Tuesday, March 31, 2009
Monday, March 30, 2009
Sunday, March 29, 2009
While Buffett has made it clear that he believes options should be expensed, the author takes issue with Buffett's logic. Because the value of options are difficult to measure at the date of grant (since they can end up being worth nothing, or being worth a whole lot more than expected), the author's take is that expensing them is not as straight forward as it is for other uncertain expenses such as depreciation (where the cost of the purchased good is at least known).
The author believes the real problem is abuse of options. Excessive grants, re-pricings and backdating are all forms of abuse that shareholders should be looking to curtail, rather than focusing their energies on forcing option expensing. Diluted Earnings Per Share already accounts for outstanding options, so the author suggests expensing is unneccessary.
The mandatory expensing of options has lead to a drop in this form of compensation. The author seems to believe this will stifle new companies, many of which cannot afford to pay enough cash to attract top managers. Unfortunately, this argument seems rather flimsy, as it could also be taken to the next step in a claim that depreciation should not be "expensed", since this would curtail necessary capital investments.
Although the value of options is uncertain, Buffett's argument is that we should make a best effort to put some expected value on them, rather than have the income statement completely ignore them.
Saturday, March 28, 2009
For example, governance experts suggest that a company's CEO and Chairman position should be occupied by different individuals, but this is not the case at Berkshire where Buffett holds both roles.
Berkshire (until recently) also didn't meet governance standards when it came to the number of independent directors on its board. As recently as 2002, the board of Berkshire consisted of only 7 individuals. There were three Buffetts on this board, along with Charles Munger and Richard Olson (a partner at Munger, Tolles & Olson LLP). Therefore, clearly 5 of the 7 board members were not independent.
In fairness to Buffett, however, he disagrees with the definition of "independent" when it comes to directors. Buffett believes that while those whose association with the company results in their receiving a large portion of their income from fees for being directors are regarded as independent by the experts, they are actually the least useful. Instead, Buffett would rather have directors with a substantial investment in the company, since these individuals are most likely to be on the side of shareholders when it comes to company matters.
Buffett has also failed in his succession planning according to Janjigian. For most of Berkshire's existence under Buffett, it has not had a plan in place. It should be noted that currently Berkshire does have clear succession planning, but it took an NYSE requirement to get this process started. Even so, no one person will do Buffett's job, as his job will be split between someone who runs the business, and someone who runs the investment operation. As such, in all of Buffett's years at the top of Berkshire, he has not trained anyone who can truly take over his position.
Friday, March 27, 2009
The following post was written by Peter Schiff, who regularly writes for Money Morning. Recently, Peter authored a new book titled Crash Proof. The opinions expressed here do not necessarily reflect those of Barel Karsan.
There is an old Wall Street adage that no one rings a bell at major market tops or market bottoms. That may be true in normal times, but as many have noticed, we are now completely through the looking glass.
In this parallel reality, U.S. Federal Reserve Chairman Ben S. Bernanke has just rung the loudest bell ever heard in the foreign-exchange and government-debt markets. Investors who ignore the clanging do so at their own peril. The bell's reverberations will be felt by everyday Americans, whose lives are about to change in ways few can imagine.
While nearly every facet of America's economy has been devastated over the past six months, our national currency has thus far skipped through the carnage with nary a scratch. Ironically, the U.S dollar has been the beneficiary of the very global economic crisis that the United States set in motion. As a result, our economy has thus far been spared the full force of the storm.
Following its policymaking meeting last week, the Fed finally made clear what should have been obvious for some time: The only weapon that the U.S. central bank is willing to use to fight the economic downturn is a continuing torrent of pure, undiluted, inflation. The announcement should be seen as a game changer that redirects the fury of the financial storm directly onto our shores.
In its statement, the Fed announced its intention to purchase an additional $1 trillion worth of U.S. Treasury and agency debt. The purchases, of course, will be made with money created out of thin air through the government's printing presses. Few can doubt that it will persist with these operations until the economy returns to its former health. Whether this can ever be accomplished with a printing press alone has never been seriously considered. Bernanke himself admits that we are in uncharted waters, with no map or compass, just simply a hope that more dollars are the answer.
