Meryl Witmer is a value investor who regularly participates in Barron’s roundtables. Today, I came across a video interview with her and thought it would be worth sharing:
If you’re too lazy to watch the video, brief notes are below:
-a whole lot of things that are cheap now, it’s a “new world” for value investors.
-Remember a line from Warren Buffett: You should detach from the market emotionally, but pay attention to opportunities as they arise. That’s what you should try to do now.
-Proposes the following investment idea: Kaiser Alumnium Corporation (NASDAQ:)
-Originally purchased Kaiser at $35/$36 a share. Sold in the $70s. Now the company is back to $25. They make the aluminum sheet metal that goes into industrial products, airplanes.
-Kaiser’s book value, hard book is $50 per share. $10 per share is NOL carry forward (loss). Stock is $25 with $50 book. Replacement cost for their rolling mill would cost $1.5 billion dollars to replace + $200 million value of NOL. Might be worth $1.7 billion.
-No debt, no legacy costs due to bankrutpcy. Market cap is about $500 million.
-Should earn 3.50 to 4.00 a share in an OK environment. If Boeing gets going and planes sell, it should make $5 per share. Worst Case $2.50 per share of fully taxed earnings + $10-12 per share of NOL value..
-Minimum trading price at $35 vs $25 with upside to the $70s
-Why has it traded down? Forced liquidiations by hedge funds. No good fundamental reason.
This morning while reading at the WSJ, I saw an interesting line:
But Mr. Buffett has expressed regret that he didn’t do certain deals differently, including an investment in Gillette in 1989.
This struck me as strange since Buffett’s investment in Gillette is generally regarded as one of his best. I never knew that he had any regrets for it. The investment was regarded as his best out of the four convertible preferreds from the late ’80s (USAir, Salomon Inc., Champion International are the others). He was able to not only keep the company defended from raiders but also make a handsome profit while owning “7% of the razor market”. Upon searching a bit, I think I found what Eavis mentioned as Buffett’s regret:
Our best holding has been Gillette, which we told you from the start was a superior business. Ironically, though, this is also the purchase in which I made my biggest mistake – of a kind, however, never recognized on financial statements.
We paid $600 million in 1989 for Gillette preferred shares that were convertible into 48 million (split-adjusted) common shares. Taking an alternative route with the $600 million, I probably could have purchased 60 million shares of common from the company. The market on the common was then about $10.50, and given that this would have been a huge private placement carrying important restrictions, I probably could have bought the stock at a discount of at least 5%. I can’t be sure about this, but it’s likely that Gillette’s management would have been just as happy to have Berkshire opt for common.
But I was far too clever to do that. Instead, for less than two years, we received some extra dividend income (the difference between the preferred’s yield and that of the common), at which point the company – quite properly – called the issue, moving to do that as quickly as was possible. If I had negotiated for common rather than preferred, we would have been better off at year end 1995 by $625 million, minus the “excess” dividends of about $70 million.
This is one of the best characteristics of Buffett, he’s able to scrutinize even some of his greatest successes and learn from them. It’s something that all of us as investors should do, sometimes we spend too much time trying to learn from our failures that we forget to closely examine our successes.
The on where “smart money” investors are going as stocks continue to fall. I was happy to see Jean-Marie Eveillard of the First Eagle Global Fund on the list. Here’s what he had to say:
Mr. Eveillard has been running money for nearly 50 years, and now at age 68, he plans to retire in March from managing First Eagle Global, which has logged an annualized 11.6% over the past 10 years. Drawing on his experience, he’s asking his analysts to consider that, in a damaged economy, operating profits might fall 30% to 40%. And if so, he’s asking, “Are the stocks we like still reasonably priced?”
That’s certainly the case in Japan, Mr. Eveillard finds. His fund now has about 30% of its equity positions in Japan, because Japan has gone through what the U.S. is now dealing with, and many Japanese companies are stronger for it. In the U.S. he has been buying American Express Co. (NYSE:), “though we were too soon” as the stock has been dropping.
One thing I like about Eveillard is that he distinguishes himself from other value investors by sometimes taking positions that are influenced by macro-economic condition, for example – he’s a big proponent of gold. At this price, American Express certainly looks interesting and it’s on a shortlist of companies that I’ve been researching.
