Friday, January 31, 2014

Seth Klarman quotes on macro thinking (1991)

This is from the 1991 Barron’s interview:
“One thing I want to emphasize is that, like any human being, we can discuss our view of the economy and the market. Fortunately for our clients, we don't tend to operate based on the view. Our investment strategy is to invest bottom up, one stock at a time, based on price compared to value. And while we may have a macro view that things aren't very good right now -- which in fact we feel very strongly -- we will put money to work regardless of that macro view if we find bargains. So tomorrow, if we found half a dozen bargains, we would invest all our cash. 
Our particular view of the economy comes from talking to companies. We don't talk to all the companies that we have an interest in. But we talk to many companies. We also talk to a lot of businesspeople, including our clients. We talk to other investors. And our view is that the economy is awful. We also have a large number of anecdotal observations from being in many areas and talking to people in those areas. The Wall Street consensus right now seems to be, first of all, that the problems are all well-known and therefore need not be worried about. That just because there is a decade of oversupply of real estate, just because most of the banks and insurance companies are broke, we don't need to worry about that because it is already well-known and therefore, since the market is efficient, it must be reflected in securities prices. 
We believe it is well-known. But we don't believe it is reflected in prices at all. Or in people's actions. In effect, we think we have a market of fully invested bears. Everybody can talk about the problems, but very few investors act on them. That has a lot to do with both the trend towards indexing and, more broadly, the tendency of institutional investors to have to more or less mimic each other.”

@YaleLive with Robert Shiller

A conversation with Yale economist and Nobel laureate Robert Shiller.


[H/T ValueWalk]

On Reasonable Imagination

The team at The Manual of Ideas posted an excerpt from the quarterly letter Matt and I wrote for Boyles, in case anyone is interested and hasn't seen it yet.

Matt will also be one of the presenters at the Small-Cap InvestingSummit 2014 which is coming up soon.

Ray Dalio on CBS This Morning

Bridgewater Associates founder Ray Dalio sits down the "CBS This Morning" co-host Charlie Rose to discuss his understanding of the way the economy works, as well as his philosophies and how he puts them to work in his company and his life.

Thursday, January 30, 2014

Klarman returns cash

Link to: Klarman returns cash [via ValueWalk]
On stage at the Grant’s conference, seated on a bar stool, Seth Klarman corrected a misapprehension. This is not the first time The Baupost Group LLC, over which he presides, has returned cash to its investors. “Actually, it is the second,” he said. ‘(We returned some cash at the end of 2010 as well…. There are two or three reasons we reached the decision to return cash at the end of this year. Number one, around 50% of our assets are in cash, and that’s a very high absolute number, now around $14 billion and rising. So we look at it both as a percent of the portfolio, where 50% is a very sizeable chunk, but also $14 billion is always a lot to put to work. For most people, it is a big-sized fund, and that’s how much we have in cash on top of the other $16 billion that we have invested. 
Also, we look hard at our organization. I think one of the things that helped us be successful for 31 years is a very healthy fear of things we don’t understand, of the unknown, of not remaining humble. We literally worry every day: ‘Will we find another good idea and where might that be, because we want to find. it.’ Growing an organization from $27 million in 1982 to $30 billion, which we hit just last month, is really complicated. 
A lot of people who have tried will tell you the same thing, that you are at enormous risk all the time and, in some sense, hurting the virtuous circle that got us to where we are. The virtuous circle of good process, good record attracts good clients, attracts good people, and all of that feeds into itself successfully. But if we try to keep going-$35 billion, $40 billion, $50 billion-we would potentially start letting down our guard. We would start looking at other places, like that old joke about where the light is. I don’t want people at the firm saying, ‘Where’s something big I can work on?’ 
“If we were sure and had high conviction that the world was going to collapse in ·the first quarter of 2014,” Klarman went on, “we wouldn’t return the cash. We would keep going because our batting average would go up so high that everything we looked at would be cheap, like it was in 2008. So it’s really not a statement or prediction. 
It’s a statement about our own limitations, our own capacity constraints, and our desire to be excellent way into the future, which means not getting bigger than here.

East Coast Asset Management's Q4 Letter

In our fourth quarter letter you will find our portfolio update and general market observations. Each quarter we highlight one component of our investment process. This quarter, in the section titled Navigating Beyond the Pillars, I will discuss some lessons we have borrowed from navigation and how we apply them to our process and the current investment environment. I will also continue the discussion from last quarter’s letter on the investment checklist we employ.

Revisiting 'The Greatest Sports Deal Of All Time'

Link to 2011 article: Revisiting 'The Greatest Sports Deal Of All Time' [H/T Matt Brice, whose post is worth reading as well]
This is a tale of fortune, both good and bad. 
Here’s what’s known: Thirty-five years ago this June two brothers, Ozzie and Daniel Silna, along with their lawyer, Donald Schupak, negotiated what’s been called the greatest sports deal of all time. On an initial investment of $1 million, the Silnas have reaped an estimated $237 million. 
Here’s what’s unknown: if doing business with the greatest Ponzi-schemer ever caught has washed away those riches.