Rather than solving our problems, more inflation will only add to the crisis. Falling asset prices, the credit crunch, declining consumer spending, bankruptcies, foreclosures, and layoffs are all part of the necessary rebalancing of our economy. These wrenching movements, however painful, are the market's attempts to resolve the serious problems at the root of our bubble economy. Attempts to literally paper-over these problems will lead to disaster.
Now that the Fed has recklessly shown its hand, the mad dash to get out of U.S. Treasuries and dollars should not be far off. The more the Fed prints to buy bonds the less the dollar is worth. Holders of our debt (read China and Japan) understand this dynamic. We must expect that they will not only refuse to buy new bonds, but they will look to unload those bonds they already own.
Under normal circumstances, if creditors grew concerned that inflation was eating into their returns, the Fed would raise interest rates to entice them to buy. However, the Fed will avoid this course of action as it fears higher rates are too heavy a burden for our debt-laden economy to bear. To maintain artificially low rates, the Fed will be forced to purchase trillions more debt than it expects to as it becomes the only buyer in a seller's market.
Just last week, Chinese Premier Wen Jiabao voiced concern about his country's massive investments in U.S. government debt. In the most unequivocal statement yet by the Chinese leadership on this issue, Wen made it plain that he was concerned with depreciation, not default. With his fears now officially confirmed by the Fed statement, we must wonder when the Chinese will finally change course.
There is a growing consensus that if China no longer wants to buy our bonds, we can simply print the money and buy them ourselves. This naïve view fails to consider the consequences implicit in such a change. When the Treasury sells bonds to China, no new dollars are printed. Instead, China prints yuan, which it then uses to buy Treasuries. This effectively allows America to export its inflation to China. However, now that we will be printing the money ourselves, the full inflationary impact will fall directly on us.
With such a policy in place, America has now become a banana republic. It won't be too long before our living standards reflect our new status. Got Gold?
About the author: Peter D. Schiff, Euro Pacific Capital Inc.'s president and chief global strategist, is a well-known author and commentator, and is a periodic contributor to Money Morning. Schiff is the author of two New York Times best sellers: "The Little Book of Bull Moves in Bear Markets,"and " Crash Proof: How to Profit from the Coming Economic Collapse"." For a more-detailed analysis of the nation's financial problems, and the inherent dangers that these problems pose for both the U.S. economy and for dollar-denominated investments, click here to download Euro Pacific's new financial-research report, "The Collapsing Dollar: The Powerful Case for Investing in Foreign Securities."
In the midst of an ongoing financial crisis that's eradicated trillions of dollars in shareholder wealth, the profit search facing U.S. investors is tougher than ever. The uncertainty surrounding the economic-stimulus and banking-bailout plans isn't helping. But a free report provides insights into the threats those plans pose. Investors who subscribe to the Money Map Report can obtain a complimentary copy of Schiff's best seller, "Crash Proof," in which he details the causes of the housing bubble and financial-system collapse, and tells investors how to dodge losses from the problems that are still to come. To read the free report, please click here .
Thursday, March 26, 2009
Wednesday, March 25, 2009
Tuesday, March 24, 2009
Japan had what's known as The Lost Decade, where economic growth stagnated for several years following its credit crisis. While there are many complex issues at play that caused this episode, one of the main problems Japan's economy faced during this time was extremely low productivity growth rates. As we've discussed, productivity growth is the key to increasing a nation's standard of living. The actions and policies of the Japanese government were often a drag on productivity, and the US would do well to ensure it does not fall into these traps.
First of all, the Japanese government exacerbated its credit problem by creating what's known as "zombie companies" by subsidizing failing banks and businesses. While these moves likely reduce mass layoffs in the short-term, they effectively are taxes on good businesses to throw at poor ones, thereby stymieing growth of great companies at the expense of poor ones.
Japan has also been slow to remove tariffs and laws protecting local businesses from competition. Without competition, firms are able to get by without improving efficiencies, and bad companies are able to stay in business, which saves jobs in the short-term, but is good for no one in the long-term. This would be akin to the US proposing "Buy American" requirements or putting tariffs on Chinese imports.
