Category Archives: Uncategorized

Can the Piotroski F Score Improve Your Investment Strategy?

Bar

We will be looking at accounting metrics to screen out value traps, so I thought some may wish to read: Can-the-piotroski-f-score-also-improve-your-investment-strategy

As an example, if you want to invest with more (RELATIVE) safety in the cyclical oil service business, you would want a company like this: RPC Inc (RES)

Note balance sheet and good operating metrics.  It doesn’t mean that RPC, Inc. can’t go materially lower in price, just that the company has a high probability of surviving through this down cycle compared to competitors.

 Market Psychology

Silver-to-$60 (video during 2011 Silver Mania)

Dollar to Euro Parity (video during 2015 Dollar Mania/Panic)

Beware of “experts.”

Lesson 4: The Acquirer’s Multiple

End nearWhat happens if you get scared half to death twice?  –S. Wright

We were unable to discover any ‘magic’ qualities associated with stocks selling below liquidation value. — Joel Greenblatt (How the Small Investor Can Beat the Market)

Enterprise Multiple = Earnings before interest, taxes, and depreciation & amortization, (“EBITDA”) divided by Enterprise Value (“EV”).

We need to understand the use of EBITDA, Why we must use EV, and the requirement to use pre-tax owner’s earnings or EBITDA – maintenance capex (“MCX”).

Placing EBITDA into Perspective (from the prior post) Suggested reading

EV The Price of a Business  Understanding and calculating EV. Suggested reading

Beginning lesson on Enterprise Value for beginners (Video, Khan Academy)

Pop Quiz: Why do you include minority interests with EV?

Why you use Enterprise Value (Review)

Minority Interests (Review)

Chapter 9 EV Multiples  Only if you dare. Heavy reading. Voluntary.

Let’s tackle really grasping the use of EV, EBITDA, and EBITDA – MCX

I will also send out the Little Book via email as supplementary reading for this chapter.

Good luck.

Enron Case Study Analysis. Ask Why? Why?

Enron3

Case-Study-So-What-is-It-Worth    Prior Post where students discussed the case.

Turn up the VOLUME: Don’t believe the …..?

Enron-Case-Study-So-What-is-It-Worth  My walk-through. I go straight to the balance sheet then calculate the returns on total capital in the business. These financial statements were easy to discard because of the size of the business and the poor returns. My estimate of $5 to $7 per share worth or 90% less than the current share price, was wrong. The company was worth $0.  This is more a case of institutional imperative and incentive-based bias. Wall Street was feeding at the financial trough to keep raising money for Enron (to keep the bad businesses afloat) so guess what the financial analysts (CFAs and MBAs) suggested? Buy!   I guess the market is not ALWAYS efficient.

Forget accounting scandals, this was a crappy business based on trading so no way to determine normalized earnings.   When I was in Brazil and saw Enron’s newly-built generating plant sitting idle, I asked why.   A project developer said he got paid by doing deals by their size not profitability, therefore, the bigger the white elephant, the better.  When I called mutual funds who owned Enron as it was trading $77 per share to ask the analyst if he/she was aware of Enron’s declining businesses coupled with absurd price, I was told to shut up. As one analyst (Morgan Stanley?) told me, “I only believe what I want to believe and disregard the rest.”

Enron Annual Report 2000  Ha, ha! and Is Enron Overpriced?

The above august panel never answered why anyone would give capital to Enron?  No one mentions the elephant in the room.  Sad.

What does the above case have to do with net/nets and our course. Everything! Look at the numbers, think for thyself, ignore Wall Street, and be aware of incentives.   Buying bad businesses at premium prices is a guarantee of financial death.

This is an aside, but based on the above Enron example, does value investing serve a SOCIAL purpose or benefit? Prof. Greenblatt doesn’t think so–you are just trading pieces of paper, but what do YOU think?

See these two venture capitalists explain the social purpose of their business:

Cigar Butt Investing. Graham and Buffett Discuss

cigarette
h

















We will discuss Sanborn Map (more of an asset investment) and
See's Candies (a franchise) next. As a supplement to Chapter 3
in Deep Value, you have the early Buffett Partnership Letters 
and the Essays of Warren Buffett.  You have a business and
investing education right there. Let's look closer at Buffett's
discussion of "Cigar-butt" investing. Since Buffett wrote this
letter in 1989, has he ever gone back to deep value investing?
Imagine Ben Graham reading this passage. What would he say to
Warren?   