The rest of the value managers listed in the article read as a Who’s Who of Vale Investing for mutual funds. There’s Robert Rodriguez, Wally Weitz, David Winters, Bill Freiss, and Tom Marisco. To be honest, I wasn’t very familiar with the last two investors, but their long term annualized performance is strong and they are worth looking into.
A unifying theme that I saw was constant with these investors was the acquisition of companies that have tons of cash.
From Robert Rodriguez:
Yet amid this month’s violent moves, he began buying again for the first time in nearly a year. He wants market leaders with pristine balance sheets. Example: oil-field services firm Ensco (NYSE:)International Inc., which has more cash than debt. Stocks he likes, Mr. Rodriguez says, “will make it through to the other side of this crisis.”
And Wally Weitz:
Instead, his Weitz Value is opting for Microsoft (NYSE:), whose once-lofty stock has tumbled. Now, it sports a thrifty price-earning s multiple of less than 12. “It’s safe and has a fortress balance sheet,” Mr. Weitz says.
As we look for companies holding large cash hordes, you’re going to want to look at the management behind the company and ask “Are they good allocators of capital?” If they’re not, that cash could be wasted, try using a discount rate when you see cash.
I’m also pretty astounded by how bad performance has been YTD with all of these funds. However, most of the managers on the list would probably identify themselves as value investors, which can produce some lumpy results. With stocks at a multi-year low though, their bargain hunting prowess should be well rewarded in the years to come — meaning it might be a good time for mutual fund investors.
Sheila Bair has long been a proponent of a new plan for mortgage workouts, to help borrowers who may be stuck in unaffordable mortgages as they reset to higher rate and are unable to refinance. Specifically, Bair has been critical of the bailout plan for not having enough support for mortgage borrowers.
I think that something like this might be able to gain some more traction, it would at least help stabilize the value of these packaged mortgages which would surely fall if borrowers completely defaulted:
By achieving mortgage payments for borrowers that will be both affordable and sustainable, these distressed mortgages will be rehabilitated into performing loans and avoid unnecessary and costly foreclosures. We expect that by taking this approach, future defaults will be reduced, the value of the mortgages will improve, and servicing costs will be cut. The streamlined modification program will achieve the greatest recovery possible on loans in default or danger of default, in keeping with our statutory mandate to minimize impact on the insurance fund and improve the return to uninsured depositors and creditors of the failed institution. At the same time, we can help many troubled borrowers remain in their homes. Under the program, modifications are only being offered where doing so will result in an improved value for IndyMac Federal or for investors in securitized or whole loans, and where consistent with relevant servicing agreements.
Applying workout procedures for troubled loans in a failed bank scenario is something the FDIC has been doing since the 1980s. Our experience has been that performing loans yield greater returns than non-performing loans. In recent years, we have seen troubled loan portfolios yield about 32 percent of book value compared to our sales of performing loans, which have yielded over 87 percent.
Through this week, IndyMac Federal has mailed more than 15,000 loan modification proposals to borrowers, and has called many thousands more in continuing efforts to help avoid unnecessary foreclosures. While it is still early in our implementation of the program, over 3,500 borrowers have accepted the offers and many more are being processed. We are still working to verify incomes, but thousands of borrowers are already making their modified payments. I am pleased to report that these efforts have prevented many foreclosures that would have been costly to the FDIC and to investors. This has been done while providing long-term sustainable mortgage payments to borrowers who were seriously delinquent. On average, the modifications have cut each borrower’s monthly payment by more than $380.
This week’s column by comes at a good time. The markets are experiencing a level of volatility that they haven’t been through in a long time. Such wild swings in stock prices have the ability to induce fear in investors, causing them to make gaffes like selling companies too early or racking up high commission fees by engaging in frequent trades.
According to Zweig, fear is contagious:
You can catch other people’s emotions as easily as you can catch a cold. In an experiment by neuroscientist Elizabeth Phelps at New York University, people either watched someone else get a mildly painful electric shock or suffered the shock themselves. Their brain responses and their dread before the shock were highly similar in both cases, suggesting that seeing another person’s fear is all it takes to make us afraid. Even encountering the circumstances under which the other person was shocked is enough to trigger your own fear.
