Category Archives: YOU

Mark Twain Falls for Silver Fever (A Study in Bubbles)

SilverStock_Certificate_1863

Silver FeverEvidence of bubbles has accelerated since the [2007-2009 financial] crisis.
~ Robert Shiller (“Irrational Exuberance,” 2015).The celebrated author and humorist Samuel Clemens (pen name Mark Twain) documented his experiences in the Nevada mining stock bubble, and his writings are one of the earliest (and certainly the most humorous) firsthand accounts of involvement in a speculative mania.

After a brief stint as a Confederate militiaman during the beginning of the U.S. Civil War, Clemens purchased stagecoach passage west, to Nevada, where his brother had been appointed Secretary of the Territory. In Nevada, Clemens began working as a reporter in Virginia City, in one of Nevada’s most productive silver- and gold-mining regions. He enviously watched prospecting parties departing into the wilderness, and he quickly became “smitten with the silver fever.”

Clemens and two friends soon went out in search of silver veins in the mountains. As Clemens tells it, they rapidly discovered and laid claim to a rich vein of silver called the Wide West mine. The night after they established their ownership, they were restless and unable to sleep, visited by fantasies of extravagant wealth: “No one can be so thoughtless as to suppose that we slept, that night. Higbie and I went to bed at midnight, but it was only to lie broad awake and think, dream, scheme.”

Clemens reported that in the excitement and confusion of the days following their discovery, he and his two partners failed to begin mining their claim. Under Nevada state law, a claim could be usurped if not worked within 10 days. As they scrambled, they didn’t start working, and they lost their claim to the mine.  His dreams of sudden wealth were momentarily set back.

But Clemens had a keen ear for rumors and new opportunities. Some prospectors who found rich ore veins were selling stock in New York City to raise capital for mining operations. In 1863, Clemens accumulated stocks in several such silver mines, sometimes as payment for working as a journalist. In order to lock in his anticipated gains from the stocks, he made a plan to sell his silver shares either when they reached $100,000 in total value or when Nevada voters approved a state constitution (which he thought would erode their long-term value).

In 1863, funded by his substantial (paper) stock wealth, Clemens retired from journalism. He traveled west to San Francisco to live the high life. He watched his silver mine stock price quotes in the newspaper, and he felt rich: “I lived at the best hotel, exhibited my clothes in the most conspicuous places, infested the opera. . . . I had longed to be a butterfly, and I was one at last.”

Yet after Nevada became a state, Clemens continued to hold on to his stocks, contrary to his plan. Suddenly, the gambling mania on silver stocks ended, and without warning, Clemens found himself virtually broke.

“I, the cheerful idiot that had been squandering money like water, and thought myself beyond the reach of misfortune, had not now as much as fifty dollars when I gathered together my various debts and paid them.”

Clemens was forced to return to journalism to pay his expenses. He lived on meager pay over the next several years. Even after his great literary and lecture-circuit success in the late nineteenth century, he continued to have difficulty investing wisely. In later life he had very public and large debts, and he was forced to work, often much harder than he wanted, to make ends meet for his family.

Clemens had made a plan to sell his silver stock shares when Nevada became a state. His rapid and large gains stoked a sense of invincibility. Soon he deviated from his stock sales plan, stopped paying attention to the market fundamentals, and found himself virtually broke.

Clemens was by no means the first or last person to succumb to mining stock excitement. The World’s Work, an investment periodical published decades later, in the early 1900s, was beset by letters from investors asking for advice on mining stocks. The magazine’s response to these letters was straightforward:  “Emotion plays too large a part in the business of mining stocks. Enthusiasm, lust for gain, gullibility are the real bases of this trading. The sober common sense of the intelligent businessman has no part in such investment.” (from Meir Statman)

While the focus of market manias changes – mining, biotech, Chinese stocks, housing, etc… – the outline of a speculative bubbles remains remarkably similar over the centuries.  Today’s newsletter examines the latest research into speculative bubbles and looks at how we can apply that knowledge, with examples of the recent booms (bubbles?) in Chinese stocks and Biotech.  This newsletter is much longer than usual letter, in part because the topic is both complex and important.  Skip ahead to the end for the Chinese and Biotech conclusions.  Speculative bubbles_2

nasdaq bubble

Hate Math

Poor future returns

 