What Would Warren Buffett Suggest to a New Investor Starting
Today: Buffett - Student Discussion of Investment Style
Thanks to a student contribution!

http://www.berkshirehathaway.com/letters/1989.html

Mistakes of the First Twenty-five Years (A Condensed Version)

     To quote Robert Benchley, "Having a dog teaches a boy 
fidelity, perseverance, and to turn around three times before 
lying down." Such are the shortcomings of experience. 
Nevertheless, it's a good idea to review past mistakes before 
committing new ones. So let's take a quick look at the last 25 
years.

o     My first mistake, of course, was in buying control of 
Berkshire. Though I knew its business - textile manufacturing - 
to be unpromising, I was enticed to buy because the price looked 
cheap. Stock purchases of that kind had proved reasonably 
rewarding in my early years, though by the time Berkshire came 
along in 1965 I was becoming aware that the strategy was not 
ideal.

     If you buy a stock at a sufficiently low price, there will 
usually be some hiccup in the fortunes of the business that gives 
you a chance to unload at a decent profit, even though the long-
term performance of the business may be terrible. I call this the 
"cigar butt" approach to investing. A cigar butt found on the 
street that has only one puff left in it may not offer much of a 
smoke, but the "bargain purchase" will make that puff all profit.

     Unless you are a liquidator, that kind of approach to buying 
businesses is foolish. First, the original "bargain" price 
probably will not turn out to be such a steal after all. In a 
difficult business, no sooner is one problem solved than another 
surfaces -  never is there just one cockroach in the kitchen. 
Second, any initial advantage you secure will be quickly eroded 
by the low return that the business earns. For example, if you 
buy a business for $8 million that can be sold or liquidated for 
$10 million and promptly take either course, you can realize a 
high return. But the investment will disappoint if the business 
is sold for $10 million in ten years and in the interim has 
annually earned and distributed only a few percent on cost. Time 
is the friend of the wonderful business, the enemy of the 
mediocre.

     You might think this principle is obvious, but I had to 
learn it the hard way - in fact, I had to learn it several times 
over. Shortly after purchasing Berkshire, I acquired a Baltimore 
department store, Hochschild Kohn, buying through a company 
called Diversified Retailing that later merged with Berkshire. I 
bought at a substantial discount from book value, the people were 
first-class, and the deal included some extras - unrecorded real 
estate values and a significant LIFO inventory cushion. How could 
I miss? So-o-o - three years later I was lucky to sell the 
business for about what I had paid. After ending our corporate 
marriage to Hochschild Kohn, I had memories like those of the 
husband in the country song, "My Wife Ran Away With My Best 
Friend and I Still Miss Him a Lot."

     I could give you other personal examples of "bargain-
purchase" folly but I'm sure you get the picture:  It's far 
better to buy a wonderful company at a fair price than a fair 
company at a wonderful price. Charlie understood this early; I 
was a slow learner. But now, when buying companies or common 
stocks, we look for first-class businesses accompanied by first-
class managements.

o     That leads right into a related lesson: Good jockeys will 
do well on good horses, but not on broken-down nags. Both 
Berkshire's textile business and Hochschild, Kohn had able and 
honest people running them. The same managers employed in a 
business with good economic characteristics would have achieved 
fine records. But they were never going to make any progress 
while running in quicksand. 

     I've said many times that when a management with a 
reputation for brilliance tackles a business with a reputation 
for bad economics, it is the reputation of the business that 
remains intact. I just wish I hadn't been so energetic in 
creating examples. My behavior has matched that admitted by  Mae 
West: "I was Snow White, but I drifted."

o     A further related lesson: Easy does it. After 25 years of 
buying and supervising a great variety of businesses, Charlie and 
I have not learned how to solve difficult business problems. What 
we have learned is to avoid them. To the extent we have been 
successful, it is because we concentrated on identifying one-foot 
hurdles that we could step over rather than because we acquired 
any ability to clear seven-footers.