While Japanese exporters are extremely competitive because they are forced to compete globally, domestic companies within Japan are protected in order to for people to be able to keep their jobs. Mom-and-Pop retailers account for 55% of retail jobs in Japan, compared to just 19% in the US. The efficiencies that large retailers bring accounts for the fact that Japanese retail productivity is half of what it is in the US.
Similarly, the construction, health-care, and food processing industries suffer from further anti-competitive policies that have resulted in little in the way of productivity gains. Thankfully, the US is a very competition-friendly nation, but special interest groups can at times sway governments to protect certain groups.
The Japanese government also embarked on several stimulus packages (as we're seeing now in the US), but these only resulted in ballooning government debt. While stimulus can temporarily spur demand, only with policies that encourage productive growth can economies in the developed world grow in the long run. The US government should keep these issues in mind when determining its policies for navigating its way out of this recession.
Monday, March 23, 2009
Sunday, March 22, 2009
First of all, it is actually difficult to determine when a Buffett investment has gone wrong. Unlike the case with short-term trading, value investments can sometimes take years to show their expected returns. Many of the companies Buffett has purchased have actually dropped in value for a period of time before roaring back. But there are nevertheless some companies Buffett has sold at a loss, and those are described in further detail.
Berkshire's investments in Salomon, General Re, NetJets, and Pier 1 Imports are considered mistakes by the author. These investments are critiqued and analyzed. In a couple of cases, Buffett has had to take over active management of the firms, and managed to turn some of them into successes. But these are still deemed mistakes, as the author asserts that Buffett would not have bought in had he known what was in store.
However, in many of the cases, the incidents which caused these investments to go wrong would have been difficult to foresee. A rogue trader (Salomon) and hidden liabilities (General Re) would be very difficult for investors to prevent from occurring, so it's not immediately clear what the reader is to learn from these mistakes.
Saturday, March 21, 2009
The author examines the details (that are public) of various purchases Buffett has made over the years, including those of Forest River, Business Wire, Iscar Metal, PacifiCorp, and Russell Corp.
Buffett's approach to finding investments is also explored. The author says he does not go looking for companies, instead preferring to wait for the right opportunity to come to him. He is certainly not afraid to hold cash, unlike most of the trigger happy portfolio managers littering the finance industry.
Although Buffett is known as a buy and hold investor, Janjigian points out many instances where a stock has remained in Berkshire's portfolio for only a short period of time. Examples of such companies include Best Buy, Gap, and PetroChina.
Friday, March 20, 2009
Thursday, March 19, 2009
Wednesday, March 18, 2009
Tuesday, March 17, 2009
Monday, March 16, 2009
Please don't hesitate to let us know what you think of the new look, either by commenting on this post, or contacting us by e-mail. Many thanks to Brad, who writes regularly for Triaging to Financial Success, for getting this process started.
Sunday, March 15, 2009
The author points out a number of instances where some of Buffett's stocks may have traded above intrinsic value, but Buffett has not sold. Unfortunately, this costs his shareholders money. The author argues that Buffett doesn't do this because he doesn't want to maximize shareholder value, but instead this is a result of the fact that Buffett does not think of himself as a stock picker, but instead a buyer of a business. As such, Buffett marries businesses.
The following quote from Buffett in Berkshire's Owner's Manual illustrates this point perfectly:
"You should be fully aware of one attitude Charlie and I share that hurts our financial performance: Regardless of price, we have no interest at all in selling any good businesses that Berkshire owns...[G]in rummy managerial behavior (discard your least promising business at each turn) is not our style. We would rather have our overall results penalized a bit than engage in that kind of behavior."
Janjigian also discusses one method of investing that Berkshire is able to do that ordinary investors cannot: Private Investments in Public Equity (PIPE). Large investments in public companies allow the public company to save time and money. Some of this discount can be passed onto the buyer, who gets a deal on a stock that ordinary investors cannot. The author discusses a number of such PIPE deals Berkshire has profited from.
Saturday, March 14, 2009
The author concludes that value stocks do outperform growth stocks over time, citing and discussing several studies. It is worth noting that value stocks do not outperform in all periods, however, the longer an investor sticks to value investing, the more likely he is to outperform the market.