Source: http://hussmanfunds.com/wmc/wmc150504.htm

Prof. Greenwald on Value Investing

OVERVIEW Value_Investing_Slides

Greenwald_2005_Inv_Process_Pres_Gabelli in London

Greenwald Overview of VI

A Value Investing Class in Three Minutes

sentiment_cycles
Buying High

Next Week

I have been too busy to do another lesson but be ready next week! For those attending the Berkshire Hathaway Meeting in Omaha enjoy the experience. Flash your Deep-Value Group card for up to 95% discounts.

HAVE A GREAT WEEKEND!

Investment Checklists-Adapt Them for Yourself. GOODHAVEN

sacr

Someone sent me a postcard picture of the earth.
On the back it said, “Wish you were here.” — Steven Wright

Investment Checklists 

We left-off here Last Lesson on Gross Profitability and Magic Formula and in that post, the next focus would be on investment checklists.  We have been reading Chapter 2: A Blueprint to a Better Quantitative Value Strategy in Quantitative Value (I will email the Book to new students if they are in the Deep-Value Group at GOOGLE. Go here: https://groups.google.com/forum/#!overview then type: DEEP-VALUE and ask to join.).

On pages 56 to 59 of this chapter the author discusses the case for a checklist. Atul Gawande in his book The Checklist Manifesto: How to Get Things Right argues for a broader implementation of checklists. The author believes that in many fields, the problem is not a lack of knowledge but in making sure we apply our knowledge consistently and correctly. 

The Quantitative Value Checklist

  1. Avoid Stocks that can cause a permanent loss of capital or avoid frauds and financial distress/bankruptcy.
  2. Find stocks with the cheapest quality.
  3. Find stocks with the cheapest prices.
  4. Find stocks with corroborative signals like insider buying, buyback announcements, etc.

Below are several books on checklists.

As students may know, I throw A LOT of information at you to force a choice on your part.   You have to focus on what material can be adapted to your needs. In the three books above, you will find many interesting ideas that may be helpful in learning how to build your own list.

The more experienced you are, then the shorter the checklist.  The point of a checklist is to be disciplined and not overlook the obvious while freeing up your mind for the big picture.   Yes, you check off if there is insider buying, but if insiders are absent, but the company has a strong franchise and the price is attractive, then those factors may be overwhelmingly positive.  You may ask, “Do I understand this business?” Then it may take weeks of industry reading to say yes or no.

Checklists are helpful, but only if you adapt them to your method.

Next, we will be reading Chapter 3, Eliminating Frauds in Quantitative Value. We are trying to improve our ability to build a margin of safety.

goodx

The Problem with Investor Time-frames

Note the dark line in the chart above representing the returns of the Goodhaven Fund. Two analysts/PMs split off from Fairholme and started in mid-2011. They had a big inflow in early 2014 and then some of their investors panicked as they vastly “underperformed the market.”  I don’t know if these managers are good or bad but making a decision on twelve to twenty-four months of data is absurd unless the managers completely changed their stripes (method of investing).  Therein lies opportunity for those with longer holding periods like five years or more.

holding-period

Shareholder_Message_1114 (Some investors run for the door)

2014_AR

2013_AR

HAVE A GREAT EASTER and WEEKEND!

fredgraphcreditmarketdebtgdp

Shareholder Maximization-The Dumbest Idea in the World; Is Skill Dead?

CRB 2015 long term

JM_The Worlds Dumbest Idea_1214

Video: http://eic.cfainstitute.org/2014/10/23/shareholder-value-maximization-the-dumbest-idea-in-the-world/

Excellent video on Austrian economics and entrepreneurship:

http://mises.org/library/entrepreneurship-austrian-economics-and-cryptorevolution

Advice

I am a first year MBA student in XXXX. I am from a background of (being) a software engineer and an equity researcher in China. I was very interested in Value Investing and tried to apply it to personal investment in past 8 years. Currently, I am exploring career opportunities in the Investment Management area and see that you have been working and teaching in this area for a long time. I would learn more about your experience in this area and get some advice from you.