     The finding may seem unfair, but in both business and 
investments it is usually far more profitable to simply stick 
with the easy and obvious than it is to resolve the difficult. On 
occasion, tough problems must be tackled as was the case when we 
started our Sunday paper in Buffalo. In other instances, a great 
investment opportunity occurs when a marvelous business 
encounters a one-time huge, but solvable, problem as was the case 
many years back at both American Express and GEICO. Overall, 
however, we've done better by avoiding dragons than by slaying them.

Subjective Value:

http://www.learnliberty.org/videos/subjective-value/

Deep Value Course Materials (Updated)

cattle drive

 

Course Materials Have Been Updated Here:

https://www.hightail.com/download/UlRRN3RVdGp0TWx1a3NUQw

Read chapter 3 in DEEP VALUE and Dempster Mills Case Study (Buffett)

Have a good weekend.   

Course Review/Index to Date

Revolutionaries

Course Review

Our goals in this course are to learn about investing, especially deep value investing through the book, DEEP VALUE  by Toby Carlisle and supplemented by Quantitative Value by Toby Carlisle.  Also, many original source readings will be provided to clarify and deepen our understanding of the primary readings. Also, we wish to be skeptical, independent thinkers who prove to ourselves what works and makes sense.   We will be open to disconfirming evidence.  We will question and help each other learn.

Below are the links in chronological order. The REQUIRED readings are in BOLD. Everything else is supplementary, but I hope you dig even deeper into the concepts and ideas.

  1. Toby Carlisle talk on DEEP VALUE Investing at Google (This was a preview/introduction to the course)
  2. Introduction to the course and book DEEP VALUE
  3. Lesson 1 Read PREFACE in Deep Value, Margin of Safety chapter in Intelligent Investor, Mr. Market and Behavioral Investing The first REQUIRED readings (Preface in Deep Value book (required), then supplemented by the other three readings.
  4. Lesson 1 Emergency Crash Landing The purpose of this post was to show the element of character, temperament, and training to maintain a process in the face of extreme stress. Investing is more about discipline and character to stay with the right process than IQ.
  5. Announcement that Margin of Safety by Klarman was emailed to participants
  6. Announcement that Value Investing by Montier was sent out as a supplement reading
  7. Rodney Dangerfield Video about Questioning Traditional Concepts, Deep Value Author Lectures
  8. Review of readings, a video of a deep value and activist investor valuing a company and an activist in action from Other People’s Money Munsingwear Case Study provided to test students’ ability to approach a business problem.
  9. An example of paying a huge premium for net asset value or What NOT to do as an investor
  10. Major Reading Assignments, Chapter 2 in DEEP VALUE book, Graham and Net/nets, liquidation value The institutional imperative was introduced. As deep value investors we feast on the errors of others due to cognitive biases or the institutional imperative (We can’t hold this poor performing stock because what would the client think?) I emailed out the books Security Analysis and Intelligent Investor to all in the course.
  11. Hannibal Lecter lecture on how to do the readings-Simplicity Try to focus on the main points and how you can apply them. Humor 
  12. How to join Deep-Value group at Google I ask enrollees to join to make communication easier.
  13. Videos on search and Net/Net Investing. This post supplements your reading in Chapter 2, DEEP VALUE
  14. Munsingwear Case Study Analysis See #8 above.
  15. Supplementary Original Source Documents for Chapter 2 DEEP VALUE See #10 above. Net/Net research and Graham’s testimony to Congress, Liquidation of American Businesses in 1932—Are Companies Worth More Dead Than Alive by Graham.
  16. httpAnalysis of Liquidation Valuation from Klarman’s Margin of Safety book in Chapter 8 (Valuation) Supplement to Chapter 2 in DEEP VALUE
  17. Supplementary Readings: Buffett Partnership Letters and King Icahn emailed. Next reading assignment will be Chapter 3 in Deep Value book.

OK, so after the chaos of postings and all the videos, you SHOULD have read:

The Preface and Chapter 2 in Deep Value by Tobias Carlisle (primarily supplemented by Chapters 1 & 2 in Quantitative Value).  That’s it! All the other material is simply if you wish to go further or want greater understanding and reinforcement.  For example, a student asked me what cost of capital would I use to discount the royalty earnings in the Munsingwear case study.  If you dug into Margin of Safety by Seth Klarman, he would say to use your required rate of return.  Try to find the answers from the investing greats and then determine if it makes sense to you.  You should answer for yourself whether the returns to net/nets are due to higher risk or behavioral biases of other investors. Pose questions in the comment section of the blog if you have thoughts or other ideas.

