Friday, February 28, 2014

The Conversation talks with Joseph Tainter (2012)

Link to podcast: Episode 19: Joseph Tainter
Dr. Joseph Tainter is an anthropologist and historian who has studied collapse in numerous ancient civilizations and penned The Collapse of Complex Societies. This is our first deeply historical episode and Dr. Tainter begins by offering his definition of complexity and taking us through the story of Western Rome’s collapse. Extrapolating from the past, Dr. Tainter paints a dark scene of our possible future. In our conversation, he critiques the primitivism of John Zerzan, the transhumanism of Max More, and rains on the technological optimism heard in Ariel Waldman, Colin Camerer, and Gabriel Stempinski’s conversations. What are we left with? Not optimism, that is certain, but not pessimism, either. Perhaps Ragnarok? Interestingly, Dr. Tainter finds a ray of hope in education (which would probably peeve Andrew Keen and please Lisa Petrides) and speculates that teaching children to think on larger spatial and temporal scales might be our best way to evade collapse. Alexander Rose would almost certainly agree.

Related previous post: Collapse of Complex Societies by Dr. Joseph Tainter

Related book: The Collapse of Complex Societies

NPR: Neil DeGrasse Tyson Explains Why The Cosmos Shouldn't Make You Feel Small

When it comes to "callings" we usually think of people who feel drawn to religious career paths. But if you ask Neil deGrasse Tyson how he became an astrophysicist he says: "I think the universe called me. I feel like I had no say in the matter."

Tyson, director of the Hayden Planetarium at the Museum of Natural History in New York, is a prolific writer and frequently cited authority on astronomy in the popular media. He's hosted a four-part series on Nova and appeared everywhere from The Tonight Show to The Daily Show to Wait Wait ... Don't Tell Me!

This spring, Tyson hosts a new TV series called Cosmos: A Space-Time Odyssey. It's an update of the influential 1980 PBS series Cosmos: A Personal Journey. Tyson was entering graduate school in astrophysics at the time and remembers watching Carl Sagan host the original Cosmos.

It was "proof that a scientist can communicate with the public in a manner that was very different from a professor in front of a classroom or pontificating from up on high," Tyson tells Fresh Air's Dave Davies. "His style was very conversational and fireside-chatty. There he was on the screen, but he was really with you in the living room."

Tyson worked with Ann Druyan, Sagan's widow, in developing the new series, which debuts March 9 and 10 on Fox and the National Geographic Channel.

If you are one of those people who don't like thinking about astronomy because it makes them feel small, Tyson suggests looking at it a different way: "Our molecules are traceable to stars that exploded and spread these elements across the galaxy," he explains. If you "see the universe as something you participate in — as this great unfolding of a cosmic story — that, I think should make you feel large, not small. ... Any astrophysicist does not feel small looking up in the universe; we feel large."

Related previous post: Inspiration from the universe...

Seth Klarman quote

From Margin of Safety:
…perseverance at even relatively modest rates of return is of the utmost importance in compounding your net worth. A corollary to the importance of compounding is that it is very difficult to recover from even one large loss, which could literally destroy all at once the beneficial effects of many years of investment success. In other words, an investor is more likely to do well by achieving consistently good returns with limited downside risk than by achieving volatile and sometimes even spectacular gains but with considerable risk of principal. An investor who earns 16% annual returns over a decade, for example, will, perhaps surprisingly, end up with more money than an investor who earns 20% a year for nine years and then loses 15% the tenth year. 
There is an understandable, albeit uneconomic, appeal to the latter pattern of returns, however. The second investor will outperform the former nine years out of ten, gaining considerable psychic income from this apparently superior performance. If both investors are money management professionals, the latter may also have a happier clientele (90% of the time, they will be doing better) and thus a more successful company. This may help to explain why risk avoidance is not the primary focus of most institutional investors.

2008 Barron's Interviews - Howard Marks and Rob Arnott

Interesting interviews to go back and read. Links to:

Clayton Christensen "Be the Disruptor" (2012)



Related books:

Seeing What's Next: Using Theories of Innovation to Predict Industry Change (I just recently started this one, and it may be the most useful one from an outside investor's standpoint)

The Innovator's Dilemma

The Innovator's Solution

Thursday, February 27, 2014

Charlie Munger and Seth Klarman quotes

In the most recent Boyles letter, we included this quote from Charlie Munger, which we described as a quote that probably best summarizes our investing focus:
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.
I also recently came across a quote from Seth Klarman in his book Margin of Safety which is similar, and that I think also gives great description of where opportunities are more likely to present themselves:
The pricing of large-capitalization stocks tends to be more efficient than that of small-capitalization stocks, distressed bonds, and other less-popular investment fare. While hundreds of investment analysts follow IBM, few, if any, cover thousands of small-capitalization stocks and obscure junk bonds. Investors are more likely, therefore, to find inefficiently priced securities outside the Standard and Poor’s 100 than within it. Even among the most highly capitalized issues, however, investors are frequently blinded by groupthink, thereby creating pricing inefficiencies.
In that same letter, we then described some of the big market names that have done well since the crisis as examples of the groupthink mentioned by Klarman above. Combining those larger-cap examples with the micro-cap example we gave in our Q2 2013 letter I think gives a good flavor of the opportunities that investors and funds with a smaller asset base can look to capitalize on.

Eddie Lampert's Letter to Sears Shareholders

I am writing to you after my first full year serving as both your Chairman and Chief Executive Officer. 
While our financial results remain challenged, 2013 may have been the year that justifies why so many people across Sears Holdings have been working for several years on our transformation from a traditional, store-based retailer to a membership company that serves its members across an integrated retail platform. 
Furthermore, if the way the entire American retail industry ended 2013 is any indication, I believe 2014 may well be a year in which Sears Holdings begins to clearly demonstrate the advantages of this transformation. 
That may sound odd given our financial results, but this letter will detail why I believe that. To be clear, it is not because our performance is where we need it to be. It isn't. But not only do I believe that we are headed in the right direction in important ways, I believe the entire retail industry is headed to where we already are.

Munger and POSCO

As a follow-up to the post about the Daily Journal Holdings becoming public (HERE), here’s a comment from Charlie Munger about POSCO at the 2007 Wesco Annual Meeting:
I would argue that what POSCO does is not a commodity business at all – it’s a high-tech business. They learned from Nippon Steel and they’re now even more advanced. I’d argue that if you have the most technologically advanced steel company in the world making unusual, [non-commodity] stuff, then business can be quite attractive for a long time.

Wednesday, February 26, 2014

Target risk, not return

From Seth Klarman, via Margin of Safety:
Targeting investment returns leads investors to focus on upside potential rather than on downside risk....Rather than targeting a desired rate of return, even an eminently reasonable one, investors should target risk. Treasury bills are the closest thing to a risk-less investment; hence the interest rate on Treasury bills is considered the risk-free rate. Since investors always have the option of holding all of their money in T-bills, investments that involve risk should only be made if they hold the promise of considerably higher returns than those available without risk. This does not express an investment preference for T-bills; to the contrary, you would rather be fully invested in superior alternatives. But alternatives with some risk attached are superior only if the return more than fully compensates for the risk.

