Investment vs. Speculation: Fairholme Case Studies; Ponzi Schemes; Couch Potato Nation

An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return.”  Graham says “thorough analysis” means “the study of the facts in the light of established standards of safety and value” while “safety of principal” signifies “protection against loss under all normal or reasonably likely conditions or variations” and “adequate” (or “satisfactory”) return refers to “any rate or amount of return, however low, which the investor is willing to accept, provided he acts with reasonable intelligence.” (Security Analysis, 1934, ed., pp. 55-56)

Our Nation Today

The one aim of all such persons is to butter their own parsnips.  They have no concept of the public good that can be differentiated from their concept of their own good.  They get into office by making all sorts of fantastic promises, few of which they ever try to keep, and they maintain themselves there by fooling the people further.  They are supported in their business by the factitious importance which goes with high public position.  The great majority of folk are far too stupid to see through a politician’s tinsel.  Because he is talked of in the newspapers all the time, and applauded when he appears in public, they mistake him for a really eminent man.  But he is seldom anything of the sort.**

** This quotation is on page 67 of the 1991 collection, edited by Marion Elizabeth Rodgers, The Impossible Mencken; specifically, it’s from Mencken’s August 19, 1935 Baltimore Evening Sun essay entitled “The Constitution.”

Investment vs. Speculation

As Graham once put it, investors judge “the market price by established standards of value,” while speculators “base (their) standards of value upon the market price.” For a speculator, the incessant stream of stock quotes is like oxygen; cut it off and he dies.

Below are several case studies by Fairholme:

http://www.fairholmefunds.com/bruce-berkowitz-consuelo-mack-101212-featured-video-page#overlay-context=bruce-berkowitz-consuelo-mack-101212-featured-video-page

Try not to be swayed by stories but by facts.

You may think investing in a bank below book value is cheap and you may be correct on a grouped basis, but I don’t know how one truly can value a complex, huge financial company like Bank of America.

If you are analyzing a good company based on its normalized return on capital, you first have to identify economic capital. Financial groups (Banks, insurance companies, mutual funds) carry “third party capital” such as depositors, policyholders, and investors. This capital does not belong to shareholders, and is not provided by lenders. These are the assets deposited by the clients of these companies; bank deposits, for example.  Due to the complexity of these groups, accurately segregating only the capital financing the company’s own assets is nearly impossible, especially since most of these assets are ‘market to market’, in other words, revalued every day at their market value.

Segregating capital and identifying cash flows for financial groups is difficult because, fundamentally, these businesses do not produce profits in the same way as non-financial groups. The latter simply add some value, via a proprietary process, to a certain amount of operating costs, and sell units (goods and services) of the total cost to its clients. The former capture capital flows, often thanks to a high financial leverage (partly from debt, partly from ‘third party capital’). Transform them and clip a remuneration for this process. Even if it were possible precisely to identify cash flows and economic capital for financial groups, the difference in balance sheet leverage would demand the calculation of an expected return (‘cost of capital’) specific to them.

Investors may find that excluding financial companies from their portfolio would, at worst, not put them at a disadvantage.

It is OK to speculate and invest, just know the difference. 

Ponzi Finance

Carlo   Ponzi, Alias Uncle Sam by Gary North Reality Check(Nov. 2, 2012)Carlo “Charles” Ponzi was a con man who was the Bernie Madoff of his era. For two years, 1918 to 1920, he sold an impossible dream: a scheme to earn investors 50% profit in 45 days. He paid off old investors with money generated from new investors. The scheme has been imitated every since.Every Ponzi scheme involves five elements:1. A promise of statistically impossible high returns
2. An investment story that makes no sense economically
3. Greedy investors who want something for nothing
4. A willing suspension of disbelief by investors
5. Investors’ angry rejection of exposures by investigatorsStrangely, most Ponzi schemes involve a sixth element: the   unwillingness of the con man to quit and flee when he still can. Bernie Madoff is the supreme example. But Ponzi himself established the tradition.

The scheme, once begun, moves toward its statistically inevitable end.   From the day it is conceived, it is doomed. Yet even the con man who   conceived it believes that he can make it work one more year, or month, or day. The scheme’s designer is trapped by his own rhetoric. He becomes addicted to his own lies. He does not take the money and run.

This leads me to a set of conclusions. Because all Ponzi schemes involve   statistically impossible goals, widespread greed, suspension of disbelief,   and resistance to public exposure,

All fractional reserve banking is a Ponzi scheme.
All central banking is a Ponzi scheme.
All government retirement programs are   Ponzi schemes.
All government-funded medicine is a Ponzi scheme.
All empires are Ponzi schemes.
All Keynesian economics is a Ponzi scheme.

But there is a difference between a private Ponzi scheme and a government Ponzi scheme. The private scheme relies on deception and greed alone. A government Ponzi scheme relies on deception, greed, badges, and guns.   Read more: http://www.garynorth.com/public/10280print.cfm

Couch Potato Nation: Hooked on handouts: http://lewrockwell.com/faber/faber144.html

 

 

7 responses to “Investment vs. Speculation: Fairholme Case Studies; Ponzi Schemes; Couch Potato Nation

  1. BTW John, new UK FSA (Financial Service Authority) means that short positions > 0.5% must be disclosed.
    http://www.fsa.gov.uk/static/pubs/international/short-positions-daily-update.xls

    I think it will be a great learning resource even if you only look at what Einhorn and Chanos are up to. An opportunity to learn from the masters as to what makes a bad stock (or a good short, if you’re so inclined).

    • Thanks for the Idea. I will keep my eyes open for a clearly articulated thesis on one of their investments–that way one can see if the thesis holds.

      • John Hempton’s blog will occasionally highlight some interesting companies. While a lot of the posts are about allegedly frauds, his short thesis on First Solar was a good read. I found the relevant posts using his blog’s search function: http://brontecapital.blogspot.com/search?q=solar You’ll notice he did an analysis on a per-unit cost for solar power.

        If you find Einhorn’s presentation on their short of GMCR you’ll see that he does something similar there too with regards to the cost per K-cup. I guess a big plus there is there is also some supposed shady accounting going on so you aren’t just simply shorting a bad business.

        • Thanks for the post on other case studies–learning opportunities. There is no end to what you can do to improve as an investor.

      • Yes, good idea. I might take a look at the Chanos and Einhorn one. Einhorn is shorting DMGT (Daily Mail), a newspaper. People have proposed this as a value idea, and it may be harder to pinpoint exactly what Einhorn had in mind other than the obvious “it’s a declining industry”. Buffett appears to be buying newspapers lately, so I guess the what makes it a good short it not going to be so simplistic.

        On the other side of the coin, I’m aware of one shorter who looks ripe for a squeeze. Oh dear.

  2. The son of Donald Yacktman also manages money at YCG (Yacktman Capital Group). They sometimes blog briefly about a stock purchase, their latest blog is about MSCI (the company): http://www.ycginvestments.com/thoughts/98-msci-emerging-market-opportunity. Don’t know the business details about MSCI but it is worth watching whether a company like this is able to keep on having pricing power.

  3. Dear PT, You are asking the right questions.

    One that I am working on is Gannett (GCI). Very cheap on BACKWARDS numbers because the market explects decline. Is this back to the future? Yes, I know print media is fading, but how to people get or find good local news. One place to loof for competitive advantages is in LOCAL economies of scale. I do NOT know if GCI has them, but certainly priced for not much future success.

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