I would write-up investment ideas within your circle of competence to show fund managers your critical thinking skills and approach to investing.  Or if you have a great understanding of a particular industry or company that is public you can present your ideas to the fund managers who own the company.   Show your past investment results. Why did you make the decisions you made?  Try to sell your ideas to the appropriate money managers.   But only you can determine what your strengths particular interests.   Your reports should meld your interests with your skills.

Icahn

Our activist friend, Carl Icahn’s High River LP, Icahn Partners LP and Icahn Partners Master Fund LP collectively bought 6.6 million Chesapeake shares on March 11 at $14.15 each, bringing the investor’s total stake in the company to 11 percent, according to a filing on Monday. Prior to the purchases, Icahn controlled about 9.9 percent of Oklahoma City-based Chesapeake. That compares with an 11.11 percent stake owned by Southeastern Asset Management Inc. as of Dec. 31, the largest holding according to the latest filings.

The Forgotten Depression (Video)

Forgotten-depression-1921-crash-cured-itself

Commodities Carnage; Reversion to the Mean and the Growth Illusion; Net/Nets

Reuters

CRBSearch Strategy: Go where the outlook is bleakest (John Templeton). Keep his wisdom by your side: Sixteen Rules for Investment Success_Templeton

Commodities (CRB Index) fall back to a 40-year support zone ($185/$205)

while:Commodities-Sentiment

As global commodities prices plummet, it’s incredibly convenient to pronounce the commodities super-cycle dead, isn’t it?  Yet banks from Goldman Sachs to Citigroup to Deutsche Bank are on record as saying it’s over.   http://www.wallstreetdaily.com/2014/12/08/jim-rogers-commodities-interview/

The point is not to follow the “experts” but search where there is carnage. I am looking at Templeton’s Russian and Eastern Europe Fund TRF Semi Annual Report because:

  • Hated Countries (Russia, Ukraine)
  • Currencies Down,
  • Commodity Exporters and
  • trading at a 10% discount so the 1.4% management fee is covered for six years.
  • Poor performance for the past few years

Things can and will probably get worse. So please don’t follow the blind (me) off the cliff. This is meant as an example of a SEARCH STRATEGY.

More on Reversion to the Mean and the Growth Illusion

We are beating this subject to death but you can’t understand how investing in bargains works without grasping these concepts.

Contrarian Strategy Extrapolation and Risk  Abstract: Value strategies yield higher returns because these strategies exploit the sub-optimal behavior of the typical investor and not because these strategies are fundamentally riskier.  Yes, this is an academic paper, but worth reading to understand WHY and HOW value (buying stocks with low expectations/and low price to business metrics like earnings, cash flow, EBITDA, etc.) provide better returns.

Growth Illusion

The Two Percent Dilution It is widely believed that economic growth is good for stockholders. However, the cross-country correlation of real stock returns and per capita GDP growth over 1900–2002 is negative. Economic growth occurs from high personal savings rates and increased labor force participation, and from technological change. If increases in capital and labor inputs go into new corporations, these do not boost the present value of dividends on existing corporations. Technological change does not increase profits unless firms have lasting monopolies, a condition that rarely occurs. Countries with high growth potential do not offer good equity investment opportunities unless valuations are low.

value-vs-glamour-a-global-phenomenon (Brandes Institute)

Thick as a Bric by Efficient Frontier

Does the Stock Market Over React

Discussion of Does the Stock Market Over React

Criticism of the Over Reaction Theory

The above is meant to supplement your reading in Deep Value Chapter 5, A Clockwork Market

 

Ben Graham’s Net-Net Strategy Revisited

Ben Graham Net Current Asset Values A Performance Update

Time-out: A Case Study in Pigeons

Pigeons-pigeons-27537154-741-1095

Case Study in Pigeon Investing

Times are hard.  Your family has been struggling to make the mortgage payments on your farm since the 50% decline in corn prices.

