What If You Own a Plummeting Stock (JCP) $%^&*!

Posted on November 13, 2012 | 20 comments

In The Intelligent Investor, Benjamin Graham sums up his investment philosophy by saying that an intelligent investor must be “businesslike” in approach. Investing in shares in a company is just like owning a share in a business enterprise and the investment must be approached as if one were buying a business, or a partnership in one.

There are four guiding principles for Graham:

1. Know the business

The investor needs to become knowledgeable about the business or businesses carried on by the company in which they propose to invest – what it sells, how it operates, what is the competitive environment, what are the threats and opportunities, the strengths and weaknesses.

An investor who bought a fruit shop, or a shoe factory, without investigating these things, and knowing them, would be foolish. The same applies to share investment. An investor who does not understand the business should not be investing in it.

2. Know who runs the business

An investor who cannot operate the business for himself or herself, needs a manager. This is the position of the average share investor, who owns a share of an enterprise that is run by others.

The owner of a business in this position would want a manager who will manage the business competently, efficiently and honestly. The share investor should not be satisfied with less. Unless the investor believes, through sound research, that the company is managed efficiently, competently and honestly, in the best interests of the shareholders, the investment should not be made.

3. Invest for profits

An investor would not normally buy a business that did not, on proper research, appear to have reasonable expectations of producing good profits over time. Share investors should take the same approach and buy, as Graham says, “not on optimism, but on arithmetic”.

4. Have confidence

Graham encourages investors to properly research their investments and, if they believe their investment judgment to be sound, to act on it. He cautions investors in this position against listening to others.

“You are neither right nor wrong because the crowd disagrees with you. You are right [or wrong] because your data and reasoning are right [or wrong].”

A Plummeting Stock

You bought JCP at a higher price and now the price is dropping as sales declined more than expected, so, of course, many analysts are dropping their price targets to $15 or lower.  NOW, they tell me! Then the New York Times comes out with: http://dealbook.nytimes.com/2012/11/12/a-dose-of-realism-for-the-chief-of-j-c-penney/?ref=penneyjccompany.

You can feel the fear, anger, and despair (visit the Yahoo Finance Board for JCP to get a feel for what small investors think), because you own the company. Whom do you blame, what can you do? The only way to stop the price from going down is to turn off your screen. 🙂 

 

A Dose of Realism for the Chief of J.C. Penney  By ANDREW ROSS SORKIN

To gain a more realistic view of J.C. Penney’s prospects, however, here is the Deutsche Bank analyst Charles Grom: “Trends at J.C. Penney are obviously getting worse, not better, and we are becoming more and more convinced that sales in 2013 will also decline, which could lead to a going-concern problem next year.”  (CS Editor: OK, if that were the case would the management and Board of Directors take a different course? Slow spending, sell off assets, etc. OR is the analyst just linearly extrapolating to come up with his thesis?)

The company’s stock has fallen nearly 50 percent since the beginning of the year. Even its online sales, through jcp.com, fell 37.3 percent last quarter from a year ago.  Yet Mr. Johnson, a well-regarded and charismatic retailer who worked at Target before his meteoric rise at Apple, appears to be trying to mimic Steve Jobs and create what Mr. Jobs’s biographer, Walter Isaacson, called a “reality distortion field.”   An opinion not a fact.

Andrew Burton/ReutersRon Johnson, chief executive of J.C. Penney, says the store renovation plan is a success. Mr. Johnson has spent the last several months trying to persuade investors that his transformation of J.C. Penney was the equivalent of Mr. Jobs’s efforts to turn around Apple a decade ago.

“You know, I watched this movie before. When I joined Apple in 2000, Apple was a company dwindling. Everyone said to me, ‘What are you doing there?’ ” Mr. Johnson told investors in September. “Apple wept through 2002 and I think sales were down 38 percent as we dreamed about becoming a digital device company. But Apple invested during that downturn. That’s when Apple built, started to build its chain of stores. That’s when Apple transitioned to Intel. That’s when Apple started its app division. That’s when Apple imagined and built the first iPod.”

O.K., Mr. Johnson, but that was Apple. And J.C. Penney is not Apple — and let’s be honest, it can never be Apple. The company doesn’t make its own magical, revolutionary products that bring tears of joy to its customers. It is a low-end department store that Mr. Johnson is hoping to turn into a slightly higher-end department store that sells clothing made mostly by other manufacturers.
Still, Mr. Johnson has sought to remake the company quickly, perhaps too quickly, by eliminating promotions and discounts, moving the stores more upscale, rebranding the company as JCP and putting in place a “fair and square” pricing model. (J.C. Penney is, however, putting on a special sale for the holidays.)  Granted, JCP is no Apple, but what did Ron Johnson accomplish at Target–probably a better comparison.