You should after those readings have an understanding of why net/net investing generates superior performance. The returns are generated by the behavioral flaws of other investors. We should understand the concepts of Mr. Market and Margin of Safety.  Investing is simple but not easy. Often temperament trumps IQ.

Next to read will be Chapter 3 in Deep Value. 

There will be a review of the readings in another post. Our goal is to move DEEPLY and slowly through the readings. If you will notice all the other supplementary readings like Seth Klarman’s Margin of Safety, the Intelligent Investor, the SSRN research are from the footnotes of DEEP VALUE or Quantitative Value.

At the end of the week I will send out a zipped folder containing the books and materials collected for this course.  Relax and don’t panic if you don’t have a book. I will email the folder to everyone in the Deep-Value group at Google.

I am sorry for the confusion, and I will strive to clarify.

 

DEEP VALUE Supplementary Readings for Ch. 2, Deep Value

Pope

Below are supplementary readings and original sources for Chapter 2, Contrarians at the Gate, in Deep Value. This is an important chapter because we are introduced to the father of security analysis. He was the first person to systematize his analysis and separate the price of a security from its intrinsic value.

I realize that some may find Graham fusty and his prose turgid/boring, but Graham was a Renaissance man who had a razor-sharp intellect and integrity.  You can’t lose by reading his works.  Note his attitude, skepticism, and logic.

So far in the course I am surprised by the ironies and subtleties of Deep Value investing–picked up in the preface of the book, Deep Value.  Our Deep Value Group has close to 400 members, yet, currently (Jan. 17, 2015), the number of net/nets in the US market is negligible.  Financial assets (with a few exceptions) are sky-high in valuation due to Central Bank intervention, negative interest rates, and a six-year upward trend in US bonds and stocks.  I am surprised at the interest.

We invest today for the future, but the future is unknowable. Look at the predictive record of experts!  Investors tend to extrapolate the past into the future just in time for a reversal of fortune–reversion to the mean reverses the trend.

Deep value investing takes advantages of the cognitive biases of others to gain profits, but if we are human too then how do we avoid the same?  Cheapness or the discount from intrinsic value is the main determinant of margin of safety. The cheaper you buy the less risk and MORE reward. This smashes academic finance theory in the face.

Here I am quite surprised that the highest returns to the net/net strategy go to the MONEY-LOSING companies. The worst of the ugly gain the most. Perhaps because price drops the most due to fear and earnings trend extrapolation.  Like assuming the driver of the car will continue to motor off the cliff instead of turning or stopping the car.

A TEST: Let’s say a company earned $5 per share and it is growing at 5% per year, the cost of capital is 10%, and it is trading at $85 per share. Then the next year earnings drop to $1 per share and the following year earnings drop to $0.05 or five cents, the next year earnings go up to $3 and in the fifth year back to $5.25 and 5% growth. After ten years the company will continue to grow but only at 3%.  Guess the price drop quickly and write it down.  Now do the DCF and see where the intrinsic value is compared to your guess.

Last year $5.00

Year 1 $5.25

Year 2: $1.00

Year 3: $0.05

Year 4: $3.00

Year 5: $5.25

Year 6: $5.51 (5% growth)

…. next year, next year, etc.

After year 10, then terminal value 10% cost of capital with 3% perpetual growth. Can a financial wizard post in the comments section?  Was anyone surprised by your initial reaction the Intrinsic value result vs. their initial thoughts on how price would react?

Back to the post….

The higher probability (Montier, 5%) for each INDIVIDUAL company to go down 90% or more vs. 2% of non net/nets may cause other investors to shy away from investing. HOWEVER, the GROUP of net/nets STILL outperforms.   You have certain companies go to zero and some rebound multiple times but you don’t know which ones.  You have to deal with much uncertainty but believe you are playing the odds like an insurance company.

When net/nets are abundant like in 1932, the world appears to be ending. Investor fear is off the charts. The question is whether you will have the capital to buy and the courage to act. Again we come round and round to temperament or character or whatever you want to call acting in the face massive fear.

But knowing that a company is too cheap when it trades at less than 2/3rds to net asset value (Asset value is tenuous, liabilities are 100 cents on the dollar) does not seem difficult, but probably the surrounding circumstances for the company and/or market are ugly! “Don’t you read the papers!” an outsider might say if he or she learned of your purchase.

