30 minute video: Kyle Bass on Europe’s problems. Highly recommended. http://www.economicpolicyjournal.com/2011/11/hot-why-japan-is-going-to-go-way-of.html
Larry Parks, Founder of the Foundation for the Advancement of Monetary Education (“FAME), testifies before Congress. The transcript provides a synopsis of US monetary history.
Posted in Economics & Politics
Tagged FAME, Kyle Bass, Larry Parks, Monetary History
Let’s test our business IQ.
A restaurant owner who owns a building in New York City where he serves some of the best Spanish food (Tapas, Paella) seeks your advice. He nets about $30,000 a month. This is, apparently, an excellent income for a small individual owner. He wants to expand to another location. Should he and how would you advise him?
Please, no more than a sentence or two. How would you need to look at his restaurant business?
Correct answers are required to receive any more value videos (just kidding; power goes to my head.)
Posted in Competitive Analysis, Uncategorized
Tagged Quiz, Strategic Logic, Thinking like a business person
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Kyle Bass, who runs a hedge fund called Hayman Capital Management in Texas, is gaining notoriety as an investorwith the foresight to anticipate today’s growing sovereign debt crisis.
If eurozone governments ultimately write down their debt because the weight of supporting their banks becomes too great, Kyle Bass will go down as one of the earliest to recognize and position for that. His worldview is dire, and it’s apparently prompted him to take some strange precautions such as acquiring $1 million nickels (20 million coins) because their 6.8 cents value as scrap metal exceeds their monetary worth.
I listened to an interview yesterday on BBC Radio HardTalk in which he defended his views. The UK media tends to take a more populist stance with regard to hedge fund managers. It’s now 14 years since George Soros’s bet against Sterling preceded their leaving the European Monetary Union and ultimately declining to join the €.
How fortunate that decision looks today, but at the time UK tabloids blared that George Soros had “broken the Bank of England” and financiers have never been fully trusted in the UK ever since. So the BBC’s interviewer adopted a combative stance, for instance accusing Bass of causing the collapse in Greek bonds through his bets on credit default swaps. Her attempts to portray him as a manipulating hedge fund manager exploiting opportunities for no benefit but his own were deftly handled with facts and figures. Kyle Bass has a point of view worth considering.
I went back and reread Bass’s investor letter from February, “The Cognitive Dissonance of it All”. He reaches a similar conclusion to Jim Millstein in Tuesday’s FT, although he focuses more on government revenues, debt and interest expense.
Japan, given its shrinking and aging population combined with high levels of debt could not afford to borrow at the levels of other AAA-rated nations (such as France) because their total interest expense would exceed their revenue. As Bass says, “The ZIRP trap snaps shut.” (ZIRP is Zero Interest Rate Policy, pretty much what we have in the U.S. currently).
I know people have been betting on a disaster in Japanese bonds for literally twenty years, and it has so far been a disastrous bet. But it does increasingly look as if it still is just a matter of time before we reach the tipping point. After reading what Kyle Bass has to say it’s hard to feel comfortable owning long-term government bonds issued anywhere in the world.
Read more: http://inpursuitofvalue.wordpress.com/2011/11/18/why-kyle-bass-hoard-nickels/#ixzz1eAZaNlwu
This blog is from an intelligent thinker–worth a perusal:
http://www.oftwominds.com
Combine your Austrian Economic studies with these charts of the housing bubble: http://www.oftwominds.com/journal08/State-of-Real-Estate.pdf
Without understanding the underlying economic theory of booms and busts you won’t draw the proper conclusions.
Capex is given in cash flow statement in the investing section. All capex which is not growth capex must necessarily be maintenance capex. So if you can estimate growth capex, since you know total capex, you can estimate maintenance capex.
Estimating growth capex is sometimes easy because one knows that the company is expanding capacity from x units to y units and its capex plans are known. Even when we don’t know exact capex plans, sometimes to we know how much money is needed in an industry to expand capacity from x to y.