Wednesday, January 29, 2014

Tuesday, January 28, 2014

Fund Focus: Fairholme Hedge Fund Builds On Berkowitz’ 25 Years Of Success

Bruce Berkowitz may have made his name with his $11 billion mutual fund, but it's his partnership that's making headlines these days. 
While the average hedge fund was mired in the single-digits in 2013—the HFRX Global Hedge Fund Index stood at 6.72% for the year—Berkowitz's $200+ million Fairholme Partnership Fund was up 33% net of fees. Berkowitz launched the long-only hedge fund (which has a Caymans-based counterpart, the Fairholme Offshore Partners Fund) with $23 million of internal capital in January 2013 and opened it to outside capital in October. 
Fred Fraenkel, president and chief research officer of Miami-based Fairholme Capital Management, said the idea of launching a hedge fund began to form three years ago: 
“[W]e at Fairholme ran into the reality that Bruce's investment horizon [didn't] match up that well with the daily liquidity available in a mutual fund in 2011,” Fraenkel told FINalternatives in a recent phone interview. “[T]hat was...the kind of year that a real deep-value... investor longs for, where he sees stressed companies, he's identified them, he wants to own their stocks. 
“The world...believes that things are really bad and you, in performing your analysis on the companies, figure out that things are not bad, they're actually getting much better. Because what happens is, the prices go down a lot and you load up, and that's exactly what we wanted to do in 2011 but because of a bunch of circumstances—including that [Berkowitz] was named the Manager of the Decade for [domestic] equities in Morningstar for 2000-2010—he had huge inflows in front of that year, and then as soon as things started looking bad in the newspapers and on TV, we had dramatic outflows. So Bruce was confronted with not only not being able to buy more as the perceived crisis made stocks go down, he had to sell stocks off to meet the liquidity needs.” 
The takeaway, said Fraenkel, was “that there was a divergence in the business plan and the investment plan.” What Fairholme needed, they decided, was investors who understood how good Berkowitz's long-term record was and were willing to wait with him “until they realize huge returns.” 
Out of that realization came the Partnership. The fund has an unusual fee structure which Fraenkel said was designed to reward those investors willing to “wait with” Berkowitz. 
“[W]e don't charge any management fee so we don't make anyone pay unless they make money and we receive a declining percentage of the profits that we take depending on how long they want to entrust their money with us,” said Fraenkel.

Monday, January 27, 2014

What Drives Success? – By Amy Chua and Jed Rubenfeld

Link to article: What Drives Success?
A SEEMINGLY un-American fact about America today is that for some groups, much more than others, upward mobility and the American dream are alive and well. It may be taboo to say it, but certain ethnic, religious and national-origin groups are doing strikingly better than Americans overall. 
Indian-Americans earn almost double the national figure (roughly $90,000 per year in median household income versus $50,000). Iranian-, Lebanese- and Chinese-Americans are also top-earners. In the last 30 years, Mormons have become leaders of corporate America, holding top positions in many of America’s most recognizable companies. These facts don’t make some groups “better” than others, and material success cannot be equated with a well-lived life. But willful blindness to facts is never a good policy. 
Jewish success is the most historically fraught and the most broad-based. Although Jews make up only about 2 percent of the United States’ adult population, they account for a third of the current Supreme Court; over two-thirds of Tony Award-winning lyricists and composers; and about a third of American Nobel laureates. 
The most comforting explanation of these facts is that they are mere artifacts of class — rich parents passing on advantages to their children — or of immigrants arriving in this country with high skill and education levels. Important as these factors are, they explain only a small part of the picture.
The fact that groups rise and fall this way punctures the whole idea of “model minorities” or that groups succeed because of innate, biological differences. Rather, there are cultural forces at work. 
It turns out that for all their diversity, the strikingly successful groups in America today share three traits that, together, propel success. The first is a superiority complex — a deep-seated belief in their exceptionality. The second appears to be the opposite — insecurity, a feeling that you or what you’ve done is not good enough. The third is impulse control. 
Any individual, from any background, can have what we call this Triple Package of traits. But research shows that some groups are instilling them more frequently than others, and that they are enjoying greater success. 
It’s odd to think of people feeling simultaneously superior and insecure. Yet it’s precisely this unstable combination that generates drive: a chip on the shoulder, a goading need to prove oneself. Add impulse control — the ability to resist temptation — and the result is people who systematically sacrifice present gratification in pursuit of future attainment. 
Ironically, each element of the Triple Package violates a core tenet of contemporary American thinking.