Yet the renovations are hardly finished — or in some cases even started. Only 11 percent of its stores’ floor space has been remodeled with his successful specialty-store-within-a-store concept, in which he has opened up outposts for brands like Levi’s, Izod, Liz Claiborne and the Original Arizona Jean Company.
J.C. Penney may have been dying a slow death before Mr. Johnson’s arrival — some rivals used call it “death by coupon,” given the retailer’s penchant for discounts — but the company’s decline has only accelerated.

But the lessons, and successes, of the rollout of Apple stores are proving that they do not apply to Penney. While the customer experience at Apple is in a class by itself, and Mr. Johnson should rightly receive credit for that, the success of the stores was in large part a function of stunning products with a fan base that would stand outside stores for days in the rain to get their hands on them without any chance of a discount. Do you think there are customers who will ever stand outside J.C. Penney overnight for the next Liz Claiborne sweater? (J.C. Penney bought the Liz Claiborne brand last year.)

“Ron Johnson’s remake of JCP has assumed the consumer — the only one who matters — is the one who shops at Target or Macy’s or Nordstrom’s. Instead of pivoting on and strengthening the historic JCP brand (What brand?), Johnson’s decided to recreate the Target and Apple wheel, a move akin to Toyota suddenly deciding it’s Porsche. In short, a ridiculous and condescending move,” Margaret Bogenrief, a partner at ACM Partners, a boutique crisis management and distressed investing firm, recently wrote.

There is something romantic about watching Mr. Johnson try to remake a dying classic icon (So why did Sorkin call JCP a brand in the prior paragraph). At some gut level, you have to root for him. He’s making a bold bet. Transitions are inherently painful. And everyone loves a great comeback story.

Here’s the good news: In the stores that have been transformed, J.C. Penney is making $269 in sales a square foot, versus $134 in sales a square foot in the older stores. So the model itself is working. And Mr. Johnson has the support of the company’s largest shareholder, Pershing Square’s Bill Ackman, who personally recruited Mr. Johnson. If Mr. Johnson were starting with a blank slate, it might be a great business.

Mr. Ackman declined to comment. J.C. Penney did not make Mr. Johnson available.

Now here’s the bad news. Mr. Johnson still has to convert nearly 90 percent of his square feet of shopping space. That will very likely take $1 billion and as long as three years. If the sales decline that occurred last quarter accelerates, the company could run out of money. It now has about a half-billion in cash and access to a credit line for as much as $1.5 billion.

Of course, it remains possible that Mr. Johnson, who people close to him say is a realist, could always decide that the transformation is not working and change course to return to the old model of J.C. Penney and save all that money remodeling. But that would be a huge setback.

The question Mr. Johnson may be asking himself now is: What would Steve do?
A version of this article appeared in print on 11/13/2012, on page B1 of the NewYork edition with the headline: A Dose Of Realism For the Chief Of J.C. Penney.

Let’s pile on: JC Penny Down in the Rubble http://seekingalpha.com/article/1000571-down-in-its-own-rubble-the-sorry-state-of-j-c-penney

Rebuttal and Commentary from JCP’s Largest Investor

You hear and read the good, bad and the ugly, but what do YOU do?

My suggestion: I turn off the CNBC, set aside the NY Times, ignore the Wall Street Research Reports and do this:

 

But ASK yourself if the people who are commenting have ACTUALLY SHOPPED at JC Penny RECENTLY.

http://www.gurufocus.com/news/192562/jcp–a-consumer-perspective

So What is JCP worth? Forget the price today, what is the value of JCP? Since this is NOT a franchise, then this would be an asset type of investment. What is the real estate worth for JCP? I would start there and review with a critical mind  my valuation of the company.  Oh, and forget blaming anyone for the price being below your purchase price, perhaps or perhaps not, today is your luckiest day.

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Posted in Investor Psychology, Risk Management, Special Situations, Valuation Techniques, YOU

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Austrian Business Cycle Theory on the CFA Exam

Posted on November 12, 2012 | 1 comment

Austrian Business Cycle Theory on the CFA Exam

Monday,November 12th,  2012

A friend informs me that the mainstream and prestigious CFA Institute now features Austrian economics in the study materials for the Level 1 CFA Exam. The section “Theories of the Business Cycle” includes several pages on Mises and Hayek (as well as Schumpeter), and they’re pretty good. “As a result of manipulating interest rates, the economy exhibits fluctuations that would not have happened otherwise. Therefore, Austrian economists advocate limited government intervention in the economy, lest the government cause a boom-and-bust cycle. The best thing to do in the recession phase is to allow the necessary market adjustment to take place as quickly as possible.” About 100,000 people take this exam each year, and now they are all being exposed to Austrian teaching.