Sometimes we know that almost all the capex is maintenance capex because of competitive pressure. For example what happened in the “Shutdown of textile industry” example, or in the petrol pump example i gave in class. The functional equivalent of these examples are very very common in the business world so one must not take the accountants’ definition of capex as sacrosanct. Accountants don’t like to make estimates. They would rather have something precise even if its wrong. You don’t have to be like them.
When you look at capex numbers you must ask the following questions:
1. Is this expenditure likely to result in a sustainable rise in economic earnings in the future? This is not the same as asking if margins will improve or not – they may improve temporarily but the nature of the business may be such that such gains would be temporary and the cost savings will flow through to the customers instead of the owners. So what may look nice on DCF analysis in an excel model, will not translate into sustainable economic earnings jump. You really need to do this “second step analysis” by asking how much of the benefits of the capex will go to the owners and how much to customers. If the benefits will go to customers, then its NOT Capex for US. For US its and EXPENSE. something we reduce from operating cash flow to arrive at owner earnings.
2. How competitive is this industry? If its extremely competitive or has a lot of foolish competition, then its very likely that capex won’t result in improvement in long-term sustainable earning power. In some businesses, you just can’t be a lot smarter than your dumbest competition. And there is plenty of DUMB competition in some industry. Witness for example, what’s happening in the airline industry in India right now…
3. Is there a lot of inflation? Historical cost accounting and inflation result in under provision of depreciation in accounting books.
4. Are there substantial productivity improvements? Inflationary effects are sometimes offset by productivity improvements. This was discussed in class in detail.
5. Is the plant really old and dilapidated and probably needs replacement? Sometimes there are very old plants chugging along for a long time but ultimately they have to be replaced. The plant may have almost zero value in books because they have already been written off. But they need to be replaced and replacement cost could be a bomb. When you spent that money, should you record it as Capex? Well the accountants will ALWAYS record it as capex. But they key question you have to ask is this: will this money spent improve long term earning power, or only help the company maintain current earning power. If the consequence of the money spent is going to be mere maintenance of earning power, then its NOT CAPEX FOR US. Rather its an EXPENSE.
6. Whats the rate of Obsolescence in this industry? Industries with very high obsolescence rates require frequent capex just to keep up with the competition which keeps on inventing new applications of technology making old technology obsolete. We talked about what happened to Moser Baer and Samtel Color. Well the unfortunate people who invested in those companies learnt the hard way that essentially these companies made NO REAL PROFITS because when you CORRECTLY TREAT the money spent on frequent capex programs of such companies not as CAPEX but and MAINTENANCE CAPEX, you would have figured out that essentially there were NO OWNER EARNINGS. And when there are no owner earnings there is NO VALUE. This is true even though interim value in the market may end up being BILLIONS OF DOLLARS!
Regards,
Sanjay Bakshi
A reader asks about calculating capital expenditures and Buffett’s owner’s earnings. I believe only maintenance capex is deducted in determining owner’s earnings not growth capex because maintenance is mandatory while growth capex is discretionary.
This document is 11 pages and it includes other links.
Posted in Competitive Analysis, Valuation Techniques
Tagged Buffett, capex, Capital Allocation, owner's earnings, Sears
Thomas Sowell (born June 30, 1930) is an American economist, social
theorist, political philosopher, and author. A National Humanities
Medal winner, he advocates laissez-faire economics and writes from a
libertarian perspective. He is currently a Rose and Milton Friedman
Senior Fellow on Public Policy at the Hoover Institution at Stanford
University. Sowell was born in North Carolina, but grew up in Harlem,
New York. He dropped out of high school, and served in the United
States Marine Corps during the Korean War. He had received a
bachelor’s degree from Harvard University in 1958 and a master’s
degree from Columbia University in 1959. In 1968, he earned his
doctorate degree in economics from the University of Chicago. Dr.
Sowell has served on the faculties of several universities, including
Cornell and University of California, Los Angeles, and worked for
“think tanks” such as the Urban Institute. Since 1980 he has worked at
the Hoover Institution. He is the author of more than 30 books.
By Dr. Sowell
The current Occupy Wall Street movement is the best illustration to
date of what President Barack Obama’s America looks like. It is an
America where the lawless, unaccomplished, ignorant and incompetent
rule. It is an America where those who have sacrificed nothing pillage
and destroy the lives of those who have sacrificed greatly.