Remember 2009? Jim Cramer in a panic. http://youtu.be/rOVXh4xM-Ww?t=1m35s   (just paste into your browser)

Those are my thoughts and questions so far as I keep reading.

Graham’s Writings and Testimony

Graham Testimony to Congress (note his remarks on the MYSTERY of price eventually closing the gap with intrinsic value)

Important writings on Liquidation Values during the 1930s

1932_American Corporations Worth More Dead than Alive 3 Parts by B Grahams  (Please read). You can’t understand the depths of despair in the financial markets (and thus the net/nets and prices below liquidation values) without understanding the preceding boom.

Historical perspective

A Study of Market History through Graham Babson Buffett and Others  The 1920s BOOM.

A Great Depression_Rothbard Obviously, you don’t have time to read this, but IF you do want to understand the causes of the biggest bear market in US history then this is the definitive work.  The book destroys the common wisdom that the depression was caused by the Fed’s tight monetary policy.

The Outperformance of Net/Nets

Net NEt Strategy in London

97001708-Case-for-Quantitative-Value-Eyquem-Global-Strategy-20120613

Benjamin-Graham-s-Net-Nets-Seventy-Five-Years-Old-and-Outperforming  I imagine that some net/nets are micro/nano-cap stocks under 50 million in market cap and with wide (5% to 10% bid/offer spreads) perhaps the studies do not deduct the spread?

There is a lot here so I will refrain from posting until the middle of the week. Take your time with Chapter 2.   I will be posting next on Klarman’s thoughts on liquidation and valuation.

Traditional finance savaged: The Dumbest Ideas in Finance_Montier

 How NOT to take this course

You don’t have to read EVERYTHING, but you do have a choice. Better to understand what you read.

Thinking Differently (Money Ball); Munsingwear Analysis

BREAKING BIASES



I HIGHLY recommend you go see Money Ball or read the book by Michael Lewis.  A metaphor for deep value investing.

Case Study – Munsingwear Analysis Q&A

Who earned their wingtips?  That case was about approaching the problem as a business person.  First you had to notice the two businesses, then break them out. Stop the bleeding, then leave the rest.  Often, the smartest students struggle to resurrect the uncompetitive business. (Buffett at Berkshire Hathaway!)

Next, I will post some questions and supplementary readings for Chapter Two in DEEP VALUE (the book) over the weekend.

Enjoy your Weekend!

Hannibal Lecter on How to Read Ben Graham

What is its nature?

220px-Antoninus_Pius_Glyptothek_Munich_337_cropped

Read Marcus_Aurelius, First principles,    S I M P L I C I T Y.

For each particular, what is it in itself? What is its nature?  Why does he kill? Because he covets!

In your Readings for Lesson 3: Graham’s Liquidations and Net/Nets think about principles not accounting conventions.  When is a current asset not current? Can a fixed asset be more current than a current asset on the balance sheet?

Finally, when you are looking at a balance sheet, always think of this

UPDATE:

Google only lets me send emails to 500 people in one day. There are 497 enrollees in the deep value course.   So I can only email by group. I will be sending out invites to all enrollees in DEEP VALUE

So consider joining or else you won’t receive emails. Email communication will typically be updated on the most recent blog post at www.csinvesting.org

We already have volunteers for Schloss, Tweedy Browne, Greenblatt, and Buffett. Thanks for the quick response.  No more volunteers for now. But I DO need a volunteer to date My Ex-Wife.

All Course Materials Sent via Hightail Link to Your Email

Once again, if you did not receive this link in your email, let me know at aldridge56@aol.com because it means that you are not enrolled and not on the distribution list.

UPDATE 12:40 PM:  It looks like my aol emails are not getting through. I will be using JAC007CSI@gmail.com instead to send you communications.   Use the link below instead of the email link I sent you IF you are asked for a password. Sorry. We are getting there. ALL course materials for now can be downloaded below.

from aldridge56@aol.com via Hightail.
DEEP VALUE COURSE.zip Download
Your file will expire on February 10, 2015 08:43 PST unless you Save to folders, then you will have online access anytime.
Save to Folders
If you Save to Folders you can use the Desktop App, Mobile App and iPad App to access your files from anywhere.