A quick search of the CFA Institute website turns up several Austrian-friendly items, including a chapter from the 2011 book Boombustology that opens with a quote from Mises.

—

Just remember that Wall Street will be in a shrinkage mode for many years. The low interest rates, miniscule spreads on bonds, the tiny commissions on stocks all bode ill for employment.

Market Inefficiency:

http://www.thefreemanonline.org/features/the-virtue-of-market-inefficiency-2/

…… As marvelous as the market economy is at problem solving, in a sense the real genius of the market process is in how it brings problems to people’s attention in the first place.  Before you can solve a problem, you have to be aware that there is a problem.  This, I believe, is the great insight that Israel M. Kirzner, beginning in the 1970s, contributed to our understanding of the market—in particular, that it is a process of entrepreneurial discovery of error.

One implication of this insight is that government policies that undermine the (admittedly imperfect) reliability of money prices also make the discovery of inefficiencies profoundly problematic: Undermining prices casts doubt on the very meaning of inefficiency.

Strictly speaking, an inefficiency exists when, for a given person at a given time and place, the cost of an action outweighs the benefit.  We’ve seen that to rationally calculate costs and benefits you need money prices of inputs and outputs, of steel and bridges.  So when government erodes private property rights, interferes with trade, distorts prices, and manipulates money, it doesn’t just make it harder to be efficient; it also pulls the rug out from under anyone trying to spot inefficiencies at all.

Using the rules of arithmetic, for example, it’s easy to see that the statement 1 + 2 = 4 is wrong, but what about  _ + _ = _ ?  What’s the solution to this “problem”?  Is there even a problem here?  Money prices fill in the blanks; they “create errors”—i.e., reveal mistakes that no one could see without them—that alert entrepreneurs might then perceive and correct. If mistakes and inefficiencies remain invisible, the search for better ways of doing things could never get off the ground.

An economy without inefficiencies is either one where knowledge is so perfect that no one ever makes a mistake, or it’s one in which government policy has effectively foreclosed the very possibility of inefficiency.  In a world of surprise and discovery, of experiment and innovation, the former is impossible; the latter sort of economy, as Mises showed almost 100 years ago, is impossible as well as intolerable.

So a living economy needs to “create” inefficiencies, and lots of them, to set the stage for greater efficiency and ongoing innovation.  And that’s just what the market process does all the time—thank goodness!

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Buffett: “Value” vs. “Growth” or What is a Good Investment; Info on Spins and Prizes

Posted on November 12, 2012 | 4 comments
New info on Spins

PRIZES (You can only download contents from this folder)
View this folder 
What Makes a Good Investment (Review)
Our equity-investing strategy (in 1992) remains little changed
from what it was fifteen years ago, when we said in the
1977 annual report:
"We select our marketable equity securities in much the way
we would evaluate a business for acquisition in its entirety.
We want the business to be one
a) that we can understand;
b) with favorable long-term prospects;
c) operated by honest and competent people; and
d) available at a very attractive price."
We have seen cause to make only one change in this creed:
Because of both market conditions and our size,
we now substitute "an attractive price" for "a very attractive price."
 But how, you will ask, does one decide what's "attractive"?  
 In answering this question, most analysts feel they must choose
between two approaches customarily thought to be in opposition:
"value" and "growth."  Indeed, many investment professionals see
any mixing of the two terms as a form of intellectual cross-
dressing.


     We view that as fuzzy thinking (in which, it must be


confessed, I myself engaged some years ago).  In our opinion, the


two approaches are joined at the hip:  Growth is always a component


in the calculation of value, constituting a variable whose


importance can range from negligible to enormous and whose impact


can be negative as well as positive.




     In addition, we think the very term "value investing" is


redundant.  What is "investing" if it is not the act of seeking


value at least sufficient to justify the amount paid?  Consciously


paying more for a stock than its calculated value - in the hope


that it can soon be sold for a still-higher price - should be


labeled speculation (which is neither illegal, immoral nor - in our


view - financially fattening).




     Whether appropriate or not, the term "value investing" is


widely used.  Typically, it connotes the purchase of stocks having


attributes such as a low ratio of price to book value, a low price-


earnings ratio, or a high dividend yield.  Unfortunately, such


characteristics, even if they appear in combination, are far from


determinative as to whether an investor is indeed buying something


for what it is worth and is therefore truly operating on the


principle of obtaining value in his investments.  Correspondingly,


opposite characteristics - a high ratio of price to book value, a


high price-earnings ratio, and a low dividend yield - are in no way


inconsistent with a "value" purchase.




