Yesterday I posted, asking for any input on what to ask Michael Lewis at his talk that was given to my school today. Nobody had suggestions, so I just asked something I was genuinely curious about as a blogger. Below are answers to questions regarding football, finance, and his next book.
The talk focused mainly on his book The Blind Side because it is required reading for one of the freshmen introductory courses here — so really, the talk mainly focused on that. I would have liked it if some of the people asking questions ventured more towards finance, since that is what he has written about recently, but they didn’t. Since I was only the second person asking a question I lacked that hindsight.
Here are some interesting questions though, a mix of sports and finance that I think readers may be interested in. All of the below is paraphrased by me, so don’t take these as exact quotations.
Q: Who will play for? (Michael Oher is the subject of )
A: If I had to bet, the San Francisco 49ers.
Q: What do you think could be improved upon in financial journalism? (My Question)
A: In the scheme of things, financial journalism is not really a big of a problem or some kind of machine that hurts the republic. Print journalism is largely fine. There is this backlash right now that’s asking where the journalists were during this crisis. The fact is, they were there, they were commenting on some of these issues — but people refused to listen (My guess is that this is a hint towards his book Panic, which if I understand correctly features articles that were written from the crisis’ inception and through out it).
I think that CNBC though, is bad. It breeds a kind of hysteria which is not healthy, especially for investors. But this problem really is not limited to CNBC, you saw it with political reporting on TV as well. That’s how TV is. It should be viewed as entertainment. So no, no real need for any big improvement in financial journalism.
Q: What do you think of moral hazard and its role in the crisis and finance?
A: Moral Hazard is important,its a really subtle force. I don’t think that a trader at Merrill Lynch was thinking that if he won big he would make a lot of money on a trade and if he loses the government will have to step in and bail them out. This problem though was not limited to banks her, it was every where — global. I think that the ideal risk taking environment is with partnerships. With partnership, the senior partners have much more of a stake in the livelihood of the business and as a result, they would not lever up 30-to-1 and take these exhorbant risks, or really be able to borrow so much.
I think that “too big to fail” is a recipe for failure and these big banks will have to be dismantled in the future. Most of the future big risk taking will probably be moved to partnerships. I think that the current steps the government is taking will lead to some unintended and bad consequences because the problem is likely to be much worse than everyone thinks at the moment. Things may change but everyone will probably forget about this crisis 15 years from now and relax standards, creating yet another problem.
Q: Finding inefficiencies in sports, will it spread?
A: It is really existing everywhere. I’ve spoken to cricket and rugby teams about it. One of the things I think is that the reason it is spreading and taking hold more is the fact that players salaries have skyrocketed. A mistake with a player that costed $50,000 is much less than what’s now — a mistake that would cost the team $50M.
As a result, it becomes much cheaper and more intelligent to hire a couple PhDs from MIT than it is to chance it and stay with the same old broken system. What’s going to happen is a Darwinian process where the teams that don’t take this up will lose games and be forced to move towards it.
Q: Future book on the Houston Rockets?
A: There will be no book on the Houston Rockets. I’m working on a book right now about the financial crisis and a manager who was able to see it and profit from it. Basically it is an extension of the Portfolio article, that was the book pitch. Little work done on the book so far, I probably need another year or so for it.
If you want to know more about what he said regarding The Blind Side, feel free to ask. Like I said, most of the talk was dedicated to this subject, I’ve limited this post mainly to the select questions and answers. He spoke a bit about his writing process and literature, so I can go more in depth into those subjects if any of you wish to know more.
George Soros makes the argument for greater CDS regulation, I agree:
Up until the crash of 2008, the prevailing view — called the efficient market hypothesis — was that the prices of financial instruments accurately reflect all the available information (i.e. the underlying reality). But this is not true. Financial markets don’t deal with the current reality, but with the future — a matter of anticipation, not knowledge. Thus, we must understand financial markets through a new paradigm which recognizes that they always provide a biased view of the future, and that the distortion of prices in financial markets may affect the underlying reality that those prices are supposed to reflect. (I call this feedback mechanism “reflexivity.”)