The barbarians are at the gate! Of universities, moats and disruption! - by Aswath Damodaran

In my last post, I attempted to break down the bundled product that comprises a college education into its component parts, and closed by arguing that the future of universities rests on their ability to preserve the competitive advantages that have allowed them to get premium prices for these bundles and that of online education entrepreneurs on their capacity to find chinks in the university armor. 
In this one, I would like to look at the competitive advantages that colleges/universities have on each component and how close (or distant) the online threat is on each of them. Borrowing from the terminology of value investing, universities have moats around their “educational castles” and the online barbarians (at least as seen by the members of the educational establishment) are trying to breach the establishment. Since so much of this debate comes from one side of this divide or the other,  I decided that it would be good to try to look at both sides.

Sunday, January 26, 2014

A few Seth Klarman quotes

From Klarman's section in the 6th edition of Security Analysis, which he wrote in May 2008 (they also go well with the 1991 Klarman interview that has been making its rounds, HERE):
"In an era of rapid technological change, investors must be ever vigilant, even with regard to companies that are not involved in technology but are simply affected by it. In short, today’s good businesses may not be tomorrow’s."


"Managers who are unwilling to make shareholder-friendly decisions risk their companies becoming perceived as “value traps”: inexpensively valued, but ultimately poor investments, because the assets are underutilized. Such companies often attract activist investors seeking to unlock this trapped value. Even more difficult, investors must decide whether to take the risk of investing—at any price—with management teams that have not always done right by shareholders. Shares of such companies may sell at steeply discounted levels, but perhaps the discount is warranted; value that today belongs to the equity holders may tomorrow have been spirited away or squandered."


"Investors must also ponder the risks of investing in politically unstable countries, as well as the uncertainties involving currency, interest rate, and economic fluctuations. How much of your capital do you want tied up in Argentina or Thailand, or even France or Australia, no matter how undervalued the stocks may be in those markets?"

Rob Arnott on King World News

Hussman Weekly Market Comment: Increasing Concerns and Systemic Instability

Link to: Increasing Concerns and Systemic Instability
With the S&P 500 just 3% below its all-time high, there’s very little change our views here. Last week’s mild retreat only looks something other than mild when viewed in the context of a late-stage parabolic advance that has not seen a single 2.5% weekly decline since June of 2012. At the typical historical frequency, we would have had eight of them.

The ratio of nonfinancial equity market capitalization to nominal GDP is presently about 120%, compared with a historical average prior to the late-1990’s bubble of just 55%. The comparison - about double the historical norm - is about the same if one uses the Wilshire 5000, which includes financials, and for Tobin’s Q (price to replacement cost of assets). The price/revenue multiple of the S&P 500 is presently 1.6, versus a pre-bubble norm of just 0.8. All of these measures have a correlation of about 90% with subsequent 10-year S&P 500 returns, even including recent bubbles and subsequent busts.

The reason we generally don’t include late-90’s bubble data in the calculation of historical norms (though one should always be explicit about it), is that the S&P 500 has achieved total returns of hardly more than 3% annually for almost 14 years since the 2000 peak as the result of those valuations, and yet the historical extremes remain only partially uncorrected. We currently estimate nominal total returns for the S&P 500 averaging just 2.7% annually over the coming decade - no more than the present yield on 10-year Treasury bonds (though stocks are likely to experience far greater volatility and interim losses). These estimates incorporate a broad variety of fundamentals, including properly normalized forward operating earnings (see Valuing the S&P 500 Using Forward Operating Earnings).

Disagreements between valuation methods can be quickly resolved by examining the data. In every case, measures suggesting stocks as fairly valued or undervalued are those that take current profit margins at face value, and assume that current earnings are a sufficient statistic for corporate profitability over the next five decades (which is roughly the duration over which discounting must occur – see Superstition Ain’t the Way).

There's really no need to focus on the Shiller P/E, as it doesn't particularly underlie our views. But it's broadly followed so I often discuss it as a useful "shorthand" for other valuation measures. As it happens, the Shiller P/E at 25, versus a pre-bubble norm of just 15, is among the more optimistic valuation measures we track (at least those that have reliable historical records). This is because even the Shiller P/E is moderately biased by variations in profit margins. Its explanatory relationship to subsequent returns can be significantly improved by taking that margin variation into account (See the final chart in Does the CAPE Still Work?). Think of it this way. The ratio of Shiller earnings (the 10-year average of inflation adjusted earnings) to S&P 500 current revenues is 6.4% here, versus a historical norm of 5.3%. At normal profit margins, the Shiller P/E would presently be 30 – right in line with other more reliable measures at about double its pre-bubble norm. Even at 25, however, the Shiller P/E exceeds every pre-bubble observation since 1871, except for a few weeks leading up to the 1929 peak.
Increasing our concern is a 10-week average of advisory bulls at 57.7% versus just 14.8% bears – the most lopsided bullish sentiment in decades. Add the record pace of speculation on borrowed money, with NYSE margin debt now at 2.5% of GDP – an amount equivalent to 26% of all commercial and industrial loans in the U.S. banking system. Add the currency collapses in Argentina and Venezuela, as well as fresh credit strains and industrial shortfall in China, and one has any number of factors that could be viewed in hindsight as a “catalyst” (as the German trade gap was viewed after the 1987 crash, in the absence of other observable triggers).