BofA Reaches Deal With Buffett on Preferred Stake

Bank of America Corp. (BAC), the lender that turned to Warren Buffett in 2011 for a capital injection, reached a deal with the billionaire’s company to change terms so the investment is treated more favorably by regulators. 
The amendment would allow the bank to count preferred shares with a $2.9 billion carrying value as Tier 1 capital, the Charlotte, North Carolina-based lender said in a filing with the U.S. Securities and Exchange Commission yesterday. The deal with Buffett’s Berkshire Hathaway Inc. (BRK/A) must be approved by the bank’s shareholders in a May vote, according to the filing. 
The agreement will “benefit our Tier 1 capital and leverage ratios,” Bank of America said in the filing. “We do not expect any impact to our financial condition or results of operations as a result of this amendment.” 
Bank of America Chief Executive Officer Brian T. Moynihan has been selling assets to simplify the company and prepare for tighter regulation. U.S. and international watchdogs are pushing lenders to hold more capital to prevent a repeat of the bailouts in the financial crisis. Tier 1 capital is a measurement of a bank’s ability to absorb losses. 
The amendment would force Bank of America to wait at least five years from its approval to redeem the preferred stock. Under the 2011 deal, the bank was able to redeem the preferred stake at any time as long as it paid a 5 percent premium.

Tuesday, February 25, 2014

GMO white paper: A CAPE Crusader: A Defence Against the Dark Arts - by James Montier

Having spent a large proportion of my career prior to joining GMO working at investment banks, I’m well aware of what Andrew Smithers describes as “Stock Broker Economics,” the second tenet of which is “The market is always cheap.” Over the years I’ve witnessed many attempts by the practitioners of this most dark art to justify why tried and tested measures of valuation are no longer meaningful, or occasionally create new measures of valuation that purport to show the market to be cheap.

A recent outbreak of precisely this brand of sorcery has surrounded the Shiller P/E (price relative to 10­-year moving average earnings adjusted for inflation as shown in Exhibit 1). Wizards range from the seemingly ever optimistic Jeremy Siegel to any number of Wall Street strategists, and even a blogger whose work I generally enjoy. Given that one should always look for evidence that may prove one wrong, I’ve spent some time thinking about the issues they have raised and have summarized my thoughts in this short paper.

Michael Porter on "Value Based Health Care Delivery" (2011)


[H/T Remmelt]


Related link: How Healthcare Can Become Higher in Quality, Lower in Cost & Widely Accessible - Clay Christensen (2012)

This Woman Invented a Way to Run 30 Lab Tests on Only One Drop of Blood

Phlebotomy. Even the word sounds archaic—and that’s nothing compared to the slow, expensive, and inefficient reality of drawing blood and having it tested. As a college sophomore, Elizabeth Holmes envisioned a way to reinvent old-fashioned phlebotomy and, in the process, usher in an era of comprehensive superfast diagnosis and preventive medicine. That was a decade ago. Holmes, now 30, dropped out of Stanford and founded a company called Theranos with her tuition money. Last fall it finally introduced its radical blood-testing service in a Walgreens pharmacy near the company headquarters in Palo Alto, California. (The plan is to roll out testing centers nationwide.) Instead of vials of blood—one for every test needed—Theranos requires only a pinprick and a drop of blood. With that they can perform hundreds of tests, from standard cholesterol checks to sophisticated genetic analyses. The results are faster, more accurate, and far cheaper than conventional methods. The implications are mind-blowing. With inexpensive and easy access to the information running through their veins, people will have an unprecedented window on their own health. And a new generation of diagnostic tests could allow them to head off serious afflictions from cancer to diabetes to heart disease. None of this would work if Theranos hadn’t figured out how to make testing transparent and inexpensive. The company plans to charge less than 50 percent of the standard Medicare and Medicaid reimbursement rates. And unlike the rest of the testing industry, Theranos lists its prices on its website: blood typing, $2.05; cholesterol, $2.99; iron, $4.45. If all tests in the US were performed at those kinds of prices, the company says, it could save Medicare $98 billion and Medicaid $104 billion over the next decade.

Related links:

Inside the Showdown Atop Pimco, the World's Biggest Bond Firm

NEWPORT BEACH, Calif.—Tension increased at Pacific Investment Management Co.'s headquarters here last summer. The bond market was under pressure, losses grew and clients pulled billions of dollars from the firm. 
Bill Gross, who co-founded Pimco in 1971 and is largely responsible for building it into a behemoth overseeing almost $2 trillion in assets, struck some of his colleagues as testier than usual. He argued openly with Mohamed El-Erian, Pimco's chief executive—something employees say they rarely had seen. 
Mr. Gross—by his own admission, a demanding boss—had long showed respect for Mr. El-Erian and indicated that the younger man eventually would take over the world's biggest bond firm. But one day last June, the two men squared off in front of more than a dozen colleagues amid disagreements about Mr. Gross's conduct, according to two people who were there. 
"I have a 41-year track record of investing excellence," Mr. Gross told Mr. El-Erian, according to the two witnesses. "What do you have?" 
"I'm tired of cleaning up your s—," Mr. El-Erian responded, referring to conduct by Mr. Gross that he felt was hurting Pimco, these two people recall. 
Later, after Mr. El-Erian told Mr. Gross he needed to change the way he interacted with employees, Mr. Gross, 69 years old, agreed to make adjustments, several Pimco employees say. But last month, Pimco announced that Mr. El-Erian, 55, would leave the firm—a surprise to both employees and investors.

UPDATE: Gross responded to the article HERE.

Charlie Munger quote

“If you’re going to be an investor, you’re going to make some investments where you don’t have all the experience you need. But if you keep trying to get a little better over time, you’ll start to make investments that are virtually certain to have a good outcome. The keys are discipline, hard work, and practice. It’s like playing golf—you have to work on it.” –Charlie Munger

Monday, February 24, 2014

Warren Buffett quote

From Warren Buffett’s 2010 FCIC testimony, when asked why he sold his shares in Freddie Mac and Fannie Mae in the year 2000:
I was concerned about the management at both Freddie Mac and Fannie Mae although our holdings were concentrated in Freddie Mac. They were trying to and proclaiming that they could increase earnings per share in some low double digit range or something of the sort. And any time a large financial institution starts promising regular earnings increases you’re going to have trouble. It isn’t given to man to be able to run a financial institution where different interest rates scenarios will prevail and all of that comes to produce smooth regular earnings from a very large base to start with. So if people are thinking that way they’re going to do things maybe in accounting it’s turned out to be the case in both Freddie and Fannie but also in operations that I would regard as unsound. I don’t know when it’ll happen, I don’t even know for sure if it’ll happen. It will happen eventually if they keep up that policy and so, we, or I just decided to get out.

