Category Archives: Special Situations

Looking At Bottoms; Gold Stocks

200205666-001

No, not these…..

Bottom

 

 

 

I mean these……….. (Thanks to http://www.classicvalueinvestors.com/

Gold Stocks

The table below is meant to highlight the HUGE price ranges of the micro-cap junior precious metals sector. I tend to avoid or make allowance for some of these companies going to $0.00 or diluting shareholders with equity offerings.

GroupofMinersPerformanceFebruary182014-300x90

 If you go back and read the author’s post over the past two years, you will get a feel for the suffering of investors who ride a BIG BEAR market in small junior mining stocks. Be aware of the downside as well! See:  http://classicvalueinvestors.com/i/2014/03/goldgroup-mining-this-is-what-i-call-a-great-day/

How one investor changed his life by developing his OWN method of investing.

Below is an advertisement to get you to hear the audio story. The ad places the HOOK, “an unusual money-making secret.”  Baloney, he doesn’t use any “secret”. He simply found a method to value, buy cheaply, and manage a portfolio of precious metals’ stocks.  And over the years he has done extremely well while stomaching swings of 50% or more. He can hold on, because of his work and confidence. THAT is his secret. I know this guy and you should listen to the interview. Yes, a bit hokey at first –who cares that he got revenge on his ex-wife–but a true story. There are LESSONS here.

Dear Reader,

If you’re a middle-aged guy, divorce is one of the worst things that can happen to you. It can ruin you, both financially and emotionally.

But I recently heard the story of a Ft. Lauderdale man named John  (Actually, John Doody of www.goldstockanalyst.com) who discovered an unusual moneymaking secret after going through a bitter divorce.

John says this secret has made him a multimillionaire over the past decade… even though his ex-wife took almost all of his assets. And he asked us if he could share his story with you.

In fact, he says he even went through the expense of having his transactions verified by an independent auditing firm… just so he could prove his incredible story to the world.

Click here to listen to John’s story.

Jan. 2014 Interview of John Doody (down 50% in 2013!) http://youtu.be/95gjTXIGsgU

Regards,

Will Bonner, Publisher, Diary of a Rogue Economist 

Who Wants to Analyze a Gold Stock?

If there is interest, we can work through a company in a few posts next week.

HAVE A GREAT WEEKEND!

Activist Short-Selling

Easily offended

NBER short selling study finds Asensio to be the Pioneer of recently defined field.   See www.asensio.com  There are plenty of research reports and case studies on short-selling hyped frauds. A worthwhile education.

March 5th, 2014.  In January 2014 the National Bureau of Economic Research ["NBER"] published a behavioral finance article titled the first titled “How Constraining Are Limits to Arbitrage? Evidence from a Recent Financial Innovation.”  The study indentifies Manuel P. Asensio of Asensio & Company as the “pioneer” of short selling “arbitrage” and found that Asensio & Company’s short targets experienced the largest price correction among this recent class of short sellers during the study’s timeframe.   The study defines this recent class of arbitrage short seller as “information producers as arbitrageurs rather than as short-sellers, to distinguish them from uninformed short-sellers in the market.” 

The study describes a “recent financial innovation that allows limits to arbitrage to be sidestepped, and overvaluation thereby to be corrected” even in settings characterized by extreme costs of information discovery and severe short-sale constraints or limits.  Limits “interfere with arbitrage processes so that security prices can deviate from true values for extended periods of time” and include costs of discovering a mispriced security, the costs of the resources needed to exploit a mispricing and short-sale constraints and the risk that mispricing could get worse, forcing early liquidation of a position at a loss.  Limits mentioned in the study also include “sophisticated public relations campaigns against shorts” and targets that “put pressure on their shareholders to recall stock out on loan, to put a squeeze on short sellers.” Yet the study found that short selling arbitrage can succeed in correcting mispricing and generate cumulative abnormal profits “even in this uninviting setting.”

The study “arbitrageurs” expend considerable resources to identify overvalued companies and profitably correct overpricing.  It notes that short selling arbitrageurs reveal their information publicly as a way to sidestep the so-called limits and found evidence that “revealing the information voluntarily and thereby accelerating price discovery reduces the risk of the arbitrage strategy and sidesteps the arbs’ limited-resource constraint.”