When you cave to fear, you cease being a rational investor. You stop looking at the fundamentals and instead submit to your emotions. Often, it’s this sort of investing that ruins your portfolio.
To master fear, Zweig outlines four rules:
Break the circle. Instead of socializing with other investors nursing their losses, hang out with folks who do not obsess over the market. You are less likely to be spooked by dilated pupils, grim faces and quavering voices.
The idea of breaking your circle is one which I believe is practiced by a number of prominent value investors. They may talk about the market with their teams and associates, but they tend to reside away from Wall Street where they would be incessantly affected by the buzz of brokers and investors on Wall Street. Being away from the commotion of the markets can allow an investor to have the peace of mind needed to buck the trend or chaos that might ensue when the markets panic.
Value investors operate out of many places besides Wall Street: Warren Buffett in Omaha, Seth Klarman (of the Baupost Group) in Massachusetts, Mason Hawkins (of Longleaf Funds) in Memphis, Mohnish Pabrai in Irvine, and Bruce Berkowitz (of the Fairholme Fund) in Florida. All of these investors have had good long term track records while residing away from Wall Street.
Turn off the tube. The sight and sound of screaming traders with fear in their eyes are enough to fill you with fright, whether you are conscious of it or not. If hitting the mute button won’t suffice to calm you down, turn off the TV.
Here, I’d also recommend to be cautious of the internet as well. Many investors also like to visit message boards like on Yahoo for the specific companies they own. Many of these message boards can be cesspools of rumors and lies. During a time when the market is being excessively volatile, you risk letting your guard down and listening to these deceiving liars.
It’s important that you keep up to date with news on your companies, but you should do so by utilizing more official means of information. Instead of looking at the prices of diving charts that they show on CNBC, you should take the time to see if what’s going on in the market can actually affect the businesses you own. With Warren Buffett now buying stocks personally, it’s easy to see that he believes some businesses have been oversold. That does not mean that all are oversold, some sectors will probably be in for tough times. Anything with excessive leverage could be at the mercy of their spooked creditors.
Think positive. When Warren Buffett feels his blood pressure rising or his nerves on edge, he calms himself down by gazing at snapshots of his family or playing a game of bridge with his friends.
In The Snowball, Alice Schroeder described how Warren Buffett was excellent at compartmentalizing his emotions. This is probably a pretty hard thing for investors to do on their own, but maybe there are some other methods for staying positive. I think that having a system in place for investing or trading helps. By taking a systemic approach, you work to divorce emotions from your investing and really make it a dry activity. Benjamin Graham is said to have had simple forms for security analysts to fill out when investing a particular company – they filled the forms and then checked them against their particular system. If the company appeared cheap enough it was bought.
One idea I’ve heard that sounds interesting is to spend time studying famous leaders through history. We know that Buffett reads a tremendous amount and when he was younger he spent a lot of time reading biographies about famous business leaders (think Carnegie, Rockefeller). Investors could also read about leaders who faced periods of crisis (Churchill for example), the lessons they glean from such experiences could be used to create a powerful latticework of mental models for protecting them against Mr. Market’s swings.
The other factor is to just know yourself and how you react to stressful situations. For Warren Buffett he may like bridge, but perhaps what works for you is a jog or listening to some music. If you understand yourself and your emotions, you should be able to keep positive as the market dives.
Finally Zweig says:
Stick to it. Set yourself the simple, stark goal of investing more money in something you don’t want to own. You may need help fighting your fears, so visit www.stickk.com and make a public commitment to your future action. Buying a stock fund next week is mentally easier than buying it today — especially if you recruit some friends to cheer you on.