You can get in a whole lot more trouble in investing with a sound premise than with a false premise

…my former boss Ben Graham in an observation 50 or so years ago to me that really stuck in my mind and now I’ve seen elements of it. He said you can get in a whole lot more trouble in investing with a sound premise than with a false premise. If you have some premise that the moon is made of green cheese or something, you know, it’s ridiculous on its face. If you come up with a premise that common stocks have done better than bonds and I wrote about this in a Fortune article in 2001. Because it was, there was a famous little book in 2001 by Edgar Lawrence Smith, in 1924, I think, by Edgar Lawrence Smith that made a study of common stocks vs. bonds. And it showed, he started out with the idea that bonds would over-perform during deflation and common stocks would over-perform during inflation. He went back and studied a whole bunch of periods and lo and behold, his original hypothesis was wrong. He found that common stocks always over-performed. And he started to think about it and why was that. Well it was because there was a retained earnings factor. They sold, the dividend you got on stocks was the same as the yield on bonds and on top of that you had retained earnings. So they over-performed. That became the underlying bulwark for the ‘29 bubble. People thought stocks were starting to be wonderful and they forgot the limitations of the original premise which was that if stocks were yielding the same as bonds that they had this going for them. 
So after a while the original premise which becomes sort of the impetus for what later turns out to be a bubble is forgotten and the price action takes over. Now we saw the same thing in housing. It’s a totally sound premise that houses will become, worth more over time because the dollar becomes worth less. It isn’t because, you know, construction costs go up. And it isn’t because houses are so wonderful it’s because the dollar becomes worth less that a house that was bought 40 years ago is worth more today than it was then. And since 66% or 67% of the people want to own their home and because you can borrow money on it and you’re dreaming of buying a home, if you really believe that houses are going to go up in value you buy one as soon as you can. And that’s a very sound premise. It’s related of course, though, to houses selling at something like replacement price and not [unintelligible] of stripping inflation. So the sound premise it’s a good idea to buy a house this year because it will probably cost more next year and you’re going to want a home and the fact that you can finance it gets distorted over time if housing prices are going up 10% a year and inflation is a couple of percent a year. Soon the price action, or at some point the price action takes over and you want to buy three houses and five houses and you want to buy with nothing down and you want to agree to payments that you can’t make and all of that sort of thing because it doesn’t make any difference, it’s going to be worth more next year. And the lender feels the same way. Doesn’t really make difference if it’s a liar’s loan or you don’t have the income or something because even if they have to take it over, it’ll be worth more next year. Once that gathers momentum and it gets reinforced by price action and the original premise is forgotten which it was in 1929. The internet, it’s the same thing. The internet was going to change our lives, but it didn’t mean that every company was worth $50 billion that could dream up a prospectus and the price action becomes so important to people that it takes over their minds.  And because housing was the largest single asset around 22 trillion or something like on about, you know, a household wealth of 50 or 60 trillion or something like that in the United States, such a huge asset, so understandable to the public. They might not understand stocks or the internet, you know, they might not understand tulip bulbs, but they understood houses. And they wanted to buy one anyway and the financing, and you could leverage up to the sky, it created a bubble like we’ve never seen. I wish I’d figured that out in 2005.

In Slalom, Mikaela Shiffrin Zips to Bottom and Reaches the Pinnacle

Michael Mauboussin (who was also interviewed HERE recently) mentioned this story as a great example of focusing on process over outcome.

KRASNAYA POLYANA, Russia — Mikaela Shiffrin, the 18-year-old wunderkind of ski racing, is a product of a countercultural movement in American youth sports, an initiative of parents who encourage their children to focus on the process of athletic achievement instead of the results. In theory, both the journey and the destination are enhanced. 
Shiffrin, the most precocious ski racer the United States has produced, believed and preached the doctrine, even as she became the youngest slalom world champion a year ago. 
Then, on Friday night, Shiffrin skied to a commanding lead at the halfway point of the women’s Olympic slalom competition. The gold medal was hers to lose. Riding the chairlift for the second run, which would complete her coronation as ski racing’s newest queen, Shiffrin started to cry. 
“I might actually be an Olympic champion,” she gasped. 
Minutes later, roaring down the racecourse, she could not get the gold medal out of her mind. Shiffrin was on the verge of crashing, one ski airborne, her arms flailing. 
Her coach was sure the race was lost. Her mother wondered if she would have a heart attack. The racer relied on the process. 
“I’ve made that recovery in practice a hundred times, if not more,” Shiffrin said later. “So I said, ‘You know what to do — charge back into the course.’ ” 
About 25 rapid and nearly flawless turns later, Shiffrin sped past the finish line to become the youngest Olympic slalom champion. She is the first American to win the event in 42 years. 
“You can create your own miracle,” Shiffrin said when the gold medal was on a sash draped around her neck. “But you do it by never looking past all the little steps along the way.”

Daniel Kahneman, in conversation with Cass Sunstein

On February 3, 2014, Daniel Kahneman, Nobel Prize-winning author of Thinking, Fast and Slow, spoke with Cass Sunstein, Robert Walmsley University Professor in Spangler Auditorium at Harvard Business School.


[H/T The Big Picture]