The study found that “[f]or this strategy to work, critical that the information the arbs reveal to the market is credible – or else the longs will ignore it. We observe that the arbs in our sample argue their case by way of highly detailed reports which they post publicly and for free.  Compared to reports published by sell-side equity analysts at investment banks, which have a tendency to be bothoptimistic and biased.”

The study contributes to the “growing literature on the role of short sellers in producing and transmitting information in capital markets. There is little prior evidence on what short sellers know and how they acquire information. Our unique data allow us to observe the information discovery process at the level of individual information producers and to study how the information the arbs discover is then incorporated in security prices.”

The study found the short seller arbitrageur evidence ‘illustrates why financial markets need short sellers to function well. While some short sellers may indeed be speculators who do little more than destabilize share prices, as is often alleged, the short sellers in our sample are information producers who help correct mispricing and thereby help make markets more efficient. This is all the more remarkable given that many targets in our sample were held by highly sophisticated investors who apparently did not spot the overvaluation until it was too late.”

The study is available at http://www.nber.org/papers/w19834 

Book Club for The Intelligent Investor; Can a Company Have Too Much Debt? Free Courses

POWER OFF

Book Club for Value Investors (Discussion) http://www.moderngraham.com/

Graham & Doddsville – Issue 20 – Winter 2014

Can a Firm Have Too Much Debt

1988a_bpea_bernanke_campbell_friedman_summers

Is There Too Much Corporate Debt_Bernankie 1988

The above papers were written during the LBO craze of the late 1980s which, in turn, was driven by the all-time low in asset values of the early 1980s.

Liquidation and Debt Capacity   Worth a read!

Free Course with Yale’s Schiller on Financial Markets and Risk:

https://class.coursera.org/financialmarkets-001

Argument Clinic

The History of Trading in the Pits; Much More

Trading Pits

The successful investor is a master of paradox. He expects the unexpected, distrusts the experts and loves what the majority hates. He believes that, in markets as in heaven, the first shall be last and the last shall be first.

There’s fool’s gold–pyrite–and then there’s fools’ gold owned by idiots who will trade it for worthless dollars.

History of the trading pits: http://www.tradingpitblog.com/ Great blog!

What is money? What is money_ TTMYGH_17_Feb_2014

Assessing Long-Term Account Performance

http://www.tocquevillefunds.com/insights/secular-lessons

Hard wired for bubbles (Dan Ariely)

http://www.peakprosperity.com/podcast/84804/dan-ariely-why-humans-hard-wired-create-asset-bubbles?

Thinking properly about “cash sitting on the sidelines.” Or how to think properly. http://www.acting-man.com/?p=28594

Rick Rule on Gold Miners and Gold (Of course, when you ask a barber if you need a haircut…..But, he has a lot of experience in these markets.  Survival is proof enough of competence in the miners!

AUDIOhttp://kingworldnews.com/kingworldnews/Broadcast/Entries/2014/2/16_Rick_Rule_files/Rick%20Rule%202%3A16%3A2014.mp3

Rick Rule: We’ve said on your interviews, ‘You’ve suffered through the pain, why not hang around for the gain?’  I think we’re in the beginning of the gain session.  Your readers and listeners, at least those who are new to the sector, need to understand that we are in a rising channel, but we are in a rising channel that is going to have higher highs and higher lows….

It’s going to be volatile.  You are going to see 15% declines, and you are going to see 20% gains for seemingly no reason.  The important thing to note is that I certainly believe the precious metals sector and the precious metals shares have bottomed and they are moving up.

We’re tempted to say that the bottom was reached and the recovery in the junior shares began in July of last year.  Certainly, November, December, and January have seen pretty good rises — 40% share price escalations have not been uncommon.

It is not uncommon for well-constructed portfolios in a precious metals market recovery to experience five-fold or ten-fold gains.  So for those people who went through the downturn and are now beginning to experience the upturn, firstly, congratulations.  And second, keep your seatbelt on.  It’s going to be very volatile but I think we are higher, probably substantially higher from here.” 

 

Eric King:  “William Kaye, the outspoken hedge fund manager from Hong Kong, was telling King World News that demand (for gold) out of China is just ‘insatiable.’  Your thoughts on the physical demand we’ve seen around the globe — it’s been quite stunning.”

Rule:  “He would know better than I with regard to Hong Kong demand, but certainly we’ve seen very strong physical demand from around the world.  A lot of the physical demand has taken place right here in the United States.