With the help of this new paradigm, the poisonous nature of CDS can be demonstrated in a three-step argument. The first step is to acknowledge that being long and selling short in the stock market has an asymmetric risk/reward profile. Losing on a long position reduces one’s risk exposure, while losing on a short position increases it. As a result, one can be more patient being long and wrong than being short and wrong. This asymmetry discourages short-selling.
The second step is to recognize that the CDS market offers a convenient way of shorting bonds, but the risk/reward asymmetry works in the opposite way. Going short on bonds by buying a CDS contract carries limited risk but almost unlimited profit potential. By contrast, selling CDS offers limited profits but practically unlimited risks. This asymmetry encourages speculating on the short side, which in turn exerts a downward pressure on the underlying bonds. The negative effect is reinforced by the fact that CDS are tradable and therefore tend to be priced as warrants, which can be sold at anytime, not as options, which would require an actual default to be cashed in. People buy them not because they expect an eventual default, but because they expect the CDS to appreciate in response to adverse developments.
AIG thought it was selling insurance on bonds, and as such, they considered CDS outrageously overpriced. In fact, it was selling bear-market warrants and it severely underestimated the risk.
The third step is to recognize reflexivity, which means that the mispricing of financial instruments can affect the fundamentals that market prices are supposed to reflect. Nowhere is this phenomenon more pronounced than in the case of financial institutions, whose ability to do business is so dependent on trust. A decline in their share and bond prices can increase their financing costs. That means that bear raids on financial institutions can be self-validating.
Taking these three considerations together, it’s clear that AIG, Bear Stearns, Lehman Brothers and others were destroyed by bear raids in which the shorting of stocks and buying CDS mutually amplified and reinforced each other. The unlimited shorting of stocks was made possible by the abolition of the uptick rule, which would have hindered bear raids by allowing short selling only when prices were rising. The unlimited shorting of bonds was facilitated by the CDS market. The two made a lethal combination. And AIG failed to understand this.
Many argue now that CDS ought to be traded on regulated exchanges. I believe that they are toxic and should only be allowed to be used by those who own the bonds, not by others who want to speculate against countries or companies. Under this rule — which would require international agreement and federal legislation — the buying pressure on CDS would greatly diminish, and all outstanding CDS would drop in price. As a collateral benefit, the U.S. Treasury would save a great deal of money on its exposure to AIG.
I’ll be attending a talk given by Michael Lewis of ,, and fame tomorrow. These things usually have a decently long Q&A period at the end, so feel free to use the comments section or e-mail me to suggest questions for him.
Sorry for the weak posting these past two weeks. I’m on my spring break right now and am attending the but I’ll be back soon with what I am hoping to be some good stock analysis posts.
For now though, check out this article from Bloomberg’s Elizabeth Stanton, she tries to figure out just what sort of companies Buffett may be attracted to right now for US acquisitions:
The chairman of Omaha, Nebraska-based Berkshire Hathaway Inc., who took a four-country tour of Europe last year in search of targets, told Bloomberg Television last week that he’s now most likely to pursue U.S. deals after the Standard & Poor’s 500 Index sank to the lowest level since 1996 this month. While the credit crisis is preventing rival bidders from borrowing money, Buffett has $25.5 billion in cash to deploy.
The world’s most successful investor is seeking acquisitions after his company suffered the biggest annual drop in book value since he took control four decades ago. Sysco, North America’s largest distributor of food to restaurants; VF, the world’s biggest clothing maker; and Danaher, maker of Craftsman tools, are among 50 companies that meet his standards, according to data compiled by Bloomberg.
Stanton goes on to list a series of companies that Bloomberg found:
Aetna
Aflac
Agilent Technologies
Allergan
Anadarko Petroleum
Aon
Archer Daniels Midland
Baker Hughes
Becton Dickinson
Brown-Forman
Bunge
Cardinal Health
Carnival
Chubb
Computer Sciences
Covidien
Danaher
EOG Resources
General Dynamics
Halliburton
Hess
Illinois Tool Works
Intercontinental Exchange
Intuit
ITT
Kohl’s
Loews Corp.