Related link: Daniel Kahneman's interview with Michael Covel

Warren Buffett on investment, speculation, and gambling

From Warren Buffett’s 2010 FCIC testimony (the audio is available HERE):
I’d be interested in, you know, what you think speculation is as opposed to investing which you’ve written about and also what you think excess speculation or excess risk is in that context. 
Warren Buffett:
It’s a tricky definition, you know, it’s like pornography (laughs) the famous quote and all that, but I look at it in terms of the intent of the person engaging in the transaction. And an investment operation, and that’s not the way Graham defines it in his book, but an investment operation in my view is one where you look to the asset itself to determine your decision to lay out some money now to get some more money back later on. So you look to the apartment house, you look to the stock, you look to the farm in terms of what that will produce. And you don’t really care whether there’s a quote under it all. You are basically committing some funds now to get more funds later on through the operation of the asset. 
Speculation, I would define, as much more focused on the price action of the stock, particularly that you buy or the indexed future or something of the sort. Because you are not really, you are counting on, for whatever factors, could be quarterly earnings, could be up or it’s going to split or whatever it may be or increase the dividend, but you are not looking to the asset itself. And I say the real test of how you, what you’re doing is whether you care whether the markets are open. When I buy a stock, I don’t care whether they close the stock market tomorrow for a couple of years because I’m looking to the business, Coca-Cola or whatever it may be to produce returns for me in the future from the business. Now if I care whether the stock market is open tomorrow then I say to some extent I’m speculating because I’m thinking about whether the price is going to up tomorrow or not. I don’t know where the price is going to go. 
And then gambling I would define as engaging in a transaction which doesn’t need to be part of the system. I mean, if I want to bet on a football game, you know, the football game’s operation is not dependent on whether I bet or not. Now, if I want to bet on October wheat or something of the sort people have to raise wheat and when they plant it they don’t know what the price is going be later on. So you need activity on the other side of that and who may be speculating on it but it is not an artificial transaction that has no necessity for existing in an economic framework. And the gambling propensity with people is huge. I mean, you took a, you know, some terrible sand out in the west about 100 years ago and you created, you know, huge industry with people flying thousands of miles to do things which are mathematically unintelligent, you know. Now that is, shows something in mankind that has a strong, strong behavioral, has a strong behavioral aspect to it and think how much easier it is, you know, to sit there in front of a computer and have the same amount of fun without, you know, getting on a plane and going a 1,000 miles and having to make reservations and do all that sort of thing. So with this propensity to gamble encouraged incidentally by the state with lotteries, you know, with terrible odds attached to them, people don’t have to be trained to want to gamble in this country but they, they have this instinct, a great many people. They’re encouraged when they see some successes around, that’s why the bells and whistles go off in the casino when somebody hits a jackpot, you know. So, you know, you have all these things pushing to that including governmental urging to buy lottery tickets and all that sort of thing. And now you’ve got a vehicle like, you know, S&P futures or something where you can go in and out and where Congress has granted particularly favorable tax treatment to you if you win. I mean, you can be in for ten seconds and have 60% long term gain which I regard as, you know, extraordinary. But it exists. 
That’s all I know about gambling, actually speculation (laughs) but I do know it when I see it.

Robert Shiller on WealthTrack


Excerpt from Warren Buffett's annual letter

In an exclusive excerpt from his upcoming shareholder letter, Warren Buffett looks back at a pair of real estate purchases and the lessons they offer for equity investors.

"Investment is most intelligent when it is most businesslike." --Benjamin Graham, The Intelligent Investor 
It is fitting to have a Ben Graham quote open this essay because I owe so much of what I know about investing to him. I will talk more about Ben a bit later, and I will even sooner talk about common stocks. But let me first tell you about two small nonstock investments that I made long ago. Though neither changed my net worth by much, they are instructive.

Sunday, February 23, 2014

Matthew Miller: In-depth Idea Presentation

Thanks to John and Oliver for opening this up to the public, and for hosting another great conference. My partner at Boyles Asset Management, Matt Miller, gave his presentation on Zicom Group (ASX: ZGL).

Link to video and presentation: Matthew Miller: In-depth Idea Presentation

Disclosure: I am a portfolio manager at Boyles Asset Management, LLC ("Boyles") and the fund managed by Boyles owns shares of stock in Zicom Group Ltd.  We may in the future buy or sell shares in the fund and 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.

Saturday, February 22, 2014

Charlie Munger on the insurance business and ethical limits

Views on the insurance business and ethical limits 
I don’t think the insurance business will be that great for most people in it. I think we will do way better. We have great people. When I was younger, I probably wouldn’t have even tried to get into the game. It’s like a juggler with milk bottles who ends up juggling ten. Before we knew it, Berkshire had 10 insurance businesses. [Munger asked Gen Re CEO Joe Brandon to comment and he said, “We have the best collection in the world.” Munger continued:] That may be an absolutely correct statement. We gradually learned our way into that position. It didn’t happen overnight. If you’re not a learning machine, it won’t happen.   
My father had a friend who used to say everyone’s the same over the years, only more so. To some extent we’re more so. We learned good lessons when we were young. We’ve been more selective. I don’t think we’ve ever regretted not making a lot of easy money when we decided it was beneath us. 
Warren told the story of the opportunity to buy Conwood, the #2 maker of chewing tobacco. I never saw a better deal, and chewing tobacco doesn’t create the same health risks as smoking. All of the managers chewed tobacco – it was admirable of them to eat their own cooking. Warren and I sat down, said we’re never going to see a better deal; it’s a legal product; and we can buy it at a wonderful price; but we’re not going to do it. Another fellow did and made a couple of billion easy dollars. But I don’t have an ounce of regret. I think there are a lot of things you shouldn’t do because it’s beneath you.

Friday, February 21, 2014

2008 FOMC Meeting Excerpt

I’ve only read a little of the transcripts so far, but it is pretty interest to read what was going on inside the Fed in real time during the financial crisis. Here’s one example, which is a little speech Bernanke gave during an October 2008 FOMC Meeting:
CHAIRMAN BERNANKE. Thank you. Other questions? All right. If not, let me just say a few words. I will be brief. It’s more than obvious that we have an extraordinary situation. It is not a single market. It’s not like the 1987 stock market crash or the 1970 commercial paper crisis. Virtually all the markets—particularly the credit markets—are not functioning or are in extreme stress. It’s really an extraordinary situation, and I think everyone can agree that it’s creating enormous risks for the global economy. 
What to do about it? The exchange we just had suggests that we may have disagreements about the benefits of liquidity provision. I personally think that it has been helpful. But I think we can agree that it is obviously not a panacea because, as the Vice Chairman points out, it doesn’t address the underlying capital issues. That suggests that the right solutions probably have a significant fiscal element to them. However, one feature of the last few days is how striking, how uncoordinated, and how erratic some of the fiscal approaches have been—particularly in Europe, where there has been a remarkable lack of coordination in the European Union. So the fiscal solutions are coming, but they’re not there yet, and it is going to be a while. We need greater clarity on those issues. We had a meeting today on the Treasury’s authority, and they are hoping in the next few weeks to begin to provide greater clarity, which will be very helpful. But I think that, if we can find some kind of bridge, it would be helpful, and that’s what this meeting is about. 
Although the financial markets are the dramatic element of the situation, I think we can make a case for easing policy today on the macro outlook, as given by Larry and Nathan. I won’t go into detail. I think it’s fairly clear. You look first at inflation, and you see the remarkable decline in commodity prices, the appreciation of the dollar, and the decline in breakevens. The 10-year breakeven this morning was about 1.35. Of course, that could be a noisy indicator, but certainly it’s quite low. I would say that, in terms of activity and the relation to inflation, we don’t have to rely on any flat Phillips curves here. We have a global slowdown, and the implications for commodity prices are first order for our inflation forecast. It is never safe to declare inflation under complete control, and I certainly don’t claim that no risks are there; but clearly the outlook for inflation is not looking nearly so threatening as it may have in the past. 
On the economic growth side, what is particularly worrisome to me is that, before this latest upsurge in financial stress, we had already seen deceleration in growth, including the declines, for example, in consumer spending. Everyone I know who has looked at it—outside forecasters and the Greenbook producers here at the Board—believes that the financial stress we are seeing now is going to have a significant additional effect on growth. Larry gave some estimates of unemployment above 7 percent for a couple of years. So even putting aside the extraordinary conditions in financial markets, I think the macro outlook has shifted decisively toward output risks and away from inflation risks, and on that basis, I think that a policy move is justified. 
I should say that this comes as a surprise to me. I very much expected that we could stay at 2 percent for a long time, and then when the economy began to recover, we could begin to normalize interest rates. But clearly things have gone off in a direction that is quite worrisome. One could legitimately ask questions about the transmission mechanism under these conditions, and I think those are good questions. But first it seems to me that we can, to some extent, offset costs of credit through our actions, even if spreads are wide. Second, to the extent that the global coordination creates some more optimism about the future of the global economy, we may see some improvements in credit spreads. We may not, but it seems to me that this is the right direction in which to go. 
Despite everything that’s happening, I might not be bringing this to you at this point, except that we have the opportunity to move jointly with five other major central banks, and I think the coordination and cooperation is a very important element of this proposal. First of all, again, I mentioned before the lurching and the lack of coordination among fiscal authorities and other governments. I think it would be extraordinarily helpful to confidence to show that the world central banks are working closely together, have a similar view of global economic conditions, and are willing to take strong actions to address those conditions. I think that there is a multiplier effect, if you will. Our move, along with these other moves, will have a stronger effect on the global economy and on the U.S. economy than our acting alone. Moving together has other benefits. Just to note one, we can have less concern about the dollar if we’re all moving together and less concern about inflation expectations given that all the banks are moving and all see the same problem. 
There is a tactical issue. I think the real key to this is actually the European Central Bank. They have had some difficulty coming to the realization that Europe would be under a great deal of stress and was not going to be decoupled from the United States. They made an important rhetorical step at their last meeting to open the way for a potential cut, but I think that this coordinated action gives them an opportunity to get out of the corner into which they are somewhat painted and their move will have a big impact on global expectations about policy responsiveness. So, again, I think the coordination is a very important part of this. 
I want to say once again that I don’t think that monetary policy is going to solve this problem. I don’t think liquidity policy is going to solve this problem. I think the only way out of this is fiscal and perhaps some regulatory and other related policies. But we don’t have that yet. We’re working toward that. We are in a very serious situation. So it seems to me that there is a case for moving now in an attempt to provide some reassurance—it may or may not do so—but in any case, to try to do what we can to make a bridge toward the broader approach to the crisis.
So that’s my recommendation, that we join the other central banks in a 50 basis point move before markets open tomorrow morning.