What’s interesting about his (Kaye’s) statement is the dichotomy between the private physical markets and the long-term markets.  I can’t help going back to an announcement about 12 months ago, when the Germans wanted to repatriate their 1,500 tons of gold, and they were told by the US government that it would take seven years (to get back only 300 tons of gold) that was theirs.

At the same time, over 30 days, in the physical market, Chinese retail buyers bought and took delivery of 1,120 tons of gold.  One of the things that this points out is the very, very odd dichotomy between central bank and multilateral institutional holdings of gold, and the paper gold market on one side, and the honesty of the physical market on the other side.  

My suspicion is that the physical market is prevailing and will continue to prevail over the paper market.  And the subtext of this is that the documented large (gold) short positions that exist in the paper market may get their long awaited religious experience as they are unable to deliver against futures obligations.”

from www.kingworldnews.com

Seth Klarman on investing vs speculating:

Mark Twain said that there are two times in a man’s life when he should not speculate: when he can’t afford it and when he can. Because this is so, understanding the difference between investment and speculation is the first step in achieving investment success.

To investors stocks represent fractional ownership of underlying businesses and bonds are loans to those businesses. Investors make buy and sell decisions on the basis of the current prices of securities compared with the perceived values of those securities. They transact when they think they know something that others don’t know, don’t care about, or prefer to ignore. They buy securities that appear to offer attractive return for the risk incurred and sell when the return no longer justifies the risk.

Investors believe that over the long run security prices tend to reflect fundamental developments involving the underlying businesses. Investors in a stock thus expect to profit in at least one of three possible ways: from free cash flow generated by the underlying business, which eventually will be reflected in a higher share price or distributed as dividends; from an increase in the multiple that investors are willing to pay for the underlying business as reflected in a higher share price; or by a narrowing of the gap between share price and underlying business value.

Speculators, by contrast, buy and sell securities based on whether they believe those securities will next rise or fall in price. Their judgment regarding future price movements is based, not on fundamentals, but on a prediction of the behavior of others. They regard securities as pieces of paper to be swapped back and forth and are generally ignorant of or indifferent to investment fundamentals. They buy securities because they “act” well and sell when they don’t. Indeed, even if it were certain that the world would end tomorrow, it is likely that some speculators would continue to trade securities based on what they thought the market would do today.

Speculators are obsessed with predicting – guessing – the direction of stock prices. Every morning on cable television, every afternoon on the stock market report, every weekend in Barron’s, every week in dozens of market newsletters, and whenever businesspeople get together, there is rampant conjecture on where the market is heading. Many speculators attempt to predict the market direction by using technical analysis – past stock price fluctuations – as a guide. Technical analysis is based on the presumption that past share price meanderings, rather than underlying business value, hold the key to future stock prices. In reality, no one knows what the market will do; trying to predict it is a waste of time, and investing based upon that prediction is a speculative undertaking.

Market participants do not wear badges that identify them as investors or speculators. It is sometimes difficult to tell the two apart without studying their behavior at length. Examining what they own is not a giveaway, for any security can be owned by investors, speculators, or both. Indeed, many “investment professionals” actually perform as speculators much of the time because of the way they define their mission, pursuing short-term trading profits from predictions of market fluctuations rather than long-term investment profits based on business fundamentals. As we shall see, investors have a reasonable chance of achieving long-term investment success; speculators, by contrast, are likely to lose money over time. www.shortsideoflong.com

Pump and Dump — Being Dumped Now (OMEX)

Big Chart OMEX

 

Read the financials: SEC-OMEX-1193125-13-326785  Who in their right mind would own this? Next, a detailed research report on the company (worth a read) omexreport.  Also, thanks to www.classicvalueinvestors.com

small omex

 

The company’s typical response:

November 1, 2013

Odyssey Marine Responds to Meson Capital “Short & Distort” Piece

TAMPA, Fla., Nov. 1, 2013 (GLOBE NEWSWIRE) — Yesterday afternoon, a commentary about Odyssey Marine Exploration, Inc. (Nasdaq:OMEX) was distributed by Ryan Morris of Meson Capital Partners LLC. The author never contacted the company for clarifications or answers to his questions. Had he done so, Odyssey would have pointed out factual errors, incomplete information and erroneous conclusions which are rebutted by Odyssey’s public filings and other publicly available information. Odyssey is confident its existing public disclosures are accurate in all material respects, and that the company has provided a clear and concise explanation of all material information about the company and its relationships with associated companies and individuals.