It is an America where history is rewritten to honor dictators,
murderers and thieves. It is an America where violence, racism,
hatred, class warfare and murder are all promoted as acceptable means
of overturning the American civil society.
It is an America where humans have been degraded to the level of
animals: defecating in public, having sex in public, devoid of basic
hygiene. It is an America where the basic tenets of a civil society,
including faith, family, a free press and individual rights, have been
rejected. It is an America where our founding documents have been
shredded and, with them, every person’s guaranteed liberties.
It is an America where, ultimately, great suffering will come to the
American people, but the rulers like Obama, Michelle Obama, Harry
Reid, Nancy Pelosi, Barney Frank, Chris Dodd, Joe Biden, Jesse
Jackson, Louis Farrakhan, liberal college professors, union bosses and
other loyal liberal/Communist Party members will live in opulent
splendor.
It is the America that Obama and the Democratic Party have created
with the willing assistance of the American media, Hollywood, unions,
universities, the Communist Party of America, the Black Panthers and
numerous anti-American foreign entities.
Barack Obama has brought more destruction upon this country in four
years than any other event in the history of our nation, but it is
just the beginning of what he and his comrades are capable of.
The Occupy Wall Street movement is just another step in their plan for
the annihilation of America.
“Socialism, in general, has a record of failure so blatant that only
an intellectual could ignore or evade it.”
Thomas Sowell
Posted in Economics & Politics
Tagged Healthy Eating, Occupy Wall Street, Primal Foods, Thomas Sowell
“If it weren’t for bad luck, I’d have no luck at all.” –Stevie Ray Vaughan
Ok, so my mother never loved me. I reveled in schadenfreude as I watched the big money go down in flames buying financial fiascos during 2008/09. My twisted ego might be comforted but what can we learn for the future? Try to think through what makes financial stocks difficult to value and especially risky in a credit crisis. We will discuss under the heading, lesson, near the end of this post.
Richard Pzena, called one of the smartest men on Wall Street, nearly sank his money management firm (PZN) by buying FRE, FNM and Citigroup (“C”) in early 2008. See prior post: http://csinvesting.org/2011/11/15/pzena-pzn-disappointment-despair-and-tax-loss-selling/
Below is an inteview in early 2008 with Richard Pzena. Mr. Pzena gives his reasons for owning Freddie Mac (FRE), Fannie Mae (FNM) and Citigroup (C)
http://articles.moneycentral.msn.com/Investing/SuperModels/HowTheSmartMoneyGotItWrong.aspx
A Citi revival?
Earlier this week, I talked with Richard Pzena, one of the deans of the value camp. His company, Pzena Investment Management (PZN, news, msgs),
which I mentioned last week as a buy on big dips, runs $25.5 billion in value
money for clients worldwide, including that once-sterling John Hancock fund
that’s now in the tank. He was defiant, contending that he expects to double
his money on such road kill as Citigroup, Fannie Mae, and Freddie Mac over the next three years. I think he’s dreaming, but he does manage $25.49 billion more than I do, so perhaps you should lend him an ear.
Pzena’s main point is that though losses in subprime mortgages have generated the most headlines in the sector, few banks actually have much exposure to them. He sees Citigroup, for instance, as a global consumer-credit business that generates most of its money by issuing plastic overseas. The way he sees it, virtually every adult has a credit card while few have subprime loans, so what’s the problem?
To be sure, Citigroup has had monumental write-downs on its mortgage portfolios and gotten stuck with illiquid structured investment vehicles on its books, and credit card defaults will lead to more losses. But before too much longer new management will have taken out the garbage, and the remainder of the company will have a chance to shine again.
“We view it as a great global franchise that’s inefficiently priced,” Pzena says. “We don’t think the real value of the firm has come down at all, even though it’s
lost over $125 billion in market cap.”
Pzena says he doesn’t know how long he will have to wait to be right — and if he did know, the stock wouldn’t be cheap. His analyst team has torn the company’s financials apart, stress-tested them to the most outrageous negative cases and sees its business getting back on track in every scenario. (Editor: I doubt even Citigroup’s CFO knew what financial risks the bank’s derviatives traders were taking much less the traders.)