Chances are, we’ll be in for more market volatility than what we saw last week. If that’s the case, it’s going to be important for you to learn how to keep your emotions in check and keep your investing method in tact. If you do this, I believe that you’ll be able to take advantage of the market and find some good buys. They probably wont talk about this on CNBC or in the rest of the mainstream media, but when you’re looking at risk. Instead of gauging it by the market’s prices, try the following:
In our opinion, the real risk that an investor must assess is whether his aggregate after-tax receipts from an investment (including those he receives on sale) will, over his prospective holding period, give him at least as much purchasing power as he had to begin with, plus a modest rate of interest on that initial stake. Though this risk cannot be calculated with engineering precision, it can in some cases be judged with a degree of accuracy that is useful.The primary factors bearing upon this evaluation
are:
1) The certainty with which the long-term economic characteristics of the business can be evaluated;
2) The certainty with which management can be evaluated, both as to its ability to realize the full potential of the business and to wisely employ its cash flows;
3) The certainty with which management can be counted on to channel the rewards from the business to the shareholders rather than to itself;
4) The purchase price of the business;
5) The levels of taxation and inflation that will be experienced and that will determine the degree by which an investor’s purchasing-power return is reduced from his gross return.
These factors will probably strike many analysts as unbearably fuzzy, since they cannot be extracted from a data base of any kind. But the difficulty of precisely quantifying these matters does not negate their importance nor is it insuperable. Just as Justice Stewart found it impossible to formulate a test for obscenity but nevertheless asserted, “I know it when I see it,” so also can investors – in an inexact but useful way – “see” the risks inherent in certain investments without reference to complex equations or price histories.
Note: these notes come from BenGrahamMan at the Motley Fool Boards, the original thread is .
Seth Klarman runs the Baupost Group, a prominent value investing fund that has had stellar performance since inception. What’s really amazing about Klarman is how risk averse he is, I’ve heard that sometimes he will convert nearly 50% of his portfolio into cash while still still posting strong returns. In my previous post, I mentioned the Buffett quote where he says that they look for people with risk aversion programmed into their DNA, I think Klarman fits the bill.
He’s the author of Margin of Safety, the expensive and out of print value investing book, and has recently contributed an entry to .
1. The biggest fear was buying too soon and on way down, from up in over-valued levels. We knew market collapse was possible and sometimes imagined I was back in 1930. Surely there were tempting bargains and just as surely would have been crushed after decline of next 3 years. A fall from 70 to 20 and fall from 100 to 20, would feel almost exactly the same. At some point being too early becomes indistinguishable from being wrong.
2. Getting in too soon brings risk to all investors. After a stock market has dropped 20% – 30% there is no way to tell when the tides will change. It would be silly to expect that every bear market will turn into a great depression. Yet fair value from under-valued can’t be predicted, and would be equally wrong.
3. As market descends you are tempted with purchasing companies. You will be bombarded with tempting opportunities. You never know how low things will go. When credit contracts and tide goes out on liquidity. At these times recall the wisdom of Graham and Dodd. At this time, you should not market time, but stick to your value convictions. You will see tempting bargains and value imposters. Ignore macro and look to buy cheap.
4. In a market like we have been experiencing. Most investors lose their rudders. They become unwilling to part with cash. They start working on macro economic level. Investors look to pull out of market and wait for a clear signal of change. Value investors should be able to keep their focus and remember Graham and Dodd of 1934.
5. If you can maintain your focus, resist business pressures and have a multifaceted tool kit, you can expect to prosper, even in difficult times.
A. Always recall road map of Graham and Dodd. Revisit this road map when times get difficult. Maintain discipline and value with a margin of safety. This doesn’t mean you won’t lose money. It means if there are drops in price, you have even more of a bargain.
B. Avoid highly leveraged stocks, junk bonds and shaky financials.
C. Look for bargains in various industries and nations.
D. Look at value, not great companies and great management.
E. Listen to Warren Buffett when he states you should buy a stock as if the market would close for a long period of time after you bought the stock.
6. Remain focused on the long run. Graham and Dodd motivate our diligence. They are like silent sentinels. Navigate the best you can and Graham and Dodd are the North Star for value investors.
7. Stand against the prevailing winds, selectively and resolutely. Yet for a while a value investor will under-perform. Interim price declines allow you to average down. Do not suffer the interim losses, relish and appreciate them.
8. Value investing at its core is the marriage between a contrarian streak and a calculator. Buying what is in favor is ensuring long-term under-performance.
9. It is critical to remind your clients, investment team and as often as necessary yourself, that you can only control your process and approach. Understand that you cannot control or forecast the vagaries of the market. Then you should invest in what you believe and what your research dictates. Be indifferent if you lose your short-term oriented clients, remembering that they are their own worst enemies.