Odyssey’s management believes that it is in the best interest of our shareholders to remain focused on business rather than debating or responding to rumor and innuendo. However, due to the number of inquiries to the company, management felt it important to reaffirm and stand by the accuracy of all information which has been released by the company. It is also important for interested parties to carefully consider the statement the author made on the first page of his editorial attacking the company (emphasis added):

“You should assume that as of the publication date of our reports and research, Meson Capital Partners, LLC (possibly along with or through our members, partners, affiliates, employees, and/or consultants) along with our clients and/or investors has a short position in all stocks (and/or options, swaps, and other derivatives related to the stock) and bonds covered herein, and therefore stands to realize significant gains in the event that the price of either declines.”

The company believes this statement by the author, and the likelihood that this is part of an attempt to profit from a “short and distort” strategy, calls into question the motivation and intent behind the allegations as well as the timing of its release. Accordingly market authorities have been notified.  (CSInvesting: So any bullish research report from an author who owns stock should also be questioned.)

Next week Odyssey management plans to host a conference call to discuss corporate developments and to address the false and misleading statements and innuendo in the Meson Capital piece. The call date and dial-in instructions will be issued in a press release early next week.   (This might be FUN to listen to–see website address below)

About Odyssey Marine Exploration

Odyssey Marine Exploration, Inc. (Nasdaq:OMEX) is engaged in deep-ocean exploration using innovative methods and state of-the-art technology for shipwreck projects and mineral exploration. For additional details, please visit www.odysseymarine.com. The company also maintains a Facebook page at http://www.facebook.com/OdysseyMarine and a Twitter feed @OdysseyMarine.For additional details on Odyssey Marine Exploration, please visit www.odysseymarine.com.

CONTACT: MEDIA CONTACT:

It is always good to refresh yourself on WHAT NOT to invest in.

Gift from Heaven: A Classic Guide to Special Situations Investing.

https://www.hightail.com/download/OGkOGNlYSs5RmJ2WnRVag

SPEC Sits

HAVE A HAPPY WEEKEND!

 

If you want more to study go here: http://aswathdamodaran.blogspot.com/

VACATION! Gold Mining Case Studies

SUMMER

Time has come to head to the beach because I might start to sell ALL my miners after a 20% to 80% rise from the depths of the five-year bear market.

It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight! It is no trick at all to be right on the market. You always find lots of early bulls in bull markets and early bears in bear markets. I’ve known many men who were right at exactly the right time, and began buying or selling stocks when prices were at the very level which should show the greatest profit. And their experience invariably matched mine–that is, they made no real money out of it. Men who can both be right and sit tight are uncommon. –Edwin Lefevre in Reminiscences of a Stock Operator

Case Studies

Why don’t YOU have a crack at valuing these companies? I will provide supporting materials.

Royal Gold (RGLD)

Royal Gold Chart

http://www.royalgold.com/investors/why-invest-in-royal-gold/default.aspx

Video: http://youtu.be/znx74K1-qVg

Streamers: RGLD_VL and SLW_VL

How to value a net smelter return: http://www.goldroyalties.ca/how_to_value_a_NSR_NPI_mining_royalty.php and http://www.frickcpa.com/tvom/TVOM_PV_SS.asp

http://www.theaureport.com/pub/na/precious-metal-royalties-the-new-landscape

http://seekingalpha.com/article/1341411-gold-and-silver-royalty-companies-part-1-the-pros-and-cons-of-royalty-companies

http://seekingalpha.com/article/1367241-gold-and-silver-royalty-companies-part-4-royal-gold-inc

http://seekingalpha.com/article/1532432-clash-of-the-gold-titans-royal-gold-vs-franco-nevada

Romarco Minerals, Inc. (RTRAF) A pre-production gold miner (Speculative)

RTRAF

Brent Cook https://www.explorationinsights.com/. See his work on Yukon Gold http://www.youtube.com/user/ExplorationInsights. View the three videos

http://youtu.be/qwZeJjXmN1A Brent Cook of Exploration Insights discusses junior miners.