Marathon Oil
McKesson
Newmont Mining
Noble Corp.
Noble Energy
Nucor
Precision Castparts
Raytheon
Reynolds American
Rockwell Collins
SAIC
Smith International
Southern Copper
Southwestern Energy
St. Jude Medical
Staples
Sysco
TJX
Union Pacific
VF
WellPoint
W.W. Grainger
Zimmer Holdings
It will be pretty interesting to see if he does indeed dip his toes into the public market again. Domestically he’s mainly completed private acquisitions, I think the Pritzker’s Marmon Holdings is the most recent one. The last time Berkshire acquired public US businesses was during 2000/2001 if my memory serves. These deals were and . Maybe these past acquisitions can give us a hint of what to expect from future acquisitions.
For weeks, Warren Buffett’s Berkshire Hathaway (NYSE:) has come under attack. Most bearish investors point to a series of European-style put options as the main culprit for the panic surrounding Berkshire. It’s likely that all of this commotion is simply that, panic. With that in mind, here is a series of intrinsic value estimates for Berkshire, put together by Daniel Roberts (be sure to thank Daniel for his great work) of the . As you can see, even with varying models for determining the value of Berkshire, they all seem to imply that Berkshire Hathaway is trading at 50-64% of its intrinsic value.
as of 03/04/08
* Used for calculating the average of the estimates and for constructing a histogram. If the author does not imply a preference, then the inferred best estimate is taken to be the midpoint of the stated range. If the author implies a preference, then the value is inferred from the author’s wording.
Summary
Number of Estimates: 7
Range: $117,000 – $148,000
Average: $131,000
Standard Deviation: 11
Median: $128,000
Lately, we’re seeming more and more stories describing investor groups, similar to this one:
Patricia Greenberg’s townhouse in Irvine, California, was losing about $10,000 a month in value when she received a letter in February 2008 that looked too good to be true: An investor was offering to cut her $472,000 mortgage by 26 percent and her monthly payment by a third.
“I didn’t want to get involved in a scam,” says Greenberg, a cosmetics saleswoman for Orlane Inc., who had bought the house with no money down eight months earlier.
It was no ruse. New York hedge fund manager Ralph DellaCamera Jr. says he’d purchased the mortgage for 60 cents on the dollar and forced the originator, MLSG Home Loans of Reno, Nevada, to eat the loss. Protecting his investment, DellaCamera lowered Greenberg’s debt to keep her in the home. She now pays $2,400 a month instead of $3,800 and plows some of her savings into upgrading the Cape Cod-style residence.
The mortgage area seems like it will be fertile ground for value investors. You have a great situation where the banks desperately need to get these toxic assets off of their balance sheet, so they’re motivated sellers. In addition, they may lack the ability to actually examine the loans, borrowers, and homes themselves to accurately peg the true value of these mortgages. Investors like DellaCamera are certainly interesting and will probably make a good deal of money — but I don’t think they’re going to be the solution to our housing problem. Simply because the number of houses far outnumbers the numbers of groups like DellaCamera’s.
First, thanks to of reactions to Berkshire Hathaway’s bad year. Most of these are pretty much the same, a condemnation for a terrible year and all sorts of scrutinizing in hindsight. Being the optimist that I am, I’d like to address a few things or at least make more of a glass half-full argument.
Lets start with and his own thoughts on Berkshire’s performance:
Based on the year-end portfolio presented in the letter (and it has changed only modestly over time, but now excludes two stocks, Burlington Northern and Moody’s, in which Berkshire owns 20% and must report its holdings under the equity method,) Berkshire’s entire equity portfolio, which had a $37 billion cost basis and a $49 billion market value at year-end 2008, was, as of yesterday’s market close, worth only about $37 billion.
Now, we know what you’re thinking: you’re thinking, “Warren doesn’t mind, so why should we?”