Within the value stocks, the author determines that the small-cap subset outperforms the most. Buffett clearly agrees, as he has stated many times that as Berkshire gets larger, he cannot possibly match the returns he was able to achieve back when he was starting out.
Though Buffett and many value investors tend to buy and hold, the author does argue that traders do provide a valuable service. They offer liquidity to the market which would not otherwise be present, thus lowering trading costs (lower bid ask spreads, more scale for brokers etc) for all investors. It is also noted that traders prefer growth stocks since these are the stocks that perform well for momentum investing. Academic research is cites which demonstrates that momentum investing can be used successfully.
Friday, March 13, 2009
The financial news media are no exception, and although I've tried to demonstrate their folly in the past, I don't have the nearly the expressive talent to illustrate this as does John Stewart:
Clearly, estimates that predicted the good times to keep rolling forever were flawed. But it's important to note that the reverse may also be occurring today: doom and gloomers dominate the financial news, but astute members of the public will recognize that this is simply the result of the media once again exaggerating the situation - this time to the negative. Investors who buy when others are fearful and sell with others are greedy have done well in the past, and should continue to do so going forward.
Thursday, March 12, 2009
A rather famous classic case involves Enron, which was one of the world's largest energy companies. Enron execs were allowed to override Enron's code of ethics that forbade practices involving self-dealing by executives - and they were able to do this with board approval. Boards are supposed to be on the side of shareholders, but it's clear that in this case they were not.
Specifically, Enron's CFO acted on behalf of Enron (which is acceptable for a CFO) in transactions with companies for which he served as partner (totally unacceptable - major conflict of interest!). He was thus able to transfer large amounts of wealth from Enron to himself. These partnerships also served to hide rather large debt obligations that really belonged to Enron.
The permission of such activities is not simply the result of one-off mistakes or omissions on the part of the board of directors. Rather, they are the result of a culture of non-independence and poor checks and balances.
Investors that don't consider the corporate governance structures of the companies in which they invest are the next potential victims of such shenanigans. In the past, we've looked at Charles Brandes views of what corporate governance should look like. In a future post, we'll discuss how ordinary investors can go about getting information on how well a company's corporate governance structure is working, so that they can reduce the chances of falling victim to such egregious activities.
Wednesday, March 11, 2009
Tuesday, March 10, 2009
Monday, March 9, 2009
Therefore, Reyer and I decided to conduct our own research into the matter. When the results looked promising, we subsequently teamed up with Professor George Athanassakos of the Richard Ivey School of Business to author a paper describing these results and the methodology. I'm pleased to announce that the paper is available here, under the heading:
In it, we analyze financial data for low P/E and low P/B firms for each year in the preceding business cycle. We attempt to weed out the higher risk firms (due to business risk, financial risk, or a combination of the two), as value investors would normally do. We then observe that this process does indeed bear fruitful results, which the reader is encouraged to see for himself!
Many thanks to Reyer and George, whose contributions to the paper far outweighed mine!
Sunday, March 8, 2009
To illustrate the difference between growth and value, the author takes the reader through an investment in the Washington Post versus an investment in Google. It is clear from the data that Google is the more expensive stock (higher P/E, P/CF, P/B and P/S), but the difference is explained by the appeal of Google's growth potential.
Where Buffett sees an issue with the way the finance industry treats growth is that expectations get out of hand. Investors almost always pay too much for growth, as expectations are rarely matched by the actual results over the long term. The author also discusses the fact that growth always invariably slows down, even for the best companies.
Indeed, despite the fact that Buffett would probably agree that Google is a fantastic company, he would still rather own (and does) The Washington Post than Google, as the author argues it's the price of the stock relative to the value of the firm that counts, not simply how great the firm's prospects are.
The author concludes the chapter by discussing how Buffett determines whether a company is cheap: the discounted cash flow valuation. To Buffett (and indeed most of the finance world), an investment is worth the discounted future stream of cash flows that accrue to the investor. This estimate of the value of a company can fluctuate wildly with tiny changes in assumptions. This is why Buffett prefers companies that are easy to understand, as the future cash flows can be predicted with more certainty.