Doug Casey:8202013casey (21-minute Audio/Excellent!) on searching for opportunity/miners. His book recommendations : Economics_in_one_lesson and Liberty: The Market for Liberty. His suggestion: Read widely and ask a lot of questions.

Handbooks on valuing mining equities: book_excerpt Invest in Gold and Silver and GSA_2012_User_Guide and Profiting from the Dismal State of Gold miners and Explorers

RTRAF Excerpt: There is another company that I like, but it’s not in production yet. Romarco Minerals Inc. (R:TSX) doesn’t have a full permit, but I feel strongly that it will be able to get permitted. The mine is going to have about 91 million tons of ore at 1.6 grams per ton for a total of 4.8 Moz gold. You are essentially buying this thing for $50/oz at the current trading price of $0.39/share. I believe Romarco will get up and running, because its management knows a lot of large institutional shareholders who would be willing and able to front them some more cash. I believe the Haile project in South Carolina will be a mine in a couple of years.

TGR: How does that $50/oz compare to its peers?

HI: They range from $40/oz to almost $120/oz. It is definitely in the lower range, and it should be because it doesn’t have a permit. It is not as derisked as a producing mine.

TGR: How likely are those permits to come within the next year?

HI: If you asked me that question a year ago, I would have said about 75%. Today, I am going to give you the same answer. There is a very decent chance that the permits are going to come reasonably soon. The permitting process, especially in South Carolina where there are no real mines, is not easy. The company has to have constant discussions with the U.S. Army Corps of Engineers. Romarco claims to be making progress. I am inclined to believe that, but these things always take a lot longer than you would like.

TGR: Meanwhile, Romarco has increased its resource and it has brought in more experienced personnel. What institutional support does it have?

HI: Van Eck Global, BlackRock, Baker Steel Capital Managers, Oppenheimer & Co., Tocqueville Asset Management and so on, the usual suspects. Seventy percent of shares are institutionally owned. Those firms haven’t owned this and watched the stock sink in order to throw in the towel when it actually comes time to build a mine.

TGR: Can this management team get the permitting done?

HI: Yes, it should be able to do it.

Read more: http://seekingalpha.com/instablog/399928-the-gold-report/2024862-somethings-got-to-give-in-the-precious-metals-market-heiko-ihle

Romarco Minerals: http://www.romarco.com/Investors/default.aspx

Instructions: You have two ends of the investing spectrum: A major royalty company and a pre-production mining company–though not a pick and shovel exploration company.

Try to come up with reasonable values. If you can’t, pass. I will present my thoughts upon my return next week.

HAVE A GREAT WEEK/WEEKEND.

Search for Panic/Capitulation: Hui-Gold Index at 16.8

gold miners

Just as I seek panic and capitulation as a place to find value among the carnage, the Colonel loves the smell of napalm.

Geico Case Study; Klarman Sees Collapse

TALK SHOW SHEEP

As David Ricardo, a successful speculator who, in his early retirement, became one of the finest economists of the early nineteenth century, explained in 1817:

It has been my endeavor carefully to distinguish between a low value of money and a high value of corn, or any other commodity with which money may be compared. These have been generally considered as meaning the same thing; but it is evident that when corn rises from five to ten shillings a bushel, it may be owing either to a fall in the value of money or to a rise in the value of corn…..

The effects resulting from a high price of corn when  produced by the rise in the value of corn, and when cause by a fall in the value of money, are totally different. 

GEICO CASE STUDY

You can never read enough about a great business and the importance of HOLDING ON to reap the benefits of growth.  If you can combine patience with the knowledge of understanding the moat of a great business, then you will have an outstanding investment career.

Geico Case Study and  wedgewood partners second quarter 2013 client letter

Klarman’s Speech (Thanks to a reader)

His latest speech also includes a distinct tone of regret over where the current state of affairs is taking the U.S. He sounds positively saddened by how things are run in his country. In Klarman’s words:

“Like all of you, I am worried about our future, I am concerned about the prospect for upcoming generations to have the same opportunities that ours did, and I’m saddened that our generation was handed something unique, the stewardship of the greatest country in the history of the world– and we are far down the path of making it less great.”

Klarman Slams Myth Of Efficient Markets

Klarman said that the idea that financial markets are efficient is foolish, and he goes on to describe how that will always remain the case. Markets are governed by human emotions and they do not follow laws of physics—prices will unpredictably overshoot, therefore the academic concept of market efficiency is highly incorrect.

