. The only thing you can rely on is that glutted sectors will always return less than non-glutted sectors. $$ Sep 12, 2012
  • .@BradErvin1 The crisis came from capital misallocation. The bailouts tossed more capital into sectors that were glutted already. Not C-P $$ Sep 11, 2012
  • @Oval54 comes back w/interest to special interests, not to the average person Sep 11, 2012
  • @EddyElfenbein Can’t be any other way. My first statistics professor told us on on day 1: “Statistics is a meeean profession.” $$ #malehumor Sep 11, 2012
  • @BoydRoddy @finemrespice Funny thing is that Federal Reserve did not talk publicly about the life cos, but sys risk during $AIG crisis $$ Sep 11, 2012
  • @finemrespice @BoydRoddy Agreed, it wasn’t the sole reason. Systemic effects of AIGFP, and do you hae a link on the FRC Basel issue? Sep 11, 2012
  • @finemrespice @BoydRoddy AIG’s Domestic Life companies lost all of their surplus when the AAA subprime RMBS underlying sec lending failed $$ Sep 11, 2012
  • @cabaum1 Quirk of Twitter, no #FM, #FT, #FW, #FTh, #FSa, or #FSu, only #FF for “Follow Friday,” & people typically only do #FF on Friday Sep 10, 2012

 

Retweets

 

  • US Govt outsources a lot RT @paulvieira:Joe Biden Calls Outsourcing “Not Bad If You’re Running A Company” http://t.co/vB42Feia via @buzzfeed Sep 14, 2012
  • RE: @bloombergview Bernanke should do the right thing: admit that he is wrong, and resign. http://t.co/1R5mxQw9 Sep 13, 2012
  • RE: @bloombergview Doing the same thing again and again, and expecting a different result.? You back an insane moneta? http://t.co/73aZFlFI Sep 13, 2012
  • I’m in the stagflation camp too $$ RT @BubblesandBusts: @alephblog I’ll take the under on GDP and over on unemployment and inflation Sep 13, 2012
  • RT @KeithMcCullough: Maybe one of the saddest days in American economic history; history wont forget this Sep 13, 2012
  • RT @credittrader: THIS!! RT @PragCapitalist: Bernanke basically just described the theory that asset bubbles are good for the economy…. $$ Sep 13, 2012
  • I tend to agree $$ RT @Nonrelatedsense:I think any allocation model faces a challenge today. Those two face more than they have in the past. Sep 13, 2012
  • Creation of credit has never brought prosperity. U r deluded $$ RT @BloombergView: Bernanke, You have no excuse | http://t.co/KwoPTjCJ Sep 13, 2012
  • As my Dad would say, for “socks & underwear” too $$ RT @pdacosta: Fed Chairman Bernanke spotted at Wal-Mart. Shopping for kitchen sink. Sep 13, 2012
  • Best since Paulson, including Hank $$ RT @pegobry: Geithner: best Treasury Sec in decades? Sep 12, 2012
  • RT @wesbury: It’s the spending. It’s the spending. It’s the spending. It’s the spending. It’s the spending. It’s the spending. It’s the … Sep 12, 2012
  • Performance art, yes $$ RT @TheStalwart: I think I might like to attend this conference, merely as performance art. http://t.co/PO6fzBp6 Sep 11, 2012
  • RT @dwotapka: RT @AskMiles: My mother used to say I’d get bored with pizza if I had it every day. My mother was wrong. Sep 11, 2012
  • At least those that cite the labor force participation rate $$ RT @TheStalwart: U-6ers are the truthers of the economics profession. Sep 11, 2012
  • RE: @bloombergview Same is true of Obama.? We face gridlock regardless of who gets elected. http://t.co/jGXTXoLI Sep 11, 2012
  • RT @annasacca: “Anyone wanting to learn about private equity would benefit from The New Tycoons by @jasonkellynews” http://t.co/xaF7HhLf $$ Sep 11, 2012
  • RT @BoydRoddy: Sole reason for AIG rescue: Sec.Lending undisclosed scheme under Neuger imperiled largest Life co’s in the world. No Life … Sep 11, 2012
  • As a happy user for around 2 years, I salute you; to my readers, look into getting free Opendns. $$ RT @opendns: Thanks for the RT! Sep 10, 2012
  • RT @opendns: We’re hearing reports that OpenDNS #SmartCache is helping OpenDNS users get to sites otherwise down during @godaddy #outage … Sep 10, 2012
On Tech Company Dividends

On Tech Company Dividends

Posted on by David Merkel

There’s a lousy idea floating out there, that it is a bad thing for a tech company to pay dividends (also here).? Not true!? Companies that pay dividends treat their capital more carefully, because now their equity has an explicit cost.? Studies that I have read indicate that dividend-paying stocks do better then those that do not pay dividends, in the long run.