10. Controlling your process is essential.
A. Be focused on process, not outcome.
B. Do not judge a decision based on its outcome.
C. During periods of under-performance it is easy to change your process.
D. When a firm is worried about tempers, second-guessing and fear, the process will fail. Look for long-term results; anything else will corrupt the process.
11. Value investing is an art and not a precise science. It is dealing with the fact that we do not work with perfect information.
12. Mechanical rules are dangerous. Graham and Dodd principles should serve as a screen.
Q&A
1. How do you see current investment climate?
A. James Grant - Look at some MBS and beaten down bonds. Some are priced to yield teens. They are priced for a further 25% decline. Also unsecured debentures of nations top retailers. These are priced at 5% to 7%. Hence, short the retailers at 6% and go long the beaten down mortgages.
B. Seth Klarman – Unusual amount of forced sellers, via margin calls. This could breed opportunity. We see a lot of money managers staying on the sideline. We finds this to be an opportunity to buy. Buy when others react to news or false news. Our experience is when people give away stocks out of need, due to fear or margin calls, that sounds like a great buying opportunity. In this environment you are playing against very smart people.
C. Bruce Greenwald – Take a deep breath. All the doomsday talking is not being reflected in stock prices. Stocks are basically down 25%, but unemployment is not great like early 1940’s. You need to put this into perspective like 1991 or 1982.
2. Klarman discussed buying one security at a time. Not everything is a bargain out there. Be selective. Many of us have seen opportunities now, and history says to buy them. We bought knowing that banks are going to fail, that real estate would drop, but that certain mortgage backed securities were under-valued. Never leverage, where you can have an opportunity to buy and not be able to take advantage of it because of leverage.
3. James Grant – Treasuries are yielding less than expected future CPI. Treasuries are now being priced as a macro-economic play. Treasuries are not intrinsically safe. They are not safe based on valuation.
4. What factors do you look at in sizing a position?
Seth Klarman – We think this has been missed over the last 15 years. Most of the diversified risk is done via 20 to 25th position. We have had a 10% or so concentrated position about a dozen times over the last 20 years. Most of the time we have 3,5 and 6% position. We will take it higher if we see a catalyst for increased value. We would not own 10% position in a common stock, only because it seemed under-valued. We would have a greater than 10% position if there was a margin of safety. I see managers make mistakes with concentrated positions in similar industries. Small positions of say 1% are nonsensical. We do not use macro views, yet when we hedge, we will use a macro view. We think inflation could become out of control in 3 to 5 years. Yet, we might not wait for that position. Hence, perhaps early, we have a large inflation hedge. We don’t own gold as a commodity. We won’t disclose our inflation hedge, yet with enough work, you can find true inflation hedges.
I have to wonder what Klarman’s inflation hedge is. I know that Warren Buffett believes that one of the better ways to navigate through inflationary times is to own companies that can increase prices (think See’s Candies) with little worry for losing market share. On the other hand, some investors choose to look towards commodities. David Swensen of Yale’s Endowment fund is pretty famous for investing in timber and Prem Watsa of Fairfax Financial (NYSE:) made a recent investment in that area as well. Anyone out there have an idea?
Aubrey K. McClendon, CEO of Chesapeake Energy (NYSE:) recently had a major margin call and was forced to sell his entire stake (rumored to be around 5%) in his company. McClendon’s margin call made me think – does having a margin call mark the sign of a bad CEO?
To answer that, first we’ve got to understand what kind of factors make for a good CEO, or jockey as Warren Buffett likes to sometimes refer to them. Many companies become undervalued because of missteps by the company itself. Usually, the mistake is small but the market overreacts. However, if you’ve got a poor jockey, you risk having mistakes occur repeatedly and have intrinsic value decline.
The following interview is with Larry Pitkowsky of the . The track record for the Fairholme Fund is awesome and what I really like is the fact that they place a good deal of importance on the jockeys of the companies they invest in. In this interview, Pitkowsky outlines the characteristics they look for in a manager for the businesses that they invest in.
So what do the people at Fairholme look for in a jockey?
First, they enjoy owning businesses where the manager owns a lot of stock that makes up a big percentage of their net worth. It must be someone who lives for business and is a true fanatic for their work, this makes me think of people like Tom Murphy or . When you have people like this, they will be working hard every day to make sure that your company’s value is maximized and your competitive moats stay in tact.