corn

Your lucky day! You get a call from a friend’s neighbor that he (The Pigeon King) desperately  needs breeders for his growing pigeon business. With a $125,000 investment financed with a second mortgage against your farm you can buy 360 pairs of pigeons at $165 a pair.  Then he offers to buy back the newly bred pigeons for $40 each (pigeons breed prolifically) with a ten-year contract.  He says these pigeons are for racing.  Then he gives you a list of five farmers in your state who are breeding pigeons for him.  Take your time and do your due-diligence, he says.

You check his credit ratings–all good.  No criminal or civil complaints. He owns his farm free and clear–he is a farmer like you!  After meeting with three of the pigeon farmers who confirm with check stubs that he has been paying them on time and as promised. The returns are good–in excess of 80% to 100% in terms of food and overhead to raise the chicks. Considering your time to look over your pigeons, you figure you can net a 50% pre-tax return on your capital. Plus, your contract allows you to sell whatever you produce at the stipulated price, so growth will be profitable.

Also, you hire an investigator to interview the Pigeon King. She sends you this video interview: Making Fowl into good fare—it this a good idea and A successful pigeon farmer

Times are hard. What do you do? Before you decide, you are inspired by

You gotta have dreams and the will to believe!

Pedgeon King

You remember what you learned as a deep value investor over at csinvesting.org and you_________? Why? What INVESTING/BUSINESS principles help you in your decision?

Please write them down now.  Then read on.

Many years later, you notice in the paper:

the-pigeon-king-and-the-ponzi-scheme-that-shook-canada.html

This article, The Pigeon King (same as the link above but with additional commentary for easier reading) is one of the most amazing stories–a farce, a tragedy, a comedy AND chock full of lessons for the investor.  You may think you are too smart to be a pigeon or a bird-brain (sorry!) but ANYONE can be blind.  What checklist items stop you (besides it’s too good to be true?).

What did YOU learn?

Money for nothing and your chicks for free

 

 

A Reader’s Suggestion for DEEP VALUE COURSE

I have recently received many suggestions to improve this course. There are almost 600 people in our group with many different backgrounds and experiences.  There may be advanced students who wish to discuss current case studies (Why is DLX, Deluxe, not a value trap like Radio Shack?) or potential investments or subjects into greater depth.  This course planned to follow Deep Value (book) while digging deeper into the footnotes without preconceived notions.  If, for example, we read about Buffett’s transition from net/nets to franchises, we will look at franchises but not focus on them. The point is to give students background to understand the distinctions. However, this may be too basic for many of you.

My goal is to make this a learning community. One idea would be to set up another blog (volunteers?) to discuss various ideas if there is enough interest. I won’t give out anybody’s email without their permission, but if a group of students wanted to dig deeper into various subjects, I am happy to provide a link to this new group or discussion area.  I will wait until I hear your feedback.

For example, a reader/student went into vast effort to provide feedback and suggestions.  Dr. K (my nickname for this reader) might be an excellent leader to develop a new discussion blog?  Below are Dr. K’s emails and links.  I will post your suggestions.

EMAIL 1

John; This is Dr. K following up from our phone conversation. So far I am very frustrated with the deep value course and in the following series of emails I will explain why.