The US dollar could turn out to be the big comeback surprise of the year. One reason: As foreign investors put big money into US companies, those foreign countries are less likely to dump the dollar, MSN Money’s Jim Jubak says.
“The reason it’s so depressed is that no one really knows how bad it will be, but we think that sometime in 2008 there will be clarity and we’ll start to see buyers come back,” he says. “They might have to cut their dividend — which would
not be so terrible — to shore up their capital base, but they’re not going out
of business. They will weather this storm.”
The manager says his analysts have put their money where their spreadsheets are — buying more Fannie, Freddie and Citi for their personal accounts than at any time in the past five years. “They believe they have properly analyzed these franchises and should buy even though they don’t know when the turn is
coming,” Pzena says. “There’s no dissension about this position within the firm. Buying low is a strategy that has never failed to work.”
No competition left for Fannie and Freddie
Catching falling knives is a strategy that has never failed to leave your hand in shreds, either. But Pzena insists he has history on his side. Financial stocks got
extremely cheap in the year before the past five recessions, he says, then
began to outperform the market about three months after the recessions’
official start dates, as determined later by the National Bureau of Economic
Research.
If the current recession began in the fourth quarter, as many independent experts believe, then it could be time for Citi, Fannie and Freddie to start bucking up. The idea is that when people fear the unknown, they sell. But in the reverso-world logic of Wall Street, once a recession becomes evident, investors begin anticipating a recovery.
—
Editor of Csinvesting: I hope you caught the flaw in Pzena’s thinking. Buying “low” is a false premise. A plunging price does not equal value though it may be a place to look for it.
Another famous investor, Jim Rogers, saw Pzena’s picks as over-leveraged death traps. http://articles.moneycentral.msn.com/Investing/SuperModels/StockMarketWinterIsMovingIn.aspx?page=1
Rogers, who is equally negative on stocks, was one of the earliest proponents of investing in China and in metals, long before their surge of the past few years. He achieved notoriety three years ago by warning that shares of Fannie Mae would get crushed once the market realized that it was “unbelievably over-leveraged” and would sink under the weight of its out-of-control derivatives positions. At the time, the government-sponsored mortgage-lending titan was on top of its game, and his warning drew derision. But no one’s mocking him now that Fannie shares have lost 60% of their value.
“There was clearly outright fraud, as they were reporting earnings for years when they really had no idea whether they were making money — they were just making stuff up,” he says. “People are still in denial about Fannie Mae’s value. They took every phony mortgage loan ever made by banks, losing billions, and now the government wants them to take on even more bad loans to bail people out? They should just let it go bankrupt!”
Rogers, who is short Fannie Mae shares, is also short Citigroup (C, news, msgs)
and highly negative on its prospects, too.
“Technically, it’s bankrupt, with gigantic off-balance-sheet derivatives positions whose value it cannot possibly know,” he says. Though he believes some large
banks can and will go under in the next year or two under the weight of
billions of dollars worth of bad loans and blown-up derivatives positions, he
doubts the government will allow Citi or Fannie to fail. “They’ll nationalize them in some way. It’s wrong, but they can’t let the two largest lenders in the nation go down.”
The fund manager, who has traveled extensively in emerging markets and lives part of the year in Asia, says sovereign wealth funds in Abu Dhabi and Singapore that recently made large investments in Citigroup and UBS AG are likely to lose a lot of money on their ploys. “They’re making a big mistake; these banks have many more problems still ahead. They should wait until these companies are really on the ropes a few years from now . . . and trading at $5 a share.”
But aren’t they supposed to be the smart money? Maybe not. “I know these people, and they have never given me the impression that they’re smarter than anyone else,” Rogers says. “They have gigantic amounts of money, but they’ve made a bad judgment in these cases.”
US economic problems contagious
As for the rest of the market, well, Rogers doesn’t see equities to buy right now, as he forecasts that a U.S. recession — already in progress, in his view — will choke off earnings growth at companies worldwide. He calls the emerging markets “overexploited” and likes only a few commodities, such as farm goods
and energy.