…Yet Buffett also disclosed what might go down as the second most surprising disclosure in today’s letter: he had to sell some of Berkshire’s stocks to make those headline-grabbing investments in GE, Goldman Sachs and Wrigley:
…Yet the fact is, the value of Berkshire’s equity portfolio is not only of enormous economic importance to Berkshire Hathaway and its shareholders, but to investors around the world who watch what Warren does and frequently imitate his moves.
And the fact that it appears to be right back to its cost basis—after decades of not—is startling.
This sounds really bad, but Matthews mistakenly leaves out dividends. Warren Buffett is not a fan of trading stocks often. Once he builds a core holding, he likes to keep it. Think of companies like American Express, the Washington Post, or Wells Fargo. All of which are over a decade old. Sometimes he makes a mistake of keeping them past their prime, like Coca-Cola but all of these companies feature a pretty good dividend arrangement. Check out page 68 of the annual report, the earnings from dividends and interest payments on fixed income securities are broken out for you.
While Berkshire may have had an equity portfolio that did not move for a year, it received positive dividend payments, that are going to one of the greatest capital allocators in the business. Dividend income actually increased $534 million for the year, but was offset by other declines. In total though, after taxes and minority interests Berkshire received about $3.5 billion in investment income.
The reason I bring up dividend payments is that they’re significant. Buffett is not someone who trades around his biggest holdings, he keeps them. It’s an affirmation of his belief in having a 20 hole punch card for your investments. Find 20 of the best businesses, invest in them, and watch them grow.
Matthews goes on to call Buffett’s selling of stocks shocking and his equity potfolio’s lack of movement startling. But, what if the two are intertwined? One of the biggest and worst performers in Berkshire’s portfolio is Wells Fargo. But if you go back and look, the bulk of the Wells Fargo position was accumulated in the years running up to 2008. Sure, he initially invested in the company back in 1989/1990 but that wasn’t majority of the position. For example, in 2006 to 2007 alone, Berkshire acquired a bit over 80 million Wells Fargo shares. Its arguable that commentators like Matthews are deriding the portfolio’s performance without giving it adequate time. Value investors are, after all, in it for the long term. One year’s performance may not be reflective of the underlying businesses. Wells Fargo is not Citigroup or AIG, it so far has not needed quarter after quarter of government aid. Buffett has already purchased Wells Fargo shares for his personal account, so I’d say he believes that Mr. Market is getting it wrong this time.
Secondly though, I wanted to address Matthews’ shock. If Buffett believes that Mr. Market is having a bout with depression, why wouldn’t he sell stock to find more attractive opportunities? He could be selling cheap to buy cheaper ( “Regardless of the impact upon immediately reportable earnings, we would rather buy 10% of Wonderful Business T at X per share than 100% of T at 2X per share.” – ) The preferred share investments offer Berkshire a steady stream of large dividend payments that can be deployed in the market now. In addition, the fact that he used preferred shares rather than common investments likely indicates that he thinks the market for common stocks will be in flux for a while. This strategy accommodates Berkshire’s size too because Berkshire’s elephant of a cash-horde lacks the nimbleness to acquire positions without alerting the world and raising prices.
If Buffett was a high frequency trader, with tons of turnover, I could maybe accept Matthews’ argument regarding the equity portfolio’s lack of movement. But he’s not. When he acquires some of these big stakes, he keeps them for years, through the bad times and the good. That makes the dividend payments of these securities rather important. Quite a strange omission from someone who sells a book about the annual meeting.
Moving on to of Portfolio magazine’s Market Movers:
He had to liquidiate some of his stock-market portfolio in 2008 in order to make investments in GE, Goldman Sachs and Wrigley. Which stocks did he sell? “Primarily Johnson & Johnson, Procter & Gamble and ConocoPhillips”.
With hindsight, of course, the main stock he should have sold, before it entered a truly torrid 2009, was Wells Fargo. And selling Wells — or American Express, for that matter, which has also sunk like a stone of late — would have made a lot of sense, given that he was loading up on financials in the form of Goldman and GE securities. But instead he chose to go massively overweight financials, and sold instead safe-and-reliable defensive stocks. Weird.