Why I hate mechanical investing and problems with back-testing

  • First of all Seth Klarman in his book (Intro xvi, p.13, p.16-18, p.151, p.162) discusses the folly of searching for the holy grail “mechanical” formula for investing success. BG in The Intelligent Investor p.38-46 and p.194-195 also says mechanical formula investing is self-defeating. It contradictory that we are reading about mechanical formula (Toby Carlisle’s books). Mechanical formula (Toby Carlisle and Joel Greenblatt’s 2nd book) come off as lazy, naïve, and immature to me.
  •  Seth also is not a fan of Wide Moats (see p.32-34, p.93) but I guess that’s OK but it’s very confusing how we are jumping around from one investment ideology to another!! Seth also does not think much of EBITA (see p.71-78) while you seem to mention it on the front of your blog home page in a link at the top.
  •  Now go to http://falkenblog.blogspot.com and read as many past articles as you can. You should also get his first book: “Finding Alpha.” There is no need to read the rest of his books. In that book especially key in on p.115-116 “Geometric vs. Arithmetic Averaging”, p.116-117 “Survivorship Bias”, Ch. 6 p. 113-125 “Is the Equity Risk Premium Zero?” especially read p.121-123 “Transaction Costs” , p.47 “the Size Effect” and p.48 “Delisting bias.” These are just some of the many reasons why mechanical back testing is a dead-end path to investing success.
  •  And/or you can go to http://www.efalken.com and watch the Finding Alpha videos. This should take 8 hours but it’s good if you are short on time or you can do both. I also have many of the papers he has written or mentioned. I can send them to you upon request.
  • Next go to www.davidhbailey.com.Click on the Mathematical Investor blog and read all of the articles. Now see that attached papers he wrote along with Campbell Harvey.
  • Go to www.numeraire.com and read all of the links at the top. In the search site map section click on the article about why screening is not valuation.
  • Now go to www.numeraire.com/download.htm . Read every article in the Research Related Letter section. These are short but notice whom he is critical of. Now read all of the articles in the Research Notes section. Especially read “What is Circular Reasoning” which will explain why most stock screens and mechanical formulas (Toby Carlisle, Joel Greenblatt) are garbage! Make sure you click on or go to all of the links in this article. Notice the lists of various forms of logical errors. Notice the cross correlation with behavioral finance! These logical error list need to be studied in greater detail!! Also especially read “What is Economic Simultaneity?”, “A History of the Size Effect” and notice that on p.4-5 he lists some of the variables that are and are not circular!!, “Evolution of Stock Picking”, “Visual Detection of Circular Reasoning” (it’s vital you understand this) and finally “Fatal Summary.” (it’s vital you understand this also) Read all of the articles in Research Presentations and in Research papers (especially “Circling the Square” and notice on p.8 he gives the return formula and it’s vital you understand this).

You should a somewhat better idea of why mechanical investing is not scientific. You should not trust academic research as well as a lot of p-side research! I am not impressed with Toby Carlisle and Joel Greenblatt’s second book. I have a good feeling that many people in this course and google group are more advanced then you are aware of and feel the same way. I can tell you that I have been reading many academic papers over the years and would attach them when I tried to apply for a research job and never got any positive feedback from attaching them!! In addition Alpha Titans such as Seth Klarman, Peter Lynch, Warren Buffett, Ben Graham were not fan of this type of investing approach.

Let me know when you have read this stuff. I think you need to read and understand them otherwise you are not fully grasping how difficult value investing really is!! Keep in mind I don’t fully understand everything in this material but I know enough to not be impressed by mechanical investing research garbage studies!!

Most Factor Models that Explain Returns are False _ 1

Anamolies Don’t Do as Well after Publication

A Skeptical Appraisel of Asset-Pricing Tests _ 3

Backtest Overfitting

Significance Testing Issues for Empirical Finance 5

The Probability of Backtest Overfitting 6

Factor models to sensative to the time period tested 7

Email #2 about Net Nets.

You mentioned www.oldschoolvalue.comon your site in the resource section. I like this site for the free screens and the blog articles which do a good job of teaching quality investment theory. I am not too fond of his software program and he raised the price and his spreadsheets do not include critical off-balance sheet accounting adjustments (I will explain the New Constructs platform in a later email). Jae Jun thinks his spreadsheet program is better than it really is. (in my opinion).

Go to the -VeEV, NNWC and NCAV screens. Some of the stocks duplicate themselves. Now go to Ben Graham Net Net Stocks and a 7 Step Checklist to Make Money with Net Nets . Notice on p.7 Jae says 99% of Net Nets are useless and on p.9 he does not like Chinese ADRs. I think he also does no include financial companies, REITs, CEFs, Shells etc.