Federal Reserve releases 2008 meeting transcripts


It may also be worthwhile to go back and review some of the Financial Crisis Inquiry Commission testimonies HERE.

Facebook, Whatsapp deal articles

A couple of reads on the deal that I thought were interesting.

This week, I was at the Tuck School of Business at Dartmouth, talking about the difference between price and value. I built the presentation around two points that I have made in my posts before. The first is that there are two different processes at work in markets. There is the pricing process, where the price of an asset (stock, bond or real estate) is set by demand and supply, with all the factors (rational, irrational or just behavioral) that go with this process. The other is the value process where we attempt to attach a value to an asset based upon its fundamentals: cash flows, growth and risk. For shorthand, I will call those who play the pricing game “traders” and those who play the value game “investors”, with no moral judgments attached to either. The second is that while there is absolutely nothing wrong or shameful about being either an investor  (No, you are not a stodgy, boring, stuck-in-the-mud old fogey!!) or a trader (No, you are not a shallow, short term speculator!!), it can be dangerous to think that you can control or even explain how the other side works. When you are wearing your investor cape, you can be mystified by what traders do and react to, and if you are in your trader mode, you are just as likely to be bamboozled by the thought processes of investors. So, at the risk of ending up with a split personality, let me try looking at Facebook’s acquisition of Whatsapp for $19 billion, with $15 billion coming from Facebook stock and $4 billion from cash, using both perspectives. 
Closing Thoughts
My experience with markets has been that no one has a monopoly on virtue and good sense and that the hubris that leads to absolute conviction is an invitation for a market take-down. To investors who view deals like the Whatsapp acquisition as evidence of irrational exuberance, remember that there are traders who are laughing their way to the bank, with the profits that they have collected from their social media investments. Similarly, for traders who view fundamentals and valuation as games played by eggheads and academics,  recognize that mood and momentum may be the dominant factors driving social media companies right now, but markets are fickle and fundamentals will matter (sooner or later).


Two years ago, Jan Koum, founder of mobile-messaging service WhatsApp, decried online advertising, saying it drives tech companies to write "better code to collect all your personal data." 
On Wednesday, Mr. Koum agreed to sell his company to Facebook Inc., which built the world's second-largest online advertising platform after Google Inc.'s by harvesting information users post on the social network. 
How Mr. Koum and Facebook Chief Executive Mark Zuckerberg navigate that clash may determine the success or failure of the $19 billion deal, the largest ever for a tech startup. WhatsApp will operate independently of Facebook, and Mr. Koum will join Facebook's board, creating a delicate balance of influence. 
The men are divided by more than differing approaches to making money. A legacy of his childhood in Ukraine is Mr. Koum's emphasis on privacy: WhatsApp doesn't collect any personal information other than a mobile-phone number and address book, and it wipes out messages shortly after they are sent. 
Mr. Zuckerberg, by contrast, has riled users by changing Facebook's privacy settings in ways that some thought exposed more of their personal information more widely.

Charlie Munger on Salomon and the importance of a good reputation

Comments on the Salomon crisis 
What was interesting about that day was that it would have had reverberations that would have made the Long Term Capital Management blow-up look like nothing if the Secretary of the Treasury, Nick Brady, hadn’t reversed the government’s decision to suspend Salomon from participating in government Treasury auctions. Nick Brady’s family was one of the original shareholders of Berkshire but sold out before Warren came on. 
Nick correctly recognized that the New England textile industry was doomed and sold all of the family’s Berkshire stock. His cousin held on until Warren came on and even after. By making this correct decision, one branch of the family benefited from lollapalooza effects. 
Because of this, Nick Brady knew all about Warren, and I think he trusted Warren. [During their phone call on that fateful Sunday afternoon,] there was a catch in Warren’s voice. Faced with a decision that would have had catastrophic impact had they made the wrong decision, but when Nick heard the catch in Warren’s voice, he realized how concerned Warren was and trusted him when he said he needed some reversal of an announced Treasury decision. 
Getting a good reputation in life can have remarkably favorable outcomes, and not just for Warren. If Salomon had gone under, it wouldn’t have been trouble for Berkshire but would have been terrible for the country and Warren.

Thursday, February 20, 2014

The Up Side of Down...

Here are a couple of appearances by Megan McArdle discussing her book The Up Side of Down: Why Failing Well Is the Key to Success. I haven’t gotten to read it yet but I’ve seen a few people recommended it and the publisher was kind enough to pass a copy along to me. She also wrote about Warren Buffett and Berkshire Hathaway after a 2009 trip to the Berkshire Annual Meeting that I had previously linked to (HERE) which may be worth going back and reviewing.