That said, it doesn’t mean that companies that pay high dividends do better than those with low dividends.? It is well-known in REIT stocks that those that pay low but growing dividends have outperformed those with high dividends that grow slowly.? The right combination is that a small dividend is paid, and the company uses the retained earnings wisely, in order to grow the business profitably, leading to increases in dividends.

When Microsoft started paying a dividend I was a skeptic, because Microsoft was overvalued at the time.? No degree of financial engineering would change that.? Dividends are at most a modest positive for any stock.? Better you should look at the underlying ability to grow free cash flow and be able to reinvest it well.

That’s where investors should focus.? Dividends are good, but growing dividends are better.

How Warren Buffett is Different from Most Investors, Part 2

How Warren Buffett is Different from Most Investors, Part 2

Posted on by David Merkel

Before I begin this evening, let me simply say that where I find intelligence, I appreciate it, whether I agree with all the ethics of the situation or not.? Buffett is a bright guy, brighter than most.? I have *not* been shy to criticize Buffett when I thought there were ethical lapses — whether it was retroactive reinsurance, life settlements, David Sokol, or anything else.

The fifth way that Buffett is different is that Buffett was comfortable managing a company, rather than a pass-through vehicle like a mutual fund or a hedge fund.? That may sound trivial, but it is significant, because few investors do that.? The advantages are considerable.? You have permanent capital to work with, so you can focus on the distant future when times are bad.

The article that prompted this piece talked about how Buffett would “bet against beta,” and would invest in quality stocks.? These are the strategies that one can take advantage of if one has sufficiently long-term capital.? But I differ from the article, because value, betting against beta, and an emphasis on quality are not risk factors if you have a sufficiently long time horizon.? They are sources of alpha.? I disdain everything from MPT.? Real investing is finding companies that can compound free cash flow at above average rates.

I think that is a part of the problem with academic consideration of investing.? Typically they embed an idea that the investment horizon is short, which makes their ideas useless for long-term investors.

The sixth way that Buffett is different is that Buffett uses leverage (“float”) from the insurance companies to fund much of his assets.? The float has grown, but in an era of low interest rates, P&C insurance companies focus hard on making an underwriting profit.? In one sense, the low interest rate environment has made the P&C insurers and reinsurers to not be financials; they compete on underwriting, not investing.

The seventh way that Buffett is different, is that he doesn’t care what form the investment takes.? Buffett might say: “Stocks, great.? Convertible preferreds, even better.? Convertible bonds, yes.? Credit default swaps, only if I get to structure it, and same for selling options.? Private equity is fine; I will leave them alone, and capture the private equity niche of those who care about their corporate culture.” And more… he is a flexible guy, because he has a strong balance sheet behind him.

As for the robo-Buffett the academics create, well, hindsight is 20/20.? Who could have seen the relatively placid economics of the past 30+ years?? With that much foreknowledge, some private equity investors could have gone wild and done far, far better than that.

But Buffett had no roadmap.? He faced the same fog that we all do, but made robust choices that would do well against a fuzzy future.? As such, he deserves attention for his clever investing, because Buffett is different from the rest of us.

Volatility Analogy

Volatility Analogy

Posted on by David Merkel

Today Heidi Moore interviewed me for NPR Marketplace.? I won’t give away what it is about, but I will tell you two things:

  1. If I am on Marketplace, it will be on Friday or Tuesday.
  2. There was a point in the interview where she stumped me.? I’m usually pretty able to think on my feet, but when she asked me “Volatilty: can you explain that in language that a teenager could understand?”? I choked up, did my best on short notice, and gave what I later viewed as a lame explanation, but as I said it, my heart sank, because I realized I was not clarifying anything.