“The number of acres devoted to wheat farming is at a 30-year low while inventories of food worldwide are at their lowest since 1972,” Rogers says. “With so much corn going into our tanks as ethanol, a growing middle class worldwide eating more corn-fed meat and wearing more cotton than ever, agriculture has a great future, if you ask me, and that’s why I’m buying.”
Editor: Jim Rogers has an understanding of Austrian Business Cycle Theory. http://jimrogersblog.com/
An economic model will characterize a company, any company, except financial groups, with three endogenous and two exogenous variables: an amount of invested capital, a real growth rate and a real cash return associated with this capital, complemented by the cost of capital and a market price. Linking these endogenous variables with the two exogenous ones is what we call ‘investment analysis’.
Now you see the problem with analyzing financial companies. What IS their invested capital? How do you define economic capital for banks, insurance companies and mutual fund companies? Financial groups carry large amounts of what we could call ‘third party capital’–in other words, capital that does not belong to shareholders, and is not provided by lenders. These are the assets deposited by the clients of these companies; bank deposits, for instance. Due to the complexity of these groups, accurately desegregating only the capital financing the company’s own assets is nearly impossible, especially since most of these assets are ‘marked to market’, or revalued every day at their market value.
A large international bank like Citigroup may have thousands of derivatives contracts making the true economic picture of its balance sheet impossible to determine. Furthermore, there is an analytical issue. Segregating capital and identifying cash flow for financial groups is difficult because, fundamentally, these businesses do not produce profits in the same way as non-financial groups. The latter simply add some value, via a proprietary process, to a certain amount of operating costs, and sell units (goods and services) of the total cost to its clients.
The former capture capital flows, often thanks to financial leverage partly from debt, partly from ‘third-party capital’, transform them and clip a remuneration for this process. Even if it were possible to identify cash flows and economic capital for financial groups, the difference in balance sheet leverage would demand the calculation of an expected return (cost of capital) specific to them.
Financial firms are inherently more difficult to value and certainly subject to financing risk. Perhaps avoiding financial firms might be one strategy for improving returns. Please be aware of the unique investment risks financial firms contain and allow for them in your valuations and portfolio management. Richard Pzena’s clients suffered permanent loss of capital as shown by the two charts above.
Thoughts?
Posted in Investing Gurus, Valuation Techniques
Tagged Financial Crisis, finanicial stocks, Pzena
A reader has asked about search strategies and I plan to do a more indepth post on search strategies including screening techniques.
Some people think of what Thanksgiving may bring while I look for tax loss selling in small, obscure, and deeply disappointing stocks.
Here is one company that might fit the bill:
To understand the depth of the disappointment we might compare PZN to other small caps:
I have had enough
When I go to www.pzena.com and look at their recent press release I see $13.7 million in managed assets so a low-end valuation of assets under management (AUM) might be 2% or (2% of 13.7 billion or $274 million divided by 65 million shares (both A & B) or $4.23. Enterprise value is about $200 million after subtracting $38 million in cash and EBITDA is around $45 million (there isn’t much capex with human capital). If assets stabilize, then perhaps asset values are above enterprise value–I might have a margin of safety.
Mr. Pzena almost blew up his firm with investments in Citigroup (“C”) during the 2008/2009 crisis. His firm’s equity performance since then has been good but he has to maintain good performance to turn his three and five-year performance record to top quintile performance. Go here: www.pzena.com
Ok, so that is a reason I would then go to the 10-K and dig deeper; there is enough here to make it worth my time to spend another hour or two. Please, this is NOT an investment recommendation since there may not be enough of a cushion to have a comfortable margin of safety. Also, there may be more attractive alternative investments than this one.
The main point is to look for disappointment. Now I have no proof that there is tax loss selling but with the company underperforming the Russell 2000 for several years and the recent decline during this tax loss window (Oct. – Dec.), I am making a supposition that some investors are making a tax decision rather than an investment decision.
Let’s revisit this in 6 months to see whether my thesis has more substance.