Links to videos:

The Outsiders: The Book the Activists Are Reading

If activist investors seem like they are all using the same playbook, it may be because many are at least reading the same book. 
“The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success” has created a buzz among the activist community for laying out in plain English what the activists are often arguing for. 
Hedge-fund managers, bankers and lawyers have all cited the book to explain the logic behind much of what activists are seeking, including the push to break up companies WSJ wrote about Wednesday. 
Written by William N. Thorndike, and published in late 2012, “The Outsiders” won a mention in Warren Buffett’s annual report that year as being on the famed investor’s reading list. 
The book is more geared toward the Buffett-type of long-term investor. It chronicles the experience of eight CEOs, including Mr. Buffett, Henry Singleton, John Malone and Katherine Graham, and the huge shareholder returns they created. The entire book is built the premise that CEOs should be scored on the numbers, like baseball players today. Take Jack Welch, for example: While Mr. Welch was a good CEO at General Electric, he ranks well below other CEOs based on shareholder returns, according to the book. 
The central trait of the top chief executives, according to the book, is how successful they are at allocating capital.

Related previous post: Cash return on capital…

Wednesday, February 19, 2014

Seth Klarman quotes

From the 2008 Graham and Dodd Breakfast (which took place on October 2, 2008):
For years, when someone asked me what my biggest fear was as an investor in managing my portfolio, my answer was that it was buying too soon on the way down from often very overvalued levels. I knew a market collapse was possible. And sometimes, I imagined that I was back in 1930 after the market had peaked the year before, and then dropped 30%. Surely, there would’ve been some tempting bargains then. And just as surely, you’d have been crushed by the market’s subsequent plunge over the next three years — down to below 20% of 1929 levels. 
A fall from 70 to 20, and from 100 to 20, would feel almost exactly the same by the time you hit 20. Sometimes being too early becomes indistinguishable from being wrong. 
Of course, getting in too soon as the market falls involves great risk for all investors, including value investors. Certainly, when a few securities start to get cheap even as the bull market continues, a value-starved investor will step up and buy them. Soon enough, many of these prove to be no bargain at all, as the flaws that caused them to be rejected by the bulls become more glaringly apparent when the world gets worse. 
After a stock market has dropped 30%, there’s no way to tell how much further it might have to go. It’d be silly to expect every bear market to turn into the Great Depression. But it would be equally wrong to expect that a fall from overvalued to more fairly valued couldn’t badly overshoot on the downside. 
So when individual stocks reach levels where they are truly undervalued, what are value investors supposed to do other than to buy them? Anything else is market timing. Investors live in real time — not in several year intervals, but in months, days, hours and even minutes. 
Because we cannot know the future — and cannot see in the middle of the cycle its end, and not even necessarily its beginning — we will be bombarded by apparent opportunity as the market descends. We will see tempting bargains and value imposters, false rallies and legitimate recoveries, smart bottom fishers and mindless buy-the-dippers — and we will never know until after the fact how low things might go. 
We can become macro forecasters, predicting 10 of the next two recessions, or we can ignore the macro economy, buying bargains that cease to look cheap as the economy deteriorates and credit contracts and the tide goes out on all marketable securities. 
When a value investor is tempted to become something other than what he or she is, I find it best to recall the wisdom of Graham and Dodd. Graham and Dodd have provided us with a remarkable road map that has been carried on some of the world’s most successful investment journeys for 75 years — a road map that allows us to navigate through difficult, even uncharted, territory and come out ahead. 
In a market like we’ve been experiencing, most investors lose their rudders. They become incapacitated, unable to navigate amidst extreme turmoil, declining corporate results, and a litany of economic woes and mounting losses. They become unwilling to part with their cash — afraid of possible redemptions, and afraid of adding to their losses. 
Investors today, who are tempted to pull out of the market and wait for some kind of “all clear” signal before recommitting, would be well advised to remember the counsel of Graham and Dodd who wrote in 1934: “While we were writing, we had to combat a widespread conviction that financial debacle was to be the permanent order.” If they could say that then, I must restate it now.

Tuesday, February 18, 2014

Charlie Munger quote

"Really good investment opportunities aren't going to come along too often and won't last too long, so you've got to be ready to act. Have a prepared mind." -Charlie Munger

Epictetus quote

“Every habit and faculty is formed or strengthened by the corresponding act - walking makes you walk better, running makes you a better runner. If you want to be literate, read, if you want to be a painter, paint. Go a month without reading, occupied with something else, and you'll see what the result is. And if you're laid up a mere ten days, when you get up and try to talk any distance, you'll find your legs barely able to support you. So if you like doing something, do it regularly; if you don't like doing something, make a habit of doing something different. The same goes for the affairs of the mind.” -Epictetus, Discourses 2.18 (Source)

Monday, February 17, 2014

Remembering ‘Adam Smith’ - by Jason Zweig

George J.W. Goodman, known as Adam Smith to his readers and Jerry to his friends, died last month, age 83. But his work will outlive him for years, and quite likely decades, to come.

Warren Buffett considers Jerry Goodman the second-best writer ever to explain how the investment business works, after the brilliant Fred Schwed, whose Where Are the Customers’ Yachts? (originally published in 1940) remains the finest – and funniest – book on Wall Street ever written.

“Schwed was the best ever,” Buffett told me in a telephone interview this past week. “But Jerry, especially in ‘The Money Game,’ was incredibly insightful, and he knew how to make the prose sing as well.

“He knew how to put his finger on things that nobody had identified before. Jerry stuck to the facts, but he made them a helluva lot more interesting. He was a great writer.”

Related books:

Roger Lowenstein reviews the book "Harriman vs. Hill"

"I first read about the Northern Pacific Corner when I was ten years old. When I opened my office on January 1, 1962, I put on the wall a framed copy of the New York Times of May 10, 1901, describing the fateful prior day. Larry Haeg now tells the full story, and I enjoyed every word of it." —Warren Buffett

Takeover wars seem to have lost their sizzle. What happened to the battles of corporate goliaths? Where have they gone, those swaggering deal makers? "Harriman vs. Hill" is a corporate dust-up that takes us back to the beginning of the 20th century, when tycoons who traveled by private rail merrily raided each other's empires while the world around them cringed. 
The title characters—Edward Harriman and James J. Hill —though today strangely forgotten, were among the most powerful railroad barons in the country. Their respective bankers— Jacob Schiff and J.P. Morgan Sr.—were the very captains of Wall Street. 
At the time, railroads were America's most important industry, and moguls dreamed of controlling a westward route connecting Chicago to the Pacific Northwest. Yet few suspected that the mother of all battles was to commence when, in the spring of 1901, the stock of Northern Pacific, a down-at-heel road connecting St. Paul, Minn., to Portland, Ore., mysteriously began to rise.