Now go to www.grahaminvestor.com.In the screens link at the top go to the NCAV Stocks (Shares Outstanding) screen. Notice it does include Shell companies and Chinese ADRs but only companies listed in the USA. (no Japanese, Canada, Australia, etc.) The next screen is NCAV Stocks (Float). I am not sure what the advantage of this screen is. It only seems to leverage the Current ratio. I have never seen anyone else mention using Float instead of Shares Outstanding instead. This site also gives: NCAV Stocks (Shares Outstanding, new) and NCAV Stocks (Shares Outstanding, new, no Chinese). I sent an email to the people that run this site about the screens but they never got back to me. I would not blindly trust that these companies are true Net Nets. You should verify the numbers yourself.

Go to http://www.netnethunter.com/my-ncav-investment-scorecard/. Does this guy give you the impression that he is a fan of running a mechanical screen and blindly following it?? Notice that he does analysis on the company’s “Burn rate.” Where did Toby Carlisle mention this?? Make sure you read all of the articles.

Now for the subscription. He does screens for Japan, Australia, Canada. The Japanese financials he gets are written in Japanese and gets the aggregated data from Business week.

A good assignment would be to figure out where for free or how you can screen for Japan, Australia, Canada or anywhere else other than the USA. Given the above two mentioned sites we could also for a day analyze (or for a week) every company of the list in greater detail and not do stupid mechanical investing like it has been suggested so far!!

I think I read that www.gurufocus.com has some Net-Net screens for a subscription rate but I don’t know if they are any good or not.

Another reason why Net Net studies and papers are flawed is that they don’t account for Survivorship bias and delisting bias in the historical database the study was conducted from. It’s quite possible that a company could be a “quality Net-Net” from financial standpoint but if the trading volume is too low then the NYSE could delist the company and then the stock loses 90% of its value as it goes from being a listed company to an unlisted (or OTC) company. Most of the deep value research does not discuss how to account for this and how to follow and trade these OTC companies!!

Here is email #3 about Wide Moat Investing.

You mentioned Pat Dorsey and his books. (see The Five Rules for Successful Stock Investing and The Little Book that Builds Wealth).

  1.  I met Pat Dorsey at a CFA Rochester, NY meeting while he was working for Morningstar. Morningstar has The Stock Investor newsletter which gives coverage of about 150 companies Morningstar believes are “Wide Moat” companies.
  2.  You mentioned Bruce Greenwald’s book and presentations about this subject.
  3. Now go to www.oldschoolvalue.com/blog/tutorial/this-is-how-buffett-interprets-financial-statements. This is a good summary article of the book “Warren Buffett and the Interpretation of Financial Statements” by Mary Buffett and David Clark. The authors also wrote “Buffettology” and a workbook about this book.
  4.  Also see What Gross Margins Can Tell You About a Company’s Economic Moat by Old School Value.

The assignment here is using these various books, articles and presentations someone subscribe to Morningstar’s Stock Investor newsletter, tell us the list of the 150 companies Morningstar list for “Wide Moats.” Then once we have this list we all go through each company and analyze and verify why these companies are indeed “Wide Moat” companies. In a presentation that you posted recently by WB he mentioned that there are no “Wide Moat” companies in Japan. I suppose we could locate “Wide Moat” companies in countries outside of the USA.

—–

This is email #4 about Special Situation investing. You mentioned Seth Klarman’s book. In the second half of that book he gives various “Special Situation” opportunities. Joel Greenblatt’s first book also was pretty good (but  now a little out of date while his second book was a bunch of mechanical garbage).