Against all of these concerns is the recognition that the market doesn’t move in a straight line, and that the risks that concern us here have concerned us – though at less extreme levels – too long for many investors to give them much immediate credibility. Immediacy wasn’t really our strong suit in 2000 or 2007 either, but by the time our concerns played out, we still found ourselves far ahead over the complete cycle, with far less pain than speculators endured. Despite the challenges of an unusual but also unfinished half-cycle, and despite our awkward stress-testing transition, I'm comfortable that the tools we've developed and the benefits of discipline will be evident enough over the completion of this cycle and throughout future ones. But as Kierkegaard wrote, “patience is necessary, and one cannot reap immediately where one has sown.”

John Mauldin: Forecast 2014: The CAPEs of Hope

Last week's letter focused on my 2014 outlook for the US stock market and highlighted an important, but controversial, measure for long-term valuations: Robert Shiller's cyclically adjusted price-to-earnings ratio (CAPE). Unlike the more common trailing 12-month P/E ratio, Shiller's CAPE smooths out the earnings series and helps us avoid what could be false signals by dividing the market's current price by the average inflation-adjusted earnings of the past 10 years. Historically, this range has peaked and given way to major market declines at around 29x on average (26x excluding the dot-com bubble), and it has usually bottomed in the mid-single digits. Except for relatively brief windows during the late 1920s, the late 1990s, and the mid-2000s, Shiller's CAPE ratio has never been as expensive as it is today (see chart below).

As you can see, the S&P 500's high and rising CAPE ratio signals that US stocks are sailing into a well-proven danger zone. Also note that if we get a repeat of the stock market prior to 2007, the market can stay at this elevated range long enough to make investors complacent.

Not only does today's CAPE of 25.4x suggest a seriously overvalued market, but the rapid multiple expansion of the last few years coupled with sluggish earnings growth suggests that this market is also seriously overbought, as I pointed out last week and as we are seeing play out this week. Today's CAPE is just slightly less expensive than the 27x level seen at the October 2007 market peak and modestly below the level seen before the stock market crash in 1929. Although we are nowhere near the all-time "stupid" valuation peak of 43x in March 2000, a powerful narrative drove the markets to clearly unsustainable levels 15 years ago and a powerful narrative is driving markets today. Then it was the myth of dotcom and new tech, and now it is the tale of QE and the Fed.

Unfortunately, the outlook for US stocks only looks more daunting when we examine CAPE ratios for foreign equity markets. Mebane Faber, chief investment officer of Cambria Investments and author of The Ivy Portfolio (2009) and Shareholder Yield (2013), regularly posts international CAPE updates to his research blog, The Idea Farm ( Meb was kind enough to let me reprint his year-end 2013 update here.

A quick look reveals that the S&P 500 is the second most expensive stock market in the world today on both an absolute and a relative basis, second only to that of tiny Sri Lanka.
Expanding on recent valuations, Meb's work highlights that the relationship between CAPE valuation and subsequent returns is still very much intact. This next table compares the relative returns of the most expensive and cheapest markets. Study it carefully.
On average, the cheapest 10 markets as 2013 opened returned over 21% last year, while the most expensive 10 markets lost more than 5%. This is just one year, but we would expect to see the same basic relationship over the course of the next decade, if history is a reliable guide. I want to draw your attention to a fascinating observation: look at the outliers.

Russian stocks lost almost 1% in 2013, despite showing the fourth lowest CAPE at the beginning of the year. That's not a huge surprise. Valuations tell us a lot about long-term potential returns but not much about short-term timing. Momentum works until it doesn't.

US stocks tell quite a different story. They returned over 30% last year, despite starting 2013 with the sixth highest CAPE valuation. Rather than reversing course in the face of sluggish earnings growth, CAPE multiples expanded from 21.1x to 25.4x. By comparison, every market that started 2013 with more expensive CAPEs than the US's saw notable reversals of fortune, especially the top three: Peru's CAPE fell from 33.7x to 19.7x; Columbia's fell from 33.5x to 23.9x; and Indonesia's fell from 24.7x to 20.1x.

The impressive thing about US stocks is not simply that positive sentiment and Fed liquidity continued to drive valuations higher, but that the market rallied as much as it did with very modest earnings in the face of historically dangerous valuations. I have said it before, and I will say it again: Sentiment, rather than fundamentals, is driving the US stock market, and sentiment can quickly reverse.

Since we have no idea when the inevitable correction will come, we must expect it at any time. Shiller's CAPE can keep rising longer than any of us expect in the United States, but no one should be surprised if it corrects next week, next month, or next year.