Other comments on the topic

Warren Buffet in an interview with Becky Quick a few years ago:
Buffett: I like history. I like financial history particularly. I used to read everything in sight on that. Sometimes I ask the students, for example, about the Northern Pacific Corner. These are MBAs from prestigious ... They don't know about it. But it's useful to realize how extraordinary things can happen occaisionally. But I was talking to Alan Greenspan about it and he knew all about it. He could practically give it to me hour by hour. There's some advantages to knowing, you should know financial history.
Buffett and Munger at the 2012 Berkshire Annual Meeting:
WB: In 1962 I put seven items on the office wall. I made photocopies of pages from financial history. In the Northern Pacific Corner, they both bought more than 50% of the stock, each, and both really wanted it. Interesting things happened. 
CM: To the shorts. 
WB: 170 to 1000 per share trading for cash because the shorts needed it. A brewer in Troy NY committed suicide by diving in hot beer because of margin call. How impossible for $170 stock to go to$1000? Those seven days I put up on wall, life in financial markets has no relation to Sigma’s. If everyone who operated in financial markets operated without standard [error], they’d be better off. 
CM: Well sure, it has created a lot of false confidence. Fat tails. In Solomon meetings we’d roll our eyes when risk control people were talking.

[H/T Will]

Is Monetary Policy a Science? - The Interaction of Theory and Practice Over the Last 50 Years – by William R. White

And in case you missed the two quotes from White that I posted on Twitter last night as I was listening to his McAlvany podcast (these were in regards to economic modeling and the desire to try and control the economy through monetary policy):

"I'm becoming more and more convinced that all of the models that we use are basically useless."

"..maybe..our ambitions about control are too ambitious for the knowledge that we have."

He also mentioned Danny Kahneman’s work when discussing the psychology of how different governments are acting today. Germany, because of its experience of the 1920s hyperinflation, thinks that a hyperinflation is the worst of all outcomes, so they act to keep balanced deficits, as unbalanced ones were some of the triggers leading to the earlier problems. The U.S. experience of the debt deflation during the Great Depression is the event that is largely driving its actions today, as it also seeks to avoid a repeat of its most vivid financial crisis. Etc.  

In recent decades, the declarations of “independent” central banks and the conduct of monetary policy have been assigned an ever increasing role in the pursuit of economic and financial stability. This is curious since there is, in practice, no body of scientific knowledge (evidence based beliefs) solid enough to have ensured agreement among central banks on the best way to conduct monetary policy. Moreover, beliefs pertaining to every aspect of monetary policy have also changed markedly and repeatedly. This paper documents how the objectives of monetary policy, the optimal exchange rate framework, beliefs about the transmission mechanism, the mechanism of political oversight, and many other aspects of domestic monetary frameworks have all been subject to great flux over the last fifty years. The paper also suggests ways in which the current economic and financial crisis seems likely to affect the conduct of monetary policy in the future. One possibility is that it might lead to yet another fundamental reexamination of our beliefs about how best to conduct monetary policy in an increasingly globalized world. The role played by money and credit, the interactions between price stability and financial stability, the possible medium term risks generated by “ultra easy” monetary policies, and the facilitating role played by the international monetary (non) system all need urgent attention. The paper concludes that, absent the degree of knowledge required about its effects, monetary policy is currently being relied on too heavily in the pursuit of “strong, balanced and sustainable growth.”

Sunday, February 16, 2014

Seth Klarman quote

"An investor cannot decide to think harder or put in overtime in order to achieve a higher return. All an investor can do is follow a consistently disciplined and rigorous approach; over time the returns will come." -Seth Klarman

McAlvany Weekly Commentary Podcast: William R. White: Central Banking…Not a Science

Dan Ariely: Why Humans Are Hard-Wired To Create Asset Bubbles


Hussman Weekly Market Comment: Topping Patterns and the Proper Cause for Optimism

Notes to the FOMC

The following are a few observations regarding Dr. Yellen’s testimony to Congress. The objective is to broaden the discourse with alternative views and evidence, not to disparage FOMC members. We should all hope that Dr. Yellen does well in what can be expected to be a challenging position in the coming years.

1. While we all would like to see greater job creation and economic growth, there is little demonstrated cause-and-effect relationship between the Fed’s actions and the outcomes it seeks, other than provoking speculation in risk-assets by depriving investors of safe yield. That’s essentially the same M.O. that got us into the housing crisis: yield-starved investors plowing money into mortgage-backed securities, and Wall Street scrambling to create “product” by lending to anyone with a pulse. To suggest that fresh economic weakness might justify further efforts at quantitative easing is to assume a cause-and-effect link that is unreliable, if evident at all, and to overlook the already elevated risks.

2. In this context, the “dual mandate” of the Federal Reserve is much like charging the National Weather Service to balance the frequency of sunshine versus rainfall. If Congress was to require the Federal Reserve to change itself into a butterfly, it would not be the fault of the Federal Reserve to miss that objective. Moreover, what is absent from nearly every reference to the dual mandate is the phrase “long run” that is repeatedly included in that mandate. It seems probable that the cyclical response to economic weakness following the 2000-2001 recession – suppressing safe yields in a way that encouraged yield-seeking and housing speculation – was largely responsible for present, much longer-term difficulties.

3. The FOMC should be slow to conclude that monetary policy is what ended the credit crisis. The main concern during that period was the risk of widespread bank insolvency, resulting from asset losses that were wiping out the razor-thin capital levels at banks. In the first weeks of March 2009, in response to Congressional pressure, the Financial Accounting Standards Board changed accounting standards (FAS 157) to allow “significant judgment” in the valuation of assets, instead of valuing them at market prices. That change coincided precisely with the low in the financial markets and the turn in leading economic measures. By overestimating the impact of its actions, the FOMC may underestimate the risks. The philosophy seems to be “If an unprecedented amount of ineffective intervention is not sufficient, one must always do more.”

4. At present, excess reserves in the U.S. banking system amount to $2.4 trillion – more than double the total amount of demand deposits in the U.S. banking system, far more than all commercial and industrial loans combined, and 25% of total deposits in U.S. banks. Short term interest rates have averaged less than 10 basis points since late-2009, when the Fed’s balance sheet $2 trillion smaller. Based on the tight relationship between monetary base / nominal GDP and short-term interest rates, it is evident that even an immediate and persistent reduction in the Federal Reserve’s balance sheet of $20-25 billion per month would be unlikely to result in even 1% Treasury bill rates until 2020, absent much higher interest on reserves. The FOMC has done what it can – probably too much. A focus on the potential risks of equity leverage (where NYSE margin debt has surged to a record and the highest ratio of GDP in history aside from the March 2000 market peak), covenant lite lending, and other speculative outcomes should be high on the priorities of the FOMC.