a. The absolute best and easiest site to locate “Special Situations” is Spinoff Monitor – Actionable Opportunities in Special Situations: Spinoffs, Bankruptcy, Restructurings . Notice on the right hand side a very easy list of all of the various situations!! I am very interested in exploring this area of Investing!! Their is no analysis on this site.
b. Other sites that list Special Situations include:
c. You mentioned www.distressed-debt-investing.com in your resource section on your blog. Someone also attached Stephen Moyer’s book about Distressed Debt investing. My advice here would be to stay far away from this area of investing until the investor has more experience under your belt in analyzing distresses equities first. That website and book is very complicated as it requires specialized knowledge of Bankruptcy law, Quant Credit Modeling and simulation. You should not really list this site on your blog unless you make it clear to people this area of investing is not for beginners! It’s for advanced investors!!!!!!!!!!!!!!!! These resources are not written in a way that is easy to learn or read!!
d. There are many sites on the web for following the Insiders. I think I read that www.gurufocus.com gives you coverage of Insiders. Many sites are for free. The absolute best book on Insider Buying is “Investment Intelligence from Insider Trading” by H.Nejat Seyhun. It should be noted that Seyhun’s database goes all the way back to 1975 while I have yet to see any website that goes back that far for a affordable price.
Now here is what I think is going on with Spinoffs. Suppose you have XYZ company with a consolidated financial statement consisting of three divisions: Division A, Division B, Division C. So Consolidated XYZ = [A + B + C]. Now suppose Division B will be Spunoff. Now we have two companies: Parent Company = [A + C] and the Spunoff Company = [B]. I think what is going on here is that when this proposal takes place it won’t occur for a 90 day period so therefore their is a 90 day period where these two companies’ financial statements won’t be in the various databases. Instead Consolidated XYZ = [A + B + C] will still be in the database. I THINK WHAT YOU NEED TO DO IS RECONSTRUCT THE FINANCIAL STATEMENTS SUCH THAT YOU CAN ANALYZE PARENT COMPANY = [A + C] AND SPUN COMPANY = [B] AS TWO SEPERATE COMPANIES. DO NOT ASSUME AS MECHICANICAL INVESTORS DO THAT THE SPUNOFF COMPANY IS THE GOOD DEAL AND THE PARENT COMPANY IS THE BAD DEAL. EVEN IN JOEL GREENBLATT’S FIRST BOOK SOMETIMES THE PARENT COMPANY IS WHAT HE PURCHASED AND SOMETHIMES THE SPUN OMPANY WAS THE BETTER DEAL. I think Joel did an OK of explaining what was going on in his first book but he was not always clear about the timeline of events for how to follow a typical Spinoff situation.
As for the various other types of Special Situations (except for Merge Arb) their is almost no analysis or coverage on how to follow these events!!

Email #5 about “Expectations Investing.”

  1. Go to www.expectationsinvesting.com. Make sure you read “Expectations Investing (2000)” by Alfred Rappaport and Mchael J. Mauboussin and “Creating Shareholder Value (1998)” by Alfred Rappaport. THESE ARE THE ABSOLUTE TWO BEST BOOKS I HAVE READ THAT CLEARLY EXPLAINED WHY CONVENTIONAL ACCOUNTING IS FLAWED AND THE DIFFERENCE BETWEEN ACCOUNTING VALUE AND ECONOMIC VALUE CREATION!! I can’t go into two much detail here but make sure you read and understand every Tutorial on the site!! In a recent post your blog about Enron I think you were trying to highlight the concept of Incremental Capital expenditure. This and Incremental Working Capital expenditure are clearly taught in these two books. These books also do a wonderful job of explaining the underlying drivers of Economic Value creation! You want to understand these spreadsheets in detail!

The assignment here is that New Constructs (See links below) does about 22 various off-balance sheet adjustments. Learn these adjustments and modify the Expectation Investing sample spreadsheets. Know how to do this for companies that New Constructs does not cover. (such as REITs, MLPs, Net Nets, Special Situations, Japan and non-USA stocks). In the case of non-USA companies the accounting conventions would need to be researched.

I think these spreadsheets do such a good teaching job of explaining things!!

(Not posted here-I couldn’t open the zip file)

  1. Michael’s 2nd book “More then you know” and his 3rd book “Think Twice” are gems that do a good job of summarizing what is going on in behavioral finance and must be read. I have many of the papers he mentioned from these books.