Saturday, March 7, 2009
The chapter goes on to discuss that these statements are not in fact contradictory. Diversification is used to reduce risk for investors who have neither the time nor the inclination to study the companies they are buying. In Buffett's case, he knows his companies (and their industries) well. As such, he reduces his risk in this regard, and therefore does not require as much diversification.
The chapter continues by discussing some of the finance theory regarding diversification, defining and explaining terms such as variance, correlation and standard deviation. It then discusses why Warren Buffett is not a big fan of this theory: it is impossible to know the above parameters with certainty. For example, you might think airlines and oil prices have a certain negative correlation, but in a market panic you can basically throw that correlation out the window.
The chapter also discusses Berkshire's apparent move to diversify over the years. However, the conclusion of the author appears to be that as Berkshire has increased in size, it has had no choice but to do so. It is very difficult to find amazing deals in the tens of billion dollar ranges since the population size of this group is so low. Nevertheless, the majority of Berkshire's investments are concentrated in only a few companies, meaning Buffett is not as diversified as finance theory would suggest.
Friday, March 6, 2009
First of all, data measured in absolute numbers over time runs the risk of being irrelevant unless compared to a meaningful standard. That is, trade numbers by themselves over time don't tell us much, because the country has gotten richer over time. It makes more sense to compare the trade deficit to GDP over time in order to get a better handle of its magnitude. Here's a look at the US trade deficit as a percentage of GDP since 1960:
Even by this measure, the trade deficit has undoubtedly increased in the last several decades. It is unlikely that the US can sustain such a deficit for an extended period of time. However, note the recent decline due to the fall in oil prices and reduced consumption, which should continue to persist into this year.
The second often ignored major contributor to the trade deficit is the exceptional oil price of the last several years. This number represents about one third of the entire deficit as demonstrated in this San Francisco Fed Economic Letter.
However, instead of taking money from successful companies (in the form of government bailouts or protectionist measures) in order to invest in failed companies in old industries that are now disadvantaged in the US for various reasons including a higher prevailing wage rate, the path to prosperity is through the jobs of the future. Economists agree that comparative advantage results in increased wealth for both trading partners.
Therefore, rather than taxing successful companies (through protectionism and bail-outs of failed companies), the government should pave the way for next generation of jobs that will help carry the country into the next century. For example, considering that 33% of the trade deficit is in the form of oil, the trade deficit can be meaningfully reduced by investing both on the supply side (e.g. exploration and drilling in the US in currently banned areas along with investment in cleaner forms of energy) and the demand side (e.g. more efficient technologies, conservation methods etc) of energy.
In a previous post, we saw how protectionism likely contributed to the Great Depression.
Thursday, March 5, 2009
For example, we saw here that those with a bachelor's degree or higher are experiencing far lower unemployment rates (around 3%) than those who never completed high school (around 11%). We also saw that teenage unemployment rates are far higher than those of adults, which are likely due to artificially high wage rates.
The US Bureau of Labour Statistics also publishes employment data by race. Although it is not a comfortable topic for most Americans, there are still significant employment differences between blacks and whites, as shown below:
While the differences are clearly pronounced in the chart above, it does not even take into account wage differences between the races. Furthermore, some of the disparities between sub-categories of the races are averaged out in the chart above. For example, the difference is most pronounced between black males, who experience an unemployment rate of 15.8%, versus white females who by contrast experience only a 6.2% unemployment rate.
Much of this difference in employment rates may be explained by varying levels of education between the races. But that should be a signal of how important education levels are to an economy. Economists agree that gains from education are not part of a zero sum game. That is, an increase in the number of educated people does not result in fewer positions for those who are educated. It actually results in productivity improvements that increase wealth and opportunities for everyone in society. As such, governments need to ensure that everyone is getting a fair chance at an education, as it contributes to the welfare of the entire country.
Wednesday, March 4, 2009
Watsa founded and heads Fairfax Financial (FFH), which recently reported a 16% return on its investment portfolio for 2008, an incredible return of $2.7 billion amidst a brutal market. So how did he do it? As the market became overpriced thanks to an overheated economy, Fairfax held 75% of its portfolio in cash and government bonds, which lifted its portfolio as interest rates dropped in the ensuing meltdown.