“Academics are deliberately blind to the fifty plus year track record of Warren Buffett as well as those of other accomplished investors, for if markets are efficient, how can Warren Buffett’s astonishing success possibly explained?”

In his speech Klarman mentioned value-investor Ben Graham’s explanation of markets, where he says that Mr. Market is to be perceived as an eccentric counter-party which should be taken advantage of, but one should not follow its emotional advice. He also agrees with Ben Graham’s idea that assets should be bought at a significant discount to keep your margin of safety.

“As when you build a bridge that can hold 30 trucks but only drive 10 trucks across it, you would never want your investment fortunes to be dependent upon everything going perfectly, every assumption proving accurate, every break going your way.”

Klarman said that the current economy is being built like a house of cards that will implode. Huge deficits, empty government promises, pretty pictures painted to ease voters and reliance on external markets to keep your currency afloat, have all disrupted the margin of safety in U.S. economy.

Klarman Encourages Going Against The Grain

He says that investors have become increasingly speculative and subject themselves to frenetic trading, even the holding period of 30-yr treasuries has fallen down to a mere couple of months. Investors increasingly rely on technology to judge their performance not merely on a monthly or quarterly basis—it has now become an hourly practice.

“The performance pressure drives investors to into an absurdly short-term orientation…. If your track record is going to be considered by investment committees every quarter, if you are going to lose clients and possibly your job because of poor short term performance, then the long term becomes almost completely irrelevant.”

Read more: http://www.valuewalk.com/2013/07/klarman-economy-house-of-cards/

The Research Process Part 2

Guitine

We discussed the research process in Part 1: http://wp.me/p2OaYY-22A

Research Process Part 2

Your research process is obviously part of your investment philosophy (search, value, portfolio management, risk and you). If you are buying a non-franchise then you must buy assets cheaply since growth won’t increase intrinsic value. Or another way of approaching the problem: time is not on your side. You are dependant upon the market closing the gap between price and value. When investing in a franchise you face the difficulty in accessing the company’s sustainability of competitive advantage and how much should you pay for future growth. Hint: Not much.

You will have to spend many weeks studying your first few companies and industries to practice finding answers to your questions while learning to be an efficient reader of annual reports and proxies.  As you gain experience, you can make better assessments.  For example, say you study the title insurance business or the funeral business.  The title insurance business shows tremendous stability in return on assets but no better than normal profitability. Only one national insurance company went bankrupt in over 100 years (in 2008).  So you can have a high degree of confidence in buying below asset value that those assets will not deteriorate. But why can’t the businesses grow much or develop higher profitability? Most of the value in a title transaction comes from the originator of that transaction—the real estate broker.   Title insurance is like a local monopoly. The same goes for the funeral business.  You will notice unique aspects to various industries as you cast your net widely.

Buffett’s advice:

The Story of Warren Buffett from Of Permanent Value by Andrew Kilpatrick

Buffett rarely gets ideas from talking with other people. He gets them alone by reading and thinking. Maybe Edward Gibbon had it right: “Conversation enriches the understanding, but solitude is the school of genius.”

 How to make money 

Once Bob Woodward asked Buffett a good way to make more money and Buffett suggested investing. Woodward told Buffett, “I don’t know anything about investing.”  “Yes, you do.” Buffett said, “All it is, is investigative reporting.”

Buffett told Woodward: “Investing is reporting. I told him to imagine an in-depth article about his own paper.  He’d ask a lot of questions and dig up a lot of facts. He knows The Washington Post. And that is all there is to it.”

Buffett continues, “Bob, why don’t you assign yourself a story, get up an hour early every morning and work on a story you have assigned yourself. Now a sensible story to assign yourself would be what is the WPO worth?  Now, if Ben Bradlee gave you that story to work on what would you do for the next week or two? You would go around and talk to people (in the television business). You would try to figure out what the key variables in valuing a TV station and you would look at the four that the Post has and apply those standards to that. You would do the same thing to newspapers. You would try to figure out how the competitive battle between the Star and the Post is going to come out and how much different the world would be if the Post won that war.  All of these things are a lot easier than the problems Woodward would usually be working on. Usually people would want to talk to him but on this subject they would be glad to talk to him and then I said when you get all through with that, add it up and divide by the number of shares outstanding. All he had to do was assign himself the right story, and I assign myself stories from time to time.”