So, after the talk (It was really good to meet Heidi voice-to-voice for the first time), I took a walk outside and pondered.? Then the analogy struck me, and here it is:

Imagine you are driving down a well-engineered smooth road with gradual turns, modest traffic, and no bad weather, and you are going 60 miles per hour.? This is easy.? There is no volatility here.? That is what an average retail investor hopes for, and rarely gets.

Now consider a road that is not so smooth, with significant and frequent curves, significant traffic, and now and then it is raining hard.? That is a difficult situation.? This is similar to what the market is normally like, with all of the volatility (high variation of results).? Maybe you can’t do 60 MPH in that environment, but something less.? Those who recognize risk must run at a slower speed or risk accidents.

Now think of someone without special skills who dares to drive the easy road at 100 MPH.? He might not think it so hard, and might think he is quite a driver doing so.? So it was for equity investors in the ’80s and ’90s; conditions were uniquely favorable, and average investors thought they were hot stuff.

Now think of someone without special skills attempting to do the hard conditions at 100 MPH on average.? Odds are they wipe out, or even die.? You can’t fight physics, or can you?

Okay, now think of a highly trained driver with a special car that is able to handle the hard conditions, and can do it at 100 MPH on average, most of the time.? It doesn’t work all of the time, because there are things no one can catch — extra slipperiness, a bump in a particularly bad place that leads to an overturned car.

Finally, think of the trained driver with special car told he must average 150 MPH over the hard conditions course once.? He dies on the first try, destroying the car.? Several other trained drivers try with identical cars.? They all die, and the cars are destroyed.? Eventually, you can’t get anyone to try the hard conditions course at 150 MPH.

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In my analogy, the difference between the hard and easy course is volatility: how rough/variable are conditions.? Leverage is represented by speed.? Any course can be completed, but there is a maximum speed for which a course can be completed without disaster.? No surprise that those who are overly aggressive in investing frequently fail.

Now for the final tweak: imagine that you have no map for the hard course, it is new to you, no GPS, nothing to aid you in the driving.? That is what the markets are like.? As I often say, the markets always have a new way to make a fool out of you.? How fast could you go?? How fast could the trained driver with a special car go?

This is why I urge caution in investing and avoiding leverage.? Investing is tough enough without trying to earn something beyond what the market can bear.? I encourage safety first, after that, look for best advantage.

How Warren Buffett is Different from Most Investors, Part 1

How Warren Buffett is Different from Most Investors, Part 1

Posted on by David Merkel

There was an academic article published recently on the investing of Warren Buffett.? Afterward, I thought I saw a few articles reflecting on it, but here is the only one I see now: There?s Warren Buffett ? and then there?s the rest of?us.

Buffett is different, because he grew as an investor and as a businessman, and usually made the right moves over a 50+ year career.? When you don’t have a lot of assets, and few people are doing value investing, you can do amazing things with special situations, and being an activist investor.? In 1967, Buffett had control of a textile company named Berkshire Hathaway, when he used the resources of the company to purchase some smallish P&C insurance companies, National Indemnity and National Fire and Marine Insurance.

This brings up the first way that Buffett is different than most investors.? He understands and invests in a complex industry, P&C insurance.? He begins to realize that it can be used as a platform for greater investing.? As he sees that potential, he buys half of GEICO in the 70s, before buying the whole company in 1994.

This brings up the second way that Buffett is different than most investors: Buffett was willing to buy whole companies, not replace management for the most part, and operate them.? Buffett limited himself to being the wholly-owned company’s board, asking questions on management competence, and redirecting free cash flow for the greater good of Berkshire Hathaway.

That brings me to the third way in which Buffett is different than most investors: He analyzes cash flow streams from investments, and buys shares in companies, or the whole company when they offer a reliable high prospective free cash flow yield.? And it brings me to the fourth way Warren Buffett is different than most investors: Buffett does not diversify, particularly in the early years.? He plays for best advantage.? Buffett views investing through the lens of compounding cash flows, and does not pay much attention to the market as a whole.