Salmon seems quite certain about what should and should not have been sold and disagrees with Buffett’s increased exposure to financials. We know that Buffett believes Wells Fargo is undervalued and added shares of it to his personal account around the summer of 2008. I don’t think that he particularly cared whether he had X more in financials or Y more in healthcare. It is likely that when Buffett sold these positions, he was not thinking about diversification but rather the bargains available. He has never been a huge proponent of diversification:
The strategy (of portfolio concentration ) we’ve adopted precludes our following standard diversification dogma. Many pundits would therefore say the strategy must be riskier than that employed by more conventional investors. We disagree. We believe that a policy of portfolio concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort-level he must feel with its economic characteristics before buying into it.
Salmon is really making an apples to oranges comparison when he disagrees with selling JNJ for GE. You should not compare the performance of GE to JNJ. One is an investment in a preferred share deal and the other is simply a common stock investment. The preferred investments are not an investment on the basis of share performance, if they were, Buffett would have bought the common shares. Rather, they’re actually more of a bet on survivability. For Buffett to make money on his GE or GS investment, the companies simply have to survive and be able to pay their dividends to him. In the longer run, he does have warrants that give the ability to acquire shares of the common, but they’re not as important. If GE survives a year and Warren Buffett earns 10% on his $3 billion dollar investment, that return may likely outperform common stocks, especially if the market’s performance stays in this panicked state.
I find the particular passage enlightening:
Our convertible preferred stocks are relatively simple securities, yet I should warn you that, if the past is any guide, you may from time to time read inaccurate or misleading statements about them. Last year, for example, several members of the press calculated the value of all our preferreds as equal to that of the common stock into which they are convertible. By their logic, that is, our Salomon preferred, convertible into common at $38, would be worth 60% of face value if Salomon common were selling at $22.80. But there is a small problem with this line of reasoning: Using it, one must conclude that all of the value of a convertible preferred resides in the conversion privilege and that the value of a non-convertible preferred of Salomon would be zero, no matter what its coupon or terms for redemption.
The point you should keep in mind is that most of the value of our convertible preferreds is derived from their fixed-income characteristics. That means the securities cannot be worth less than the value they would possess as non-convertible preferreds and may be worth more because of their conversion options
.
Now the new investments aren’t exactly the same as these convertible preferreds, but they both share the fixed income characteristics that Buffett describes. In 1989, Buffett said, “Under almost any conditions, we expect these preferreds to return us our money plus dividends.” He goes on to say that it will be disappointing if they don’t also get to take advantage of the convertibility aspect of these securities. Still, it affirms the idea that one of the prime drivers in these preferred investments is the ability to receive dividend payments, convertibility is less important. The certainty is derived from betting that these companies will survive and be able to pay dividends to Berkshire.
It’s rather foolish to proclaim what mistakes Buffett has made when we’re only 3 months into the new year. Buffett has never been much of a market timer. When I saw I thought it was nice but not indicative of any market bottom. In the past he’s exhibited little in market timing ability, yet when looked at over longer periods of time he always manages to come out on top. Maybe he deserves the benefit of the doubt, but at the very least, Berkshire’s performance should be gauged from a period longer than 3 months into the new years.
of economists and thinkers regarding our recession. I really enjoyed the following piece by Jim Grant:
“WHEN you stop asking,” was the exasperated reply of the broker to the pestering client who asked the same question over and over during the 1974 stock-market crash: When will it end?
…Hope sustains life, but misplaced hope prolongs recessions. At the root of this paradox is the notion that booms don’t just precede booms, they cause them. Modern-day booms are the products of low interest rates and easy credit. People overborrow, overpay and overindulge. They love the things that borrowed money buys, but the debts become insupportable. Then the assets, or some of them, must go. A little selling — of houses, cars, companies, stocks — becomes a lot, and the next thing you know we’re talking about nationalizing Citigroup.
About Me
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
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