Street Capitalist: Event Driven Value Investments

My friend Miguel Barbosa recently interviewed me (click for the interview). He’s interviewed plenty of people who are far superior than me, but feel free to check it out if you were wondering more about me.

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 Michael Oher play for? (Michael Oher is the subject of The Blind Side)

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.

I’ll be attending a talk given by Michael Lewis of Liar’s Poker, Money Ball, and The Blind Side 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.

A few days ago, one of the best financial bloggers passed away: Doris Dungey, better known by her nom de guerre “Tanta”.

Take a moment to visit this post at Calculated Risk.

One of the greatest contributions of Tanta to the financial blogosphere can be found here, at her list of Compleat UberNerd posts, these made the esoteric world of mortgages and mortgage backed securities understandable for everyone – as the financial system started to unravel.

And personally, I always liked her posts where she pointed out the flaws in Gretchen Morgenson’s reporting at the New York Times. It’s a great service to everyone when a journalist is kept on their toes, so that we can make sure the truth is being properly disseminated to the public.

What a difference just under a year makes. If you remember, back in December of 2007 Andrew Bary at Barron’s felt that Berkshire Hathaway (NYSE:BRK.A) was overvalued as it traded around $144,000 per share. Bary cited that Berkshire would face difficulties in finding appropriate investment situations for its cash horde and that there were other undervalued securities in the market:

As noted, Berkshire looks pricey relative to many financial companies. Take AIG, the world’s largest property and casualty insurer. Depressed by its exposure to subprime mortgages, AIG has seen its shares fall 21% this year, to 57. It’s now valued at eight times projected 2008 profits. AIG has two-thirds of Berkshire’s market value and 50% more earnings. It may be a better bet than Berkshire in coming years, as could Wells Fargo, American Express and Allstate.

One alternative to Berkshire is Loews (LTR), the conglomerate run by the Tisch family that also combines insurance and investments. Loews has had a great record in recent years and now trades at 47, 12 times projected 2007 profits and a discount to its net asset value of about $62 a share. Loews is sitting on $3 billion in excess cash. It’s easier for the Tisches to move the needle than Buffett because Loews has 1/10th of Berkshire’s market value.

Buffett’s investment genius is undeniable, but his talents seem well reflected in Berkshire’s rich price. Looking out a few years, Berkshire stock probably will be higher. But our bet is that financial companies like AIG, and even the S&P 500, will do even better, especially if Buffett’s glorious tenure ends. And, remember, Buffett didn’t build the Berkshire powerhouse by paying much more for acquisitions than they were worth. That’s a lesson worth pondering by anyone considering buying his stock.

Sorry, Warren, Your Stock’s Too Pricey (Barron’s)

Out of curiosity, I decided to check Bary’s suggestions versus Berkshire’s performance over the same period:

With the exception of Wells Fargo (NYSE:WFC), Berkshire Hathaway has steadily outperformed the rest of the picks offered by Barron’s back in December.

Today though, Barron’s is actually recommending that you invest in Berkshire Hathaway:

THE FINANCIAL CRISIS HAS GOTTEN SO BAD, some investors are even questioning Berkshire Hathaway ’s strength. But the worries seem overblown…

Barron’s took heat from Berkshire boosters with our bearish cover story on Berkshire last December, when the stock traded around $144,000. Berkshire has been hurt by declining profits in the auto-insurance and reinsurance markets, both of which might be bottoming. But now is probably a good time to buy. Looking out to 2009, Berkshire’s earnings could get a lift from improving conditions in the insurance market, and from some new high-yielding investments, including $8 billion of 10% preferred stock of Goldman Sachs (GS) and General Electric (GE).

If the stock market rallies in 2009, Berkshire probably will see record profits. Its operating profits this year could be about $5,400 per Class A share, excluding losses on equity and junk-bond derivatives that may cause a fourth-quarter loss. One big investor says earnings could hit $7,000 a share by 2010, a modest 13 times the current stock price.

Historically, Berkshire’s stock price is linked to its book value. We estimate that Berkshire’s book value now is around $66,000 a share, down $11,000, or 14%, since Sept. 30. Our calculation factors in Berkshire’s recent statement that its book value fell about $9 billion, or $6,000 a share, in October, on market declines. November has been about as bad for stocks, with the S&P off 17%.

True, Buffett does have less financial firepower to make investments because Berkshire’s cash probably has been halved, to about $15 billion, since Sept. 30 — in part because of its investments in GE, Goldman and Wrigley. It’ll be interesting to see if the 78-year-old Buffett is willing to issue equity or debt for a major deal, should he want to make one in the coming months.

Berkshire now trades below 1.4 times estimated book value, versus an average of around 1.5 in the past decade — and current book is depressed. If the stock market rallies 25% in the next year, the stock could hit $110,000, or 1.4 times potential year-end ‘09 book value of $80,000 a share.