In my opinion, it is a worthy use of time (but don’t neglect your family) to read through the annual letters of Berkshire Hathaway.? If you do that, you will get a sense of a clever businessman who would invest for best advantage.? His tactics shifted over time, but he was always looking to compound free cash flows at the best possible rate.

I’m going to hit the publish button now, but I will finish this in part 2.

The Future Belongs to Those with Patience

The Future Belongs to Those with Patience

Posted on by David Merkel

I’ve finished the book “Bailout” and will review it next week.? I am in the midst of the book “The Crisis of Crowding,” and will likely review it next week.? What I write this evening is a bit of an experiment, and preparatory to what I write on “The Crisis of Crowding.”

Here’s the issue: I spend more time on liability issues than most investors.? How is an investment financed?? For those that have access to RealMoney, these old articles of mine explain the issues very well:

Managing Liability Affects Stocks, Pt. 1
Separating Weak Holders From the Strong
Get to Know the Holders? Hands, Part 1
Get to Know the Holders? Hands, Part 2

In hindsight, I wish we could have had consistent titles for the articles.? The broad idea is this: how much risk might the holder of the asset be taking on depending on how he finances the asset?? The asset in question is a long duration asset, like a house or a factory.? Consider the spectrum:

  • I own the asset “free and clear.”? I have other unencumbered assets to deal with uncertainties.
  • I own the asset “free and clear.”
  • I have a significant amount of equity invested in the asset, and the rest is borrowed on fixed terms.
  • I have a normal amount of equity invested in the asset, and the rest is borrowed on fixed terms.
  • I have a modest amount of equity invested in the asset, and the rest is borrowed on fixed terms.? I had to pay a higher interest rate to do this.
  • I have a modest amount of equity invested in the asset, and the rest is borrowed on floating rate terms.
  • I have no equity invested in the asset, and the financing is borrowed on floating rate terms.

As you go down the spectrum, the odds of loss go up that the owner of the asset might ever lose control of the asset.? As financing shifts toward the end of the spectrum, the odds of a bubble go up, as cheap financing allows marginal buyers to buy more of the asset in question.

Now this can be framed more generally: what are the likelihood of outcomes on the assets that I buy versus the fixed commitments needed to support my purchase, or the internals of the asset (i.e. too much internal debt).? The rate needed to support the purchase could be the rate needed to support a happy retirement.

And there is the problem.? When needs are fixed and outcomes are variable, it can be quite a trouble, particularly when asset prices have been rising because of increased buying power from debt arrangements.? Almost all systems would be relatively stable without debt.? Even the dot-com bubble had its slug of debt from internal trade financing, and the need to pay taxes s a result of the options received.

When a large number of people are relying on decent-sized short-term asset price gains in order to do well, that is a recipe for disaster.? Note: at the same time, that don’t need to make money, and have financial flexibility, don’t care to invest, because asset prices are too high compared to the cash flows that they are likely to throw off.? They invest in cash-like equivalents, carefully researched ideas that look weird, biding their time, looking dumb as the mania proceeds.

When those that are inflexible expect a lot, and those that are flexible expect nothing, that is the peak of the market.? There is no one left to buy the speculative assets in question, and things will mean-revert.

Prices of the speculative assets start to fall, and things cascade in ways that few would expect, because as prices fallvarious liabilities are called into question.? And, if the liabilities are called into question, so are those who funded the liabilities, because they are less certain of receiving the cash flows that they expected.? This process continues until only those with modest or no borrowings is left standing, or the government intervenes to protect her chosen.

[Note: all liabilities are assets of someone else, and net in aggregate to zero.? That is even true of the duration of liabilities; aggregate liability durations net to zero as well.? Liabilities are an important sideshow in a world driven by assets.]

The bottom comes when those that are inflexible expect nothing or worse, and those that are flexible expect that will make decent money as they wait.? This is a trite saying, but as a friend of mine once said, “The tritest sayings in life are true,” here is the saying, “Patience is a virtue.”? In investing, good things flow over time to those who are willing to invest during crisis, and sit back during the latter parts of a boom.? Bad things come to those that chase the market, investing when things are hot, and divesting when things are not.