5. Dr. Yellen suggests that equity valuations are not “in bubble territory, or outside of normal historical ranges.” The historical record begs to differ on this. The first chart below reviews a variety of reliable valuation measures relative to their historical norms. The second shows the relationship of these measures with actual subsequent 10-year equity returns. With regard to alternate measures of valuation such as price/unadjusted forward operating earnings, or various “equity risk premium” models, it would be appropriate for the FOMC to estimate the relationship between those measures and actual subsequent market returns. Having done this, the spoiler alert is that these methods do not perform very well. In contrast, the correlation between the measures below and actual subsequent 7-10 year equity returns approaches 90%. At present, U.S. equity valuations are about double their norms, based on historically reliable measures.

6. Finally, when confronted with the difficulties that quantitative easing has posed for individuals on fixed incomes, Dr. Yellen asserted that interest rates are low not only because of Fed policy, but because of generally lackluster economic conditions. This argument is difficult to support, because there is an extraordinarily close relationship between the level of short-term interest rates and quantity of monetary base per dollar of nominal GDP (see the chart below). With regard to long-term interest rates, it’s notable that the 10-year Treasury yield is actually higher than when QE2 was initiated in 2010, and is also higher than the weighted average yield at which the Federal Reserve has accumulated its holdings. In order to restore even 1% Treasury bill yields without paying enormous interest on reserves, the Fed would not only have to taper its purchases, but actively contract its balance sheet by more than $1.5 trillion.

Friday, February 14, 2014

Nassim Taleb and barbells...

Here's a link to a post I put up last year that included an excerpt from Nassim Taleb's Antifragile that I think is extremely important--probably even more so in a market environment like we are in today--and worth reviewing every now and then.

Salman Khan speaks at the Hoover Institution


[H/T Christensen Institute]

60 Minutes: Volcanoes: Nature's ticking time bombs

Link to video: Volcanoes: Nature's ticking time bombs
Volcanoes are found all over the world and many could spew lava and mass destruction -- we just don't know when

Wednesday, February 12, 2014

Marcus Aurelius quote

“There is one type of person who, whenever he has done a good deed to another, expects and calculates to have the favour repaid. There is a second type of person who does not calculate in such a way but who, nevertheless, deep within himself regards the other person as someone who owes him something and he remembers that he has done the other a good deed.

But there is a third type of person who, in some sense, does not even remember the good deed he has done but who, instead, is like a vine producing its grape, seeking nothing more than having brought forth its own fruit, just like a horse when it has run, a dog when it has followed its scent and a bee when it has made honey. This man, having done one good deed well, does not shout it about but simply turns his attention to the next good deed, just like the vine turns once again to produce its grape in the right season.” -Marcus Aurelius (Source)

Graham and Doddsville Newsletter - Winter 2014

James Grant on CNBC


Tuesday, February 11, 2014

Daily Journal Holdings

10-K comments for the year ended September 30, 2012:
In February 2009, the Company purchased shares of common stock of two Fortune 200 companies and certain bonds of a third, and during the second and the third quarters of fiscal 2011, the Company bought shares of common stock of two foreign manufacturing companies.  During the first quarter of fiscal 2012, the Company bought shares of common stock of another Fortune 200 company.  During the third and the fourth quarters of fiscal 2012, the Company purchased additional shares of common stock of one of the foreign manufacturing companies in which it had previously invested.  The investments in marketable securities, which cost approximately $49,692,000 and had a market value of about $102,156,000 at September 30, 2012, generated approximately $1,967,000 in dividends and interest income, which lowers the effective income tax rate because of the dividends received deduction.  As of September 30, 2012, there were unrealized pretax gains of $52,464,000 as compared to $24,532,000 at September 30, 2011.  Most of the unrealized gains were in the common stocks.  During the first quarter of fiscal 2013, the Company borrowed $14 million to purchase all of the outstanding stock of New Dawn and pledged its marketable securities to obtain favorable financing.
10-Q comments for the quarter ended June 30, 2013:
During the nine months ended June 30, 2013, the Company's cash and cash equivalents, and marketable security positions increased by $30,763,000. Cash and cash equivalents were used primarily for the purchase of capital assets of $258,000 (mostly computer software and office equipment). During the first quarter of fiscal 2013, the Company borrowed $14 million from its investment margin account to purchase all of the outstanding stock of New Dawn and pledged its marketable securities to obtain favorable financing. During the first quarter of fiscal 2012, the Company bought shares of common stock of a Fortune 200 company, and during the third quarter of fiscal 2012, it bought additional shares of common stock of one of the foreign manufacturing companies in which it had previously invested. There have been no additional purchases in fiscal 2013. The investments in marketable securities, which cost approximately $49,694,000 and had a market value of about $128,421,000 at June 30, 2013, generated approximately $1,832,000 in dividends and interest income, which lowers the effective income tax rate because of the dividends received deduction. As of June 30, 2013, there were unrealized pretax gains of $78,727,000 as compared to $52,464,000 at September 30, 2012. Most of the unrealized gains were in the common stocks.
Holdings from a newly-released 13-F (Note: Foreign stocks purchased that are not owned through an ADR will not be listed here…maybe there’s also some BYD in the portfolio?):
Bank of America Corp: $35,811,000
Posco ADR: $5,038,800  
US Bancorp: $5,656,000  
Wells Fargo & Co: $72,267,720


UPDATE: Rational Walk also has a post up about this as well which is worth checking out: Daily Journal’s Portfolio Holdings Revealed

Seth Klarman EBITDA Example

From Margin of Safety:
EBITDA Analysis Obscures the Difference between Good and Bad Businesses
EBITDA, in addition to being a flawed measure of cash flow, also masks the relative importance of the several components of corporate cash flow. Pretax earnings and depreciation allowance comprise a company’s pretax cash flow; earnings are the return on the capital invested in a business, while depreciation is essentially a return of the capital invested in a business. To illustrate the confusion caused by EBITDA analysis, consider the example portrayed in exhibit 1.

Investors relying on EBITDA as their only analytical tool would value these two businesses equally. At equal prices, however, most investors would prefer to own Company X, which earns $20 million, rather than Company Y, which earns nothing. Although these businesses have identical EBITDA, they are clearly not equally valuable. Company X could be a service business that owns no depreciable assets. Company Y could be a manufacturing business in a competitive industry. Company Y must be prepared to reinvest its depreciation allowance (or possibly more, due to inflation) in order to replace its worn-out machinery. It has no free cash flow over time. Company X, by contrast, has no capital-spending requirements and thus has substantial cumulative free cash flow over time. 
Anyone who purchased Company Y on a leveraged basis would be in trouble. To the extent that any of the annual $20 million in EBITDA were used to pay cash interest expense, there would be a shortage of funds for capital spending when plant and equipment needed to be replaced. Company Y would eventually go bankrupt, unable both to service its debt and maintain its business. Company X, by contrast, might be an attractive buyout candidate. The shift of investor focus from after-tax earnings to EBIT and then to EBITDA masked important differences between businesses, leading to losses for many investors.