During a bull market, it is very difficult psychologically to hold off from equity investing and exit those positions while speculators are making a bundle around you. But countless examples show us that this is what the most successful investors do. So what does Watsa hold in today's market? I'll end the post with some of his comments that speak for themselves as they repeat many of the themes that we have echoed on this site:
"As value investors we are seeing some excellent buying opportunities in common stocks for the first time in a long time, and we are taking advantage of them.”
"[In the fourth quarter, we] removed all...equity hedges and invested approximately $2.3-billion in common stock."
“We consider this a time of opportunity...When I say that, I always say that with a five-year view. We really don't know what'll happen in the next three months, six months, a year from now. But five years from now, looking back, we think these prices will seem attractive.”
Tuesday, March 3, 2009
The company also managed to earn $1/share in 2008, with a fourth quarter and full-year result fairly flat against year ago levels. But the stock price recently dropped to below $5, offering long-term investors the opportunity to buy in at a pretty good price! CAM's debt to equity sits at just 17%. Combined with the fact that it is in a contract-based business and therefore has some revenue certainty (and can therefore align variable costs with revenues in advance), it's a very safe bet that this company will emerge from this recession unscathed.
While many companies are too afraid to buy back shares in this economy not knowing what's ahead, Canam management knows its shares are cheap. They have been buying back shares, and have indicated that they will continue to do so, without levering up. Their bridge plants are at full capacity for the next 18 months, which gives management the confidence it needs that its business conditions are okay.
On the conference call last week, CEO Marcel Dutil emphasized that this is now his fourth recession in charge, and Canam is better positioned now than at any other time (looking at Canam's D/E in previous recessions shows this to be very true!). He stated that 2009 and 2010 will be years of growth for this company, which is something rarely heard in the corporate world today!
The market has punished the shares along with the overall equity market, but with a P/E of 5, a P/B of .5 and a safe capital structure, value investors may see great profits with this stock in the next few years.
Disclosure: Author has a long position in CAM
Monday, March 2, 2009
While wage rates and labour hours can be reduced to a certain extent in order to be more appropriately aligned to demand, rent agreements are often fixed for a number of years. Indeed, previously we discussed how the magnitude of Build-A-Bear's operating leases could prove crippling if revenues continued to fall.
But the company has decided to make cost-cutting a priority and has undertaken efforts to cut rents while keeping stores open! Operating lease data is only required to be released in the annual report (which hasn't yet come out for 2008), but comments from Build-A-Bear's CEO on the 2008 Q4 conference call illustrate this point:
"We expect to improve our rent structure with minimal store closures at this point. We are a highly desired tenant with mall landlords...Importantly, in many cases we are negotiating shorter term renewals to maximize our real estate flexibility as we anticipate the mall landscape will change during these times...We’ve been successful in negotiating reductions in occupancy expenses, while maintaining future leased options to re-evaluate stores and ensure they are meeting our assumptions and expectations. Let me assure you in the current environment, improving store lease terms and optimizing store productivity is a top priority."
On it's last 10-K, the company reported future operating lease obligations of $423 million. If the company is meaningfully able to bring these costs down, it becomes far less risky, even to this stingy value investor.
Coupled with the fact that Build-A-Bear still managed to earn $5 million in its fourth quarter of 2008 (on a market cap of $80 million), investors may have something to get excited about. We'll be watching for an update on these lease obligations in the next 10-k due out in a few weeks!
Sunday, March 1, 2009
Janjigian also discusses Buffett's buy and hold investment style, and notes that it is not the only way to make money in the market. He also discusses some of Buffett's diversification strategies, even though Buffett himself is quoted many times knocking the usefulness of such strategies.
Finally, the author notes that as good as Buffett is, even he has made many mistakes. The book attempts to capture some of these mistakes and lay them out for investors so that they may learn from Buffett's mishaps. Similar to the book's foreword written by Steve Forbes, the author is also critical about Buffett's tax policies.
These topics and then some will be explored in the rest of the book!