     Similarly, business growth, per se, tells us little about


value.  It's true that growth often has a positive impact on value,


sometimes one of spectacular proportions.  But such an effect is


far from certain.  For example, investors have regularly poured


money into the domestic airline business to finance profitless (or


worse) growth.  For these investors, it would have been far better


if Orville had failed to get off the ground at Kitty Hawk: The more


the industry has grown, the worse the disaster for owners.




     Growth benefits investors only when the business in point can


invest at incremental returns that are enticing - in other words,


only when each dollar used to finance the growth creates over a


dollar of long-term market value.  In the case of a low-return


business requiring incremental funds, growth hurts the investor.




     In The Theory of Investment Value, written over 50 years ago,


John Burr Williams set forth the equation for value, which we


condense here:  The value of any stock, bond or business today is 


determined by the cash inflows and outflows - discounted at an 


appropriate interest rate - that can be expected to occur during 


the remaining life of the asset.  Note that the formula is the same


for stocks as for bonds.  Even so, there is an important, and


difficult to deal with, difference between the two:  A bond has a


coupon and maturity date that define future cash flows; but in the


case of equities, the investment analyst must himself estimate the


future "coupons."  Furthermore, the quality of management affects


the bond coupon only rarely - chiefly when management is so inept


or dishonest that payment of interest is suspended.  In contrast,


the ability of management can dramatically affect the equity


"coupons."




     The investment shown by the discounted-flows-of-cash


calculation to be the cheapest is the one that the investor should


purchase - irrespective of whether the business grows or doesn't,


displays volatility or smoothness in its earnings, or carries a


high price or low in relation to its current earnings and book


value.  Moreover, though the value equation has usually shown


equities to be cheaper than bonds, that result is not inevitable:


When bonds are calculated to be the more attractive investment,


they should be bought.




     Leaving the question of price aside, the best business to own


is one that over an extended period can employ large amounts of


incremental capital at very high rates of return.  The worst


business to own is one that must, or will, do the opposite - that


is, consistently employ ever-greater amounts of capital at very low


rates of return.  Unfortunately, the first type of business is very


hard to find:  Most high-return businesses need relatively little


capital.  Shareholders of such a business usually will benefit if


it pays out most of its earnings in dividends or makes significant


stock repurchases.




     Though the mathematical calculations required to evaluate


equities are not difficult, an analyst - even one who is


experienced and intelligent - can easily go wrong in estimating


future "coupons."  At Berkshire, we attempt to deal with this


problem in two ways. First, we try to stick to businesses we


believe we understand. That means they must be relatively simple


and stable in character.  If a business is complex or subject to


constant change, we're not smart enough to predict future cash


flows.  Incidentally, that shortcoming doesn't bother us.  What


counts for most people in investing is not how much they know, but


rather how realistically they define what they don't know.  An


investor needs to do very few things right as long as he or she


avoids big mistakes.




     Second, and equally important, we insist on a margin of safety


in our purchase price.  If we calculate the value of a common stock


to be only slightly higher than its price, we're not interested in


buying.  We believe this margin-of-safety principle, so strongly


emphasized by Ben Graham, to be the cornerstone of investment


success. (Source: 1992 Letter to Shareholders of Berkshire Hathaway)


 

							

	
			

					
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Obama, What Now?  From Trader to Investor


			

				Posted on November 8, 2012 | 6 comments
			


				

				


Obama Is Elected


The “progressive” vision of a populace dependent on a central government and a European-style welfare state is now at hand. We march on the road to serfdom.


OK, so what can we learn and do? First, educate yourself in the benefits of liberty and free markets, then live your life as best you can. Be an example to others.  As an investor, note how hospital stocks were up (yesterday) overall 9%. Industry leader HCA Holdings Inc. is up nearly 10% . Tenet Healthcare Corp. is up 9% to $27.21. Health Management Associate gained 8%  and Community Health Systems rose by 6.4%.  Medicare and Medicaid insurers were also up. Centene Corp. is up 10% . WellCare climbed 4%. Molina Healthcare Inc.  also rose 3.16%.


But in the long-run (three to five years) these companies will be like the protected airlines during the era of the CAB–bureaucratic, sloppy and inefficient. You are better to look for winners in a market that is being deregulated and short the losers. When airlines became deregulated you wanted to own Southwest (low-cost operator) while shorting Eastern Airlines, American, Northwest Airlines, etc. I would rather short those companies as a hedge once they become fat and happy.