Saturday, January 25, 2014

Michael Steinhardt, Wall Street's Greatest Trader, Is Back -- And He's Reinventing Investing Again

During the three decades that Wall Street grew up, morphing from a gentlemen’s investment club into a global financial colossus, Michael Steinhardt emerged as the world’s greatest trader. From 1967 to 1995 his pioneering hedge fund returned an average of 24.5% annually to its investors, even after Steinhardt took 20% of the profits. Put a different way, $10,000 invested with Steinhardt in 1967 would have been worth $4.8 million on the day he shuttered his fund. (The same investment in the S&P would have been worth $190,000.) It was a performance that landed him on The Forbes 400 in 1993, with a net worth estimated at more than $300 million.

Trading is all about timing, and by one key measure, he failed. He walked away while in his 50s, just as the hedge fund industry, which he helped create, was becoming the most potent moneymaking machine ever invented. Had he stuck with it, he very likely would be one of the very richest people in the world, mentioned in the same breath as George Soros ($20 billion) and Steve Cohen ($9.4 billion). “I thought there must be something more virtuous, more ennobling to do with one’s life than make rich people richer,” says Steinhardt. “There’s no sin in making rich people richer, but it’s not the sort of thing from which you would go straight up to heaven.”

Steinhardt says this in the most gentlemanly–even grandfatherly–way, a far cry from the notoriously short-tempered “screamer” of his heyday. He leisurely charts his life away from Wall Street, a tale that touches on politics (he was an early Bill Clinton supporter), Jewish cultural values (an atheist, he is nonetheless an ardent supporter of Jewish causes), animals (his country estate houses one of the world’s largest private zoos) and even a type of French field strawberry, the fraise du bois, that his wife, Judy, once tried to grow commercially. (Click here to read more about Steinhardt’s zoo or here for more about his philanthropy)

But sitting behind a glass desk in his thickly carpeted Manhattan office, Michael Steinhardt has another message that Wall Street should take note of: He’s back, and rather than play by the rules that he helped establish, he’s blowing them up, positioning himself as an advocate for the little guy–and making himself a new fortune in the process.

Steinhardt is chairman of the board and, with a 14.7% stake worth some $330 million, the largest single stakeholder in WisdomTree Investments, the ETF shop created by Jonathan “Jono” Steinberg, son of the late corporate raider Saul Steinberg, who famously flamed out at the end of his career. Steinhardt was way early on hedge funds–his was among the first dozen (there are 8,000 today). He thinks exchange-traded funds have similar disruptive potential, with individual investors (and some savvy operators like him) reaping the benefits.

“I cared about one thing,” Steinhardt says of his trading years, “and that one thing was having a better performance than anybody in America.” He later adds: “I want to phrase this in the strongest possible way: Jono Steinberg has been, from my perspective, the single greatest manager in the world of money management during the last eight or nine years.”

Whoa! To the extent that Wall Street has a take on Jono Steinberg, it’s that he’s married to Maria Bartiromo, business television’s “money honey.” In the 1980s he failed to complete his undergraduate business degree at Wharton (Steinhardt’s alma mater), despite the fact that his father’s name is carved on one of the buildings. He later used his family’s money to rechristen a tout sheet called Penny Stock Journal into Individual Investor magazine, which went bust in 2001. Most critically, the man Steinhardt calls the greatest money manager of his generation has never managed a significant amount of anyone else’s money.

What Jobs Will the Robots Take?

It is an invisible force that goes by many names. Computerization. Automation. Artificial intelligence. Technology. Innovation. And, everyone's favorite, ROBOTS.

Whatever name you prefer, some form of it has been stoking progress and killing jobs—from seamstresses to paralegals—for centuries. But this time is different: Nearly half of American jobs today could be automated in "a decade or two," according to a new paper by Carl Benedikt Frey and Michael A. Osborne, discussed recently in The Economist. The question is: Which half?

Another way of posing the same question is: Where do machines work better than people? Tractors are more powerful than farmers. Robotic arms are stronger and more tireless than assembly-line workers. But in the past 30 years, software and robots have thrived at replacing a particular kind of occupation: the average-wage, middle-skill, routine-heavy worker, especially in manufacturing and office admin.

Indeed, Frey and Osborne project that the next wave of computer progress will continue to shred human work where it already has: manufacturing, administrative support, retail, and transportation. Most remaining factory jobs are "likely to diminish over the next decades," they write. Cashiers, counter clerks, and telemarketers are similarly endangered. On the far right side of this graph, you can see the industry breakdown of the 47 percent of jobs they consider at "high risk."

And, for the nitty-gritty breakdown, here's a chart of the ten jobs with a 99-percent likelihood of being replaced by machines and software. They are mostly routine-based jobs (telemarketing, sewing) and work that can be solved by smart algorithms (tax preparation, data entry keyers, and insurance underwriters). At the bottom, I've also listed the dozen jobs they consider least likely to be automated. Health care workers, people entrusted with our safety, and management positions dominate the list.