More importantly though, they want someone who is risk averse. This is harder to figure out, I suggest reading as many news stories as you can on a company and also their annual reports to get a feel for how the company acts in terms of risk. An aversion to risk helps companies as it forces them to think about unforeseen black swan-like events. Managers who do this typically keep a lot of cash on hand so that they have ability to react and take advantage of market turmoil. Conversely, businesses that are over levered and whipsawed by black swan events usually free fall into bankruptcy.
These points made me think of a think of a misstep by a prominent CEO, Aubrey McClendon of Chesapeake Energy. If you remember, Chesapeake soared as high as $74 a share this year but crashed to $11 as natural gas prices fell. One of the more interesting stories here is McClendon’s margin call:
Aubrey K. McClendon, the billionaire chief executive of Chesapeake Energy Corp., has sold “substantially all” of his stock in the company over the past three days in order to meet margin loan calls, the company said Friday.
Chesapeake Energy did not disclose the size of the stock sale, pending the filing of documents with the Securities and Exchange Commission, but media reports have placed the number of shares at more than 33 million, making him the Oklahoma City-based company’s third largest shareholder…
“I have been the company’s largest individual shareholder for the past three years and frequently purchased additional shares of stock on margin as an expression of my complete confidence in the value of the company’s strategy and assets.”
So is McClendon a bad jockey? Yes, I think so. While it’s great that McClendon had so much faith in his company, he still exercised poor judgment when it came to the use of leverage. He did not plan for the worst nor demonstrate an aversion to risk. Rather, he fully embraced risk. He broke a lot of rules described in the Morningstar video because he didn’t foresee the possibility of extreme events, like those which we have encountered for the last few months, and was caught off guard and extremely over levered.
Investors are lucky that McClendon did not employ this blatant gambler-like thinking with the company itself. However, we can’t ignore the fact that McClendon was capable of such thinking. On the managers of companies, Warren Buffett likes to say that “You need a guy at the top whose DNA is very, very much programmed against risk.”
It seems like McClendon lacks that aversion to risk gene and that means that potential investors will need to see if Chesapeake’s economic moat protects against that. Maybe it does, maybe it does not. As investors search through the companies that have been beaten down by Mr. Market, they need to take a good long look at the people managing them. If they don’t, they risk blindly putting their money in the hands of people who may be seduced by leverage and open to excessive risks.
In the end, unless you’re able to win control of the company that you’re investing in, you’re at the mercy of management. As we can see from the current destruction of value on Wall Street, the managers of companies can sometimes make grave mistakes by misusing leverage. It pays to take the time to study the people that will be allocating capital and making the strategic decisions that may unlock the value you’re looking for.
Huge markets attract people who measure themselves by money. If someone goes through life and measures themselves solely by how much they have, or how much money they earned last year, sooner or later they’re going to end up in trouble.
-Warren Buffett
I thought that the above was particularly enlightening, especially when you consider the current financial crisis. I can’t say if we’ve hit a bottom or will hit a bottom soon. What I can say is that when Mr. Market is acting like a manic depressive, you should take advantage of him. Interesting bargains are appearing. Look for companies with wide moats, good jockeys, cash per share, strong free cash flow generation, and low debt. These screen factors should provide you with the kind of armor to sustain a downturn in the business cycle while also having the ability to deploy capital and take advantage of acquisitions and investments at bargain prices.
My name is Tariq Ali, I run Street Capitalist. I recently graduated from the University of Texas at Austin. There, I stumbled onto value investing via the school library. I read everything I could and now I'm here, writing out my thoughts and investment ideas.
I have a lot of heroes when it comes to investing, it seems like every investor has some kind of niche. Some, whose books and writings have had the biggest impact on me are: , ,, , and .
Have any questions? Want to stay in touch?
Feel free to e-mail me at TariqTX@gmail.com
This week’s column by comes at a good time. The markets are experiencing a level of volatility that they haven’t been through in a long time. Such wild swings in stock prices have the ability to induce fear in investors, causing them to make gaffes like selling companies too early or racking up high commission fees by engaging in frequent trades.
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