Finally, Berkshire Looks Undervalued (Barron’s)

Bary makes a pretty good case for investing in Berkshire right now. It seems to have taken them a while to acknowledge the benefit of investing in Berkshire and its “Fort Knox”-like balance sheet, but they’ve finally come around. It makes you wonder though — did they willingly ignore the balance sheets of those other companies that they recommended back in December? Almost all of them have been absolutely obliterated by the credit crisis and represented a highly speculative investment at the time as the credit crisis took hold of the markets.

I think that in times of crisis, that’s one thing to keep in mind. Any investment you make has to be compared to the universe of opportunities around you. At the time, Berkshire may have been overvalued, but with that cash horde, AAA rating, and lack of sub-prime/CDS exposure it represented a much safer proposition than most other financials.

The WSJ seems to be a fan of repetition when describing the pain at Lehman Brothers (NYSE:LEH)

A group of three men, wearing Lehman badges and walking back into headquarters, discussed the fallout for other firms on Wall Street. “At some point, where does it stop?” one said.

The Lehman Stock Slide Hits Home: Employees Face $10 Billion in Losses (WSJ)

At a fast-food vendor across the street, people waiting to order food discussed the dive in Lehman’s share price this week, and the latest headlines from CNBC. Outside, a group of three men, wearing Lehman badges and walking back into headquarters, discussed the fallout for other firms on Wall Street. “At some point, where does it stop?” one said, as he headed back to the office.

Lehman Races to Find a Buyer (WSJ)

Most readers will recognize Jason Zweig as the guy who revised The Intelligent Investor by Benjamin Graham. In the 2003 annual letter (PDF) to Berkshire Hathaway shareholders, Warren Buffett Remarked that The Intelligent Investor is his “favorite book on investing” and that Zweig did a “first-class job in revising” it.

This was actually one of the first investing books that I read. What I liked most was Zweig’s own remarks after every chapter. Zweig was able to take a book written a long time ago and make it easy to digest and show how Benjamin Graham’s concepts parallel what is going on in modern financial markets. The commentary he added was helpful because even if some of the material was hard to understand, I was able to come back to it after reading the commentary.

So today I was pleased to see that Zweig would be penning a new column at the WSJ. Zweig says:

In the last long bear market, 1969 to 1982, stocks returned just 5.6% annually; after inflation, investors lost more than 2% a year. That mauling by the bear made stocks so inexpensive that over the ensuing 18 years they went up 18.5% a year, enough to turn $10,000 into more than $200,000.

The people who so far this year have yanked $39 billion out of U.S. stock funds, and $6 billion out of exchange-traded stock funds, do not understand this. But if you are still in your saving and investing years, a bear market is a gift from the financial gods — and the longer it lasts, the better off you will be. Instead of running from the bear, you should embrace him.

This new column takes its name from the classic book by Benjamin Graham, who wrote that “the investor’s chief problem — and even his worst enemy — is likely to be himself.” I hope to help you understand the chaotic markets around you, and the even more treacherous enemy within. For, as Mr. Buffett has also pointed out, investing is much like dieting: It is simple, but not easy. Everyone knows what it takes to lose weight. (Eat less, exercise more.) Nothing could be simpler, but few things are harder in a world full of chocolate cake and Cheetos.

Stop Worrying, and Learn to Love the Bear (WSJ)

With many investors hurting right now, a Graham themed column might be just what they need. It would prevent them from pulling out of the markets all together and instead expose them to concepts like Mr. Market and the need for a margin of safety when you invest in companies. Those two ideas will be essential for surviving and thriving in the negative market we seem to be in.

It looks like the WSJ has not set up an RSS feed yet for Zweig’s column, but since I’m really looking forward to them I’ll be linking and posting excerpts whenever I see them.

Today, Abnormal Returns asks us what role it should have in the future of the investment blogosphere. This question brings to mind some of my own thoughts on investment blogging and some ideas I’ve had in my head for a while. Before addressing what Abnormal Returns should be, I’d like to go over some of the ideas in that post.

Quality Control by Blog Type

Quality control is the most important problem facing investment blogs today. The metrics for assessing quality are dependent upon the type of blog. In the investment blogosphere, blogs generally come down to two sides:

1. Commentator types, like Paul Kedrosky who mainly focus as a central source for news he thinks is important and an outlet for his comments on current events. Going to Kedrosky’s site will keep one informed, but is probably not the best place for learning investing.

Quality control with these blogs is hard to peg. There might not even be a need for quality control. These sites are more like opinion pieces in the newspaper and in that case, they don’t have to be correct. They only need to serve as a place to get a specific type of perspective.

2. Trader/investor sites. These sometimes overlap with the previous topic. They’re written from a trader or investor’s point of view, and often you will see posts that actively go over new investment strategies or even ideas.