If you wanted to use this graph as a guide to the future of automation, your upshot would be: Machines are better at rules and routines; people are better at directing and diagnosing. But it doesn't have to stay that way.

Friday, January 24, 2014

Steve Romick's Q4 Commentary

Forgive us if we bring you up to date this year, in part, through the lens of the distant past. 
We can’t help but think that the creators of Greek tragedies – those of the ancient variety, not the ongoing, modern ones – would have relished watching the Fed and the stock market the past couple of years and envisioned all kinds of morals to the story. 
For instance, it was another year of single-digit earnings growth but double-digit gains in multiples. What’s more, our oracles – we call them economists now – failed at the beginning of 2013 to accurately predict what would occur for that year: The U.S. economy grew more slowly than expected and S&P 500 earnings were lower than anticipated and yet the stock market rocketed to its best showing since 1997. 
Overseas, things weren’t that different. Our increasingly global view includes the performance of foreign stock markets, which generally didn’t fare quite as well as the U.S., with the exception of Japan. The U.S. stock market’s relatively strong showing speaks to the Federal Reserve’s continued aggressively dovish policy stance and that our economy missed estimates by less than most other developed economies. 
Like those mythological Greek characters, we live in a windy world but we’re in the habit of leaning into it. We tend to buy with the wind in our face, and sell with it at our backs. Right now, there’s more of the latter so, as you’d expect, our equity exposure declined during 2013. The favorable market allowed us to sell sixteen long equity positions during the year, at an average gain of 64% from cost, with just one generating a loss. We initiated nine new positions. The byproduct of this – unfortunate if the market continues to rally – is that our net equity exposure declined to 51.8%, down from 61.3% a year ago. We will let valuation and risk/reward guide our exposure, not the stock market. If the market gives us tomorrow’s prices today and the risk/reward becomes unattractive, then we are unsurprisingly net sellers. 
Things aren’t cheap. Equity values, as a percentage of GDP, are near their peaks. The only time they were higher was at the apex of the dot com bubble. 
And, on a Price/Earnings ratio basis, public securities are far from on sale. 
We see ideas thrown at us every day but, like a baseball batter, we’re particular to the pace, movement, and location before we swing. Right now, we’re seeing too many ideas coming at us with a lot of speed and then curving high and outside – in other words, generally not priced to our satisfaction with some questions as to business quality. While we wait, though, we keep adding companies to our library that, at some point, we expect to check out, update and invest in.

Marcus Aurelius quote

Not just that every day more of our life is used up and less and less of it is left, but this too: if we live longer, can we be sure our mind will still be up to understanding the world—to the contemplation that aims at divine and human knowledge? If our mind starts to wander, we’ll still go on breathing, go on eating, imagining things, feeling urges and so on. But getting the most out of ourselves, calculating where our duty lies, analyzing what we hear and see, deciding whether it’s time to call it quits—all the things you need a healthy mind for … all those are gone.

So we need to hurry.

Not just because we move daily closer to death but also because our understanding—our grasp of the world—may be gone before we get there.

Thursday, January 23, 2014

A Start-Up Run by Friends Takes On Shaving Giants

[Editor’s note: With some recent changes to Blogger, I may experiment with new posting formats and see if it looks better. I like posting several paragraphs so that the words are here in case the links ever change, but maybe I’ll post more in block quotes after linking to the article first.]

Link to article: A Start-Up Run by Friends Takes On Shaving Giants (The part I made bold below is especially interesting to me.)
EISFELD, Germany – For more than 93 years, the Feintechnik factory in this small German town an hour north of Nuremberg has produced billions of razors, its machinery transforming steel by the ton into the mathematically precise blades that end up in low-end safety blades and the hardest-to-manufacture five-blade razors. 
But as of Monday, the sprawling factory now belongs to Harry’s, an Internet shaving start-up that was not even open for business 10 months ago. 
Few companies contemplate striking $100 million deals before their first birthday. But Harry’s is wagering that owning its own factory will help it better compete against Gillette and Schick, the titans that together control nearly 85 percent of the market. 
“For a nine-month-old company to buy a 93-year-old one is a lot to bite off,” Andy Katz-Mayfield, 31, one of the start-up’s co-founders, said with a laugh in an interview at Feintechnik’s offices here. 
Harry’s is but the latest start-up to reimagine a prosaic product and give it a panache that helps it stand out from the crowd. But virtually all other e-commerce ventures of recent years — from Warby Parker, the red-hot eyewear brand, to the clothiers Everlane and Bonobos — have relied on using the same factories that bigger and more entrenched players use, and then selling their wares for less. 
Harry’s and its backers, including the investment firm Tiger Global, are betting that buying Feintechnik will give Harry’s a huge advantage. By running everything from the manufacturing of the razors to selling them online directly, they believe, the start-up will control its entire customer experience, while allowing the company to change its products quickly.