More tips

Munger: “I think both Warren and I learn more  from the great business magazines than we do anywhere else…..I don’t think you can really be a really good investor over a broad range without doing a massive amount of reading.”

Buffett replied, “You might think about picking out 5 or 10 companies where you feel quite familiar with their products, but not necessarily so familiar with their financials…Then get lots of annual reports and all of the articles that have been written on those companies for 5 or 10 years…Just sort of immerse yourself.

“And when you get all through, ask yourself, ‘What do I know that I need to know?’  Many years ago, I would go around and talk to competitors where you feel quite familiar with their products, but not necessarily so familiar with their financials…Then get lots of annual reports and all of the articles that have been written on those companies for 5 or 10 years…Just sort of immerse yourself.

Search Strategy

Most mis-priced stocks tend to fall into two categories: Either they’re well-known but hated, or obscure and unknown.   Warren Buffett seems to agree.  At the Berkshire 1999 annual meeting, he said: “If I had $100,000 to invest, I would probably focus on smaller companies because there would be a greater chance that something was overlooked in that arena.”

“If you gave me a million dollars of capital to manage, I would pretty much almost guarantee that I will make 50% a year.  I think the reason he makes that statement is he would just make 100 percent doing special situations.

Question: According to a business week report published in 1999, you were quoted as saying “it’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.” First, would you say the same thing today? Second, since that statement infers that you would invest in smaller companies, other than investing in small-caps, what else would you do differently?

Yes, I would still say the same thing today. In fact, we are still earning those types of returns on some of our smaller investments. The best decade was the 1950s; I was earning 50% plus returns with small amounts of capital. I could do the same thing today with smaller amounts. It would perhaps even be easier to make that much money in today’s environment because information is easier to access.

You have to turn over a lot of rocks to find those little anomalies. You have to find the companies that are off the map – way off the map. You may find local companies that have nothing wrong with them at all. A company that I found, Western Insurance Securities, was trading for $3/share when it was earning $20/share!! I tried to buy up as much of it as possible. No one will tell you about these businesses. You have to find them.

Other examples: Genesee Valley Gas, public utility trading at a P/E of 2, GEICO, Union Street Railway of New Bedford selling at $30 when $100/share is sitting in cash, high yield position in 2002. No one will tell you about these ideas, you have to find them.

The answer is still yes today that you can still earn extraordinary returns on smaller amounts of capital. For example, I wouldn’t have had to buy issue after issue of different high yield bonds. Having a lot of money to invest forced Berkshire to buy those that were less attractive. With less capital, I could have put all my money into the most attractive issues and really creamed it.

I know more about business and investing today, but my returns have continued to decline since the 50′s. Money gets to be an anchor on performance. At Berkshire’s size, there would be no more than 200 common stocks in the world that we could invest in if we were running a mutual fund or some other kind of investment business.

Special Situations:

I am going to buy a dollar for 50 cents, and when it gets appraised at a dollar or 90 cents, I’m going to get rid of it.”  Now your returns are simply a function of how long it takes to get to convergence.  If you bought a dollar for 50 cents and sold it for a dollar and convergence took one year, you would generate a hundred percent return.  If convergence took two years, you would generate a 376% return.  If convergence took three years, you would generate a 26% return, and if convergence took four years, you would generate an 18 percent return.  So up to four years of convergence beats buy and hold.  This very simple math became obvious, and the fact is that buying great businesses is all good because you have a few more tax efficiencies and all of that.  But really the pop in terms of getting better returns on assets is first of all to sell fully priced—or nearly fully priced—assets, whether they’re special situation or net/nets and then go back and buy at 50 cents on the dollar.

To find special situations:

Let the game come to you.  You do nothing, just read and think, and occasionally, you read the paper and you will see something.

You are looking for market anomalies.  Whenever there is extreme fear in some sector, or whenever there is some big clouds over some companies, you are likely to get mis-pricing.  The question is, “Am I able to see through the clouds, and do I know the business well enough to be able to see beyond the temporary negativity of an industry or company and see what the value of the business is versus the price at which it’s being offered, and if it is enough of a delta, step in?”

The primary driver for buying the business was an ultra-cheap price and a huge discount to what it was worth.

Add your thoughts………….?