It’s my belief that quality control here is vastly more important, there are actual investment ideas being generated here. The best thing that these sites can offer to their readers is a level of transparency in their posts. For my blog, I list the positions I hold and make posts that note my entry date in these positions, and update a few times a year with how they’re doing. If I propose an investment idea i’ll also address whether or not I actually hold a position in the company myself. Both of these are important aspects that I believe should be adhered to.

A while back, I took part in an academic study on the investment blogosphere by a prominent university where I was asked questions on how I know what blogs to read and how I rate them. I specifically mentioned that I look at the track record of these bloggers in order to see whether or not they’re worth reading. A track record does not have to solely be your actual performance, it can also be the way you research, the way you summarize and explain your methodologies for how you invest/trade. All of these are sources that actually teach us and probably teach us more than a simple performance number — this is the key to monitoring the quality of trader/investor blogs.

Gatekeepers, Traffic, and Quality Control

I look at Abnormal Returns as the Drudge Report for investors. Often, I’ve discovered new sites by just visiting AR and they get added to my RSS Feed list. AR seems to take an active approach to showing a variety perspectives on one of its daily themes which makes it worth reading. A key difference between Matt Drudge and AR is that they at least appear to have different motives. Drudge pushes a certain ideology, while AR pushes themes of the day.

One thing I want to point out is that “gatekeepers” like AR can actually help in quality control. Linkfests like Abnormal Return push traffic to us which can help start discussions and create discourse.

If you compare us (financial bloggers) to our older second-cousins (political bloggers) there are some big differences. The political blogosphere is vastly greater than our own. Looking at some of the latest traffic numbers, you’ll see that sites like the Drudge Report (which does not actually report but showcase) and the Daily Kos or Huffington Post actually receive more hits than many newspapers.

Nielsen Online Names Top 30 News Sites

With such huge numbers in traffic, these groups are able to bring together larger debates than we can, which can uncover shoddy analysis and perform fact checking.

Look at the traffic numbers of major financial media outlets: the Wall Street Journal, the Financial Times, the Economist (or FMSM- the financial mainstream media). They generally perform better than the closest “independent” blogger driven competitor available – Seeking Alpha. Part of this is because we’re thinking strategically when we conceive our blogs. Most bloggers realize that there is little chance of them competing with the financial press establishment in general reporting.

The other part is because the FMSM typically have strong brand names and are associated with quality. In financial journalism, quality is an important factor, and I think this is primarily why the financial press is an oligopoly of sort. The barriers to entry – earning the recognition that you’re a worthwhile voice to listen to is difficult.

Some of us fight the war of the flea. We (initially) write about niche areas in finance that are not served by the FMSM.

To give you a few examples, look at Equity Private, Tanta (Calculated Risk), or Macro Man. Each brings a perspective that simply could not come from your run of the mill financial journalist. Unfortunately, what ends up happening is that these blogs become valued by industry professionals but typically lack a broader appeal.

Calculated Risk is probably an exception tot his, but part of that is probably because of the constant news about sub-prime mortgages in the news. I’ve been wondering if the broader audience will keep reading sites like Calculated Risk, after the credit mess blows over.

The future for Abnormal Returns and the investment blogosphere?

I can’t help but wonder about the future of the investment blogosphere and the FMSM. Will a blogger driven site ever match the traffic of the WSJ? To do so would be tough. First, content would have to be aggregated. This alone puts up a host of issues. Many bloggers have their own advertising and feel that aggregators take their content for free, without contributing traffic to add meaningful revenue to their blogs.

Then, somehow content would have to be screened. Seeking Alpha is just a mass glutton for content, they end up carrying some trashy contributors. The Huffington Post and Breitbart both supply the news, but also offer contrasting perspectives. The Breitbart blog network is mostly comprised of conservatives while Huffington Post offers a liberal perspectives. Maybe new investment aggregators could come onto the scene that provide different perspectives on the market. Some contrarian, some more mainstream. The fact that these aggregators would have content written by investors and traders, or commentators with professional backgrounds would help differentiate themselves from the typical financial journalists.

Finally, there would be the issue of the financial press broadening its scope. The FT and WSJ feature extensive coverage on current events, foreign and domestic. An aggregator would have to feature that content as well to match and be a true competitor.

With respect to Abnormal Returns though, they should stick with what they’re doing – making a good daily linkfest. I’m actually pretty glad that they have not taken a Digg or Reddit approach. Some sites are trying to become the Digg for financial news, but the problem with this model is that it thrives on mob mentality. Contrarian perspectives can get ignored by these sites and makes the editorial nature of AR’s linkfest advantageous. As for pursuing profit, as long as it is tasteful, I don’t see how a few ads here and there could hurt.