Does IBM Love or Hate Itself?

Bill Gates on Charlie Rose

Wednesday, January 22, 2014

Boyles Asset Management - Q4 2013 Letter Excerpt

Below are a couple of sections (slightly edited for public viewing) from a letter just sent to the investors of the fund I help manage.
Disclosure: I am a portfolio manager at Boyles Asset Management, LLC ("Boyles") and the fund managed by Boyles may in the future buy or sell shares of the stocks mentioned below and we are under no obligation to update our activities. This is for information purposes only and is not a recommendation to buy or sell a security. Please do your own research before making an investment decision.


Reasonable Imagination

“I am enough of the artist to draw freely upon my imagination.  Imagination is more important than knowledge.  Knowledge is limited.  Imagination encircles the world.”
– Albert Einstein, The Saturday Evening Post Interview (October 26, 1929)

There is no doubt that an appropriate temperament, a strong analytical mind, robust research process and experience are key determinants of investment success, but it is imagination that doesn’t seem to get much attention.  It is likely that the word imagination is more often associated with artists than investors, but we’ve come to appreciate the role a “reasonable imagination” plays in the investment process.  Perhaps even Mr. Buffett alludes to this in his work, often comparing his effort over the years at Berkshire Hathaway to painting his masterpiece.  It certainly took his imagination to build an investment group not seen before and, more importantly, it took an imagination to conceptualize, in potential investments, the opportunities beyond mere numbers on paper.

Defined by Merriam-Webster as, “the act or power of forming a mental image of something not present to the senses or never before wholly perceived in reality,” the noun begins to take the shape of a concept important to the investment process.  As we know, investing is about laying out cash today for something to be received in the future and so an investor had better be able to visualize as well as articulate what he or she expects to receive.  That takes more than just examining what is before one’s eyes—it takes imagination. 

A properly calibrated imagination plays a role in such things as:

§  conceiving of potential risks not immediately evident
§  hypothesizing about management and board of directors’ motivations
§  appreciating that earnings or cash flow might be markedly different in more or less optimum conditions
§  picturing competitive dynamics and responses over time
§  appreciating competitive strengths of businesses
§  seeing a future for a business that is different from general consensus
§  thinking about future regulatory issues
§  identifying potential catalysts for an investment
§  conceiving of potential future capital investment opportunities (how long is the runway)
§  identifying investment opportunities in a competitive market
§  improving the investment process
§  developing mental models

As can be inferred from the list above, we must be careful to regulate our imaginations, lest we forget that it is a “reasonable imagination,” rather than an “unreasonable imagination,” that counts.  And it certainly is not only about imagining what might be on the upside.  Equally important is an imagination about what might lurk on the downside.  In addition, it is vital to have a reasonable imagination when panic starts to impact markets or individual stocks.  Often it is investors’ imagination that gets the better of them in these situations.

Investors aren’t able to look up the answers or easily crunch some numbers to address these parts of the investment process.  They are not “present to the senses.”  For our part, we’ll continue to work on our investment imagination.

Side-Note 1

Just before we “went to press” with the letter, one of your managers happened to be reading 100 to 1 In the Stock Market, by Thomas Phelps (incidentally, we recommend the book).  Two-thirds of the way through, he came across the passage below that debunks the idea that we are the only ones thinking about the importance of a “reasonable imagination”:

To make a sensible choice we investors must make or accept some assumptions about the future…To make intelligent assumptions about the future we must try to perceive the tendency of events… It all boils down to practical imagination – the ability to see what is not there but will be soon enough to matter to you.

Side-Note 2

If you happen to know a modern art collector willing to pay top dollar for a Miller or Koster, please let us know.

Inefficient Markets

“Two markets are inefficient: very small ones (which are not much use to Berkshire, with its $120 billion), and ones where crazy people are doing crazy things, especially if they’re selling.  From time to time, the big markets have some crazily mispriced securities in them.  But there’s no question that in small markets there’s a lot of opportunity to find mispricings.”
–Charlie Munger (2007 Wesco Financial Annual Meeting)

The above quote from Charlie Munger is about the best summary we’ve seen to explain what we do, and how we believe we can generate good returns over time.  Our main focus has been on trying to find small, underfollowed, and mispriced companies.  We’re willing to look all over the world and have a particular focus on countries that speak and report in English so that we can perform the necessary due diligence we believe needs to be done when managing a concentrated portfolio.  And while our focus has been on smaller companies in the past and remains so today, we have the flexibility to venture into larger companies when opportunities present themselves, which they occasionally will just as they have before, as was evidenced during the depths of the financial crisis about five years ago.