30-00 Part 2

The-Best-Primer-to-Valuation-Multiples Part 2

Trouble with Earnings & PEs

Cash Flow vs. NI

Counting what Counts

Financial Ratios

Financial Ratioswheres the bar ROIC

CommonErrors in DCF Models

Decoding Wall Street Propaganda ( A MUST READ!)

NewConstructs_in_DC

Do Investors see through Reported Earnings

Free-Sample-Company-Research-Report-HLS-2013-02-01

NewConstructsIntro_2013

END

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:

Reader’s Q: Would Graham Consider SHOS (Sear’s Hometown) a Net/Net?

Homestores(SHO-11.01.14-10Q _Final

If we take all the liabilities of $236.576 mil. and deduct from Current Assets of $524.238 = $287.662 mil of net working capital then divide by 22.666 million outstanding shares to have $12.68 per share of working capital minus all other liabilities and leaving out other assets.  Klarman used net-net working capital as  approximating the liquidation value of a company–See Chapter 8 in Margin of Safety.  So current assets minus (current liabilities + all long-term liabilities) = net-net working capital.

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Today the price of SHOS is under $12.68 or $11.90, so yes, the price is trading below net working capital per share, but Graham would not pay more than $8.46 for SHOS given his penchant for a margin of safety of paying no more than two-thirds of net working capital.  Obviously, investors might be concerned with falling same-store sales. On the flip side, deep value investors may see comfort with asset value and the type of inventory.  Note, that there have been a few well-known deep value investors stepping in 3/Q 2014 like Chou Associates (the Canadian Deep Value Investor) Chou Associates Management-inc-top-holdings/ and video lecture: Guest_Speakers/2009/Chou_2009.htm (worth watching).

The above isn’t a plug for investing in SHOS, but pointing out how I think Graham would view investing in the company.

Advice from Wall Street

The third phone call I made that day was to the brokerage handling the stock offering, Montgomery Securities in San Francisco. The institutional salesman there who had recommended the stock was named Rick. Like just about everybody else at Montgomery, Rick was an aggressive pitchman. The word bulldog gets thrown around a lot, but I don’t think that quite captures the level of mindless tenacity the brokers at Montgomery brought to their work. Picture an angry hyena that hasn’t eaten in a couple of days. Now picture someone throwing a bloody porterhouse in front of it. That is how hard these guys sold their deals.

After I introduced myself, I told Rick about the research I had done and informed him as courteously as I could that I would not be recommending the stock.

“The bank is on the verge of insolvency,” I explained. “If they are this new company’s main customer, that is not going to be good for their earnings or their share price.”

Rick barked into the phone, “How old are you, kid?”

I swallowed hard and replied, “Twenty-five.”

“You’ve got a lot to learn,” Rick growled. “Nobody stops me from collecting a commission. I’m not going to waste my time talking to you. I ‘ll call your boss first thing in the morning.”

The line went dead. I stared at the receiver in disbelief. I didn’t understand d what had just happened. I had informed a representative of a prestigious, well-respected brokerage that a stock they were offering had significant downside risk. I had assumed that he would be grateful for my insights, or at least interested in what I had to say. Instead, he had acted like I had belched in his ear.

In reality, Rick was right: I did have a lot to learn. The idea that someone on Wall Street would give a damn about the truth or doing the right thing by his clients was almost laughably naïve.

…….After thirty years of doing this (analyzing investments and managing money), I can tell you in no uncertain terms that buying stocks on the word of so-called experts in the single biggest mistake an investor can make. … This misplaced faith in Wall Street whizzes is a symptom of a much larger and more destructive problem in the investment world: The cult of the guru. Investors of all types–from fund managers to day-traders to mom-and-pop savers hoping to boost their 401(k) accounts –are constantly looking for a market messiah, someone who’s figured out–once and for all-the magical formula for how to beat the Street. It is an understandable but self-defeating desire, because the people who actually possess these kinds of insights almost NEVER SHARE THEM. (from Dead Companies Walking (2015) by Scott Fearon)

BOILER ROOM: I Became a Stock Broker

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!