Asset returns are not what the financial planners tell you.? Asset returns are lumpy.? They are feast and famine, with more feast than famine, but with enough famine scare a lot of people away.? The good returns come when most are scared, and think the market is rigged.? The bad returns come after a period of prosperity, and those that don’t understand the market start investing, because it seems to be free money.? As I often say, the lure of seemingly free money brings out the worst in people. (Someone please send the memo to Ben Bernanke.)

Those who are patient in investing earn most of the rewards over the long haul.? Others may clip gains at the edges, but real wealth stems from owning the best assets when few want to invest, and being patient when opportunities are few.

Now, if everyone knew this and acted like this, the market would get really dull, and would grow at the rate of book value, like private businesses do.? But not everyone is patient and provident.? Moral tendencies vary.? In the long run, those that insist on returns in the short run don’t get them, while those those that wait for returns in the long run do.

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I’m planning on writing a summary post on the crisis, to explain what drove the crisis, and what did not.? The framework that I have given here will instruct that process.

Using Investment Advice, Part IV

Using Investment Advice, Part IV

Posted on by David Merkel

My last point on investment advice is to think long-term and treat it as a business.? You are trying to buy underpriced cash flow streams.

Because it is a business, you must focus on the long term, and downplay short cycle information.? Don’t let the media scare you or make you greedy.? There are bumps and jolts in all investing.? Keep your eyes on the long term.? Always ask yourself when reading news, “What is the long-term effect on profitability?”? Often good companies have bad quarters or years.? The same is true of bad companies having good years.? Look at the long-term profitability, and downplay the short-term noise.

By short-term noise, I largely mean the media.? That includes the web, and those that tout stocks on a short-run basis. There are several problems here:

1) Media investment advice (and that from Wall Street as well) is biased toward buying.? Articles will give you a list of stocks to buy either generally, or in a given industry.? The biggest problem is that they won’t generally follow up on their recommendations, nor will they tell you what the time horizon is for the recommendation, or what catalyst should lead you to sell.

2) You will not see many articles offering a list of stocks to sell.? There are several reasons for this: a) most readers have some cash, which they could use to buy stock.? Most readers do not own the stocks that one might suggest to sell, so unless readers are enterprising enough to sell short, which even fewer are willing to do, your article is of little value to the average person. b) Do you want the possibility of a lawsuit?? Unlikely, but could happen. c) If you rely on advertising, do you want the reputation of shooting companies down?

There is an even bigger reason behind this: the world is designed to be 100% long.? That is the norm.? Shorting is a side-bet.? Even holding cash is a side bet, trusting in the veracity of a central bank that mostly has claims on the taxation power of the government.

3) Most people in the media are not investors.? As journalists, they have to be neutral.? At least there has to be significant disclosure of interests.? Readers should ask themselves, “What does this writer know that I don’t?? Who disagrees with him?”? In good investment shops, they have a process where they challenge opinions.? Rarely do you see that in the media, where two parties present opposite opinions.

4) Even when professionals go on the air or on the web, be skeptical.? (This includes me.)? They may have an interest to mention stocks that are close to their “Sell” level, but they will not mention companies that they are currently acquiring.? Hey, I went through that when writing for RealMoney.? I could write about things only once we had our full position on.? It is normal for firms to not allow their employees to write, ever.? It is second most normal to allow them to write only when the firm’s interests are not affected.

5) There’s no measurement process, no feedback when people give investment advice in the media.? They seem more credible when they are on the Web, TV, Radio, but does that really make them more competent?? It does make them more marketable.

6) Investing is best when it is businesslike.? Good opinions take a lot of time to form within investment firms.? If anyone can do the “lightning round,” Cramer can.? But good investing isn’t typically snap decisions, so we should not give a lot of credence to anyone’s off-the-cuff remarks.

7) Remember, few people writing/speaking on investments are doing you favors.? They have their agenda.? Some make it clearer, like me, and others don’t.? Be aware, you are your own best defender.

8 ) Few writers will urge caution on asset allocation because it is a boring topic, and besides articles on bonds don’t sell.? People read advice that excites, not that which preserves safety, at least not to the same degree.

9) One last note, good value investing is usually boring.? There may be some interesting tales, but who will be good/talented enough to do all of the research and spill it for free?? There are uses for such a person that pay more.

This probably ends my series on Investment Advice, but feel free to send questions, ideas, etc.? Thanks for reading this.

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