In 2008, during the week that spanned from November 13th to November 20th, Class A shares of Berkshire Hathaway dropped from $103,600 to $74,100, a decline of almost 30% from the high to the low, on rumors that it was having troubles with some of the derivatives contracts it had written on four stock indices.  Those contracts still had between 10 and 20 years before Berkshire would be required to pay out a penny, though there was some worry that mark-to-market losses could force Berkshire to be at risk of falling short of the capital it is required to hold as part of its insurance business.  The rumors turned out to be false, and Berkshire’s stock recovered the full amount of the initial drop one week later, and continued its march upward over the next few years to close 2013 at $177,900 per share.

Berkshire is but one example of what can occasionally happen with the shares of larger companies when fear takes hold and you get to a point where “crazy people are doing crazy things.”  Of the roughly 400 companies with market capitalizations north of $5 billion at the start of 2007, about 15% of them had stock returns greater than 300% for the 5 years to the end of 2013.  Some well-known companies such as Whole Foods, Starbucks, and American Express are all up over 8 times where they traded during the crisis lows.  While we did not participate in the rise of those stocks, our hindsight points out one of the more difficult effects one’s psyche must face in investing: regret.

When looking back, you always find things you wish you had done (or not done), and it is important not to let the feeling that comes with knowing the past affect the way you invest in the present.  When crises strike and Mr. Market panics, the competitive advantages one can have over other market participants are largely psychological. One must be greedy when others are fearful and be willing to look stupid (since no alarm bell rings at the bottom) and look beyond short-term troubles, which can be quite real, in order to focus on long-term values.

While the above examples may be extreme and those values unlikely to repeat themselves anytime soon, history will rhyme eventually, and the opportunity to invest in “wide-moat” businesses at great prices that can compound for years will come again.  We eagerly await the day, though we have no idea when it may come, so we focus our time on what we believe is our best opportunity set at hand.  To quote Thomas Carlyle, “Our main business is not to see what lies dimly at a distance, but to do what lies clearly at hand.”  Our time today is largely spent trying to uncover a few gems among the smaller companies while continuing to learn things that we hope will lead to insights and investments in companies of any size.

Einstein quote

“The intuitive mind is a sacred gift and the rational mind is a faithful servant. We have created a society that honors the servant and has forgotten the gift.” -Albert Einstein

Warren and Jimmy Buffett on the Dan Patrick Show

Thanks to Lincoln for passing this along.

Links to videos:

Warren Buffett on the Dan Patrick Show

Warren and Jimmy Buffett on the Dan Patrick Show

The Art of Presence - by David Brooks

Greenlight Capital Q4 2013 Letter

Via ValueWalk:

Ray Dalio on CNBC

[UPDATE: Full video found via ValueWalk.]


Joel Greenblatt on CNBC


TED Talk - Bonnie Bassler: How bacteria "talk"

Feeding the healthy bacteria in the gut is essentially the purpose of the growing popularity of supplementing one's diet with Resistant Starch. For more on that part of it, read THIS and listen to THIS.


Atul Gawande on Charlie Rose (August 2013)

I think I missed this last year, but it’s worth catching up to now. They discuss Gawande’s article on the speed of innovation (HERE). I saw it as I was looking for a link to Bill Gates’ interview on Charlie Rose last night, which has yet to be put online yet.

Tuesday, January 21, 2014

Hussman Weekly Market Comment: Superstition Ain't the Way

Bernanke clearly meant it as a joke, but it is also an unfortunate statement on recent monetary policy. It's poetic that Stevie Wonder recorded Superstition in 1972, just before the stock market fell by half. A few weeks ago, William Dudley made the same point as Bernanke – even the Fed doesn’t quite understand how quantitative easing works. What FOMC officials are really saying is that aside from a very predictable effect on short-maturity interest rates, there is no mechanistic link between the monetary base and any other variables – financial or economic – that they are trying to control. There is a sense that creating more monetary base helps stocks advance, and that this contributes to economic confidence. What’s missing is a transmission mechanism that operates through identifiable banking and economic channels – other than promoting a speculative reach-for-yield and the psychological exuberance that accompanies a bull market. 

Buffett Leans on 29-Year-Old Cool to Oversee Problems

Thanks to Matt for passing this along.

Albert Edwards and Dylan Grice: Bearish Forecasts from Two Top Strategists

Found via ValueWalk.

Gates Foundation 2014 Annual Letter

Monday, January 20, 2014

Seneca quote

“It is not that we have a short space of time, but that we waste much of it. Life is long enough, and it has been given in sufficiently generous measure to allow the accomplishment of the very greatest things if the whole of it is well invested. But when it is squandered in luxury and carelessness, when it is devoted to no good end, forced at last by the ultimate necessity we perceive that it has passed away before we were aware that it was passing. So it is—the life we receive is not short, but we make it so, nor do we have any lack of it, but are wasteful of it. Just as great and princely wealth is scattered in a moment when it comes into the hands of a bad owner, while wealth however limited, if it is entrusted to a good guardian, increases by use, so life is amply long for the one who orders it properly.” -Seneca, On the Shortness of Life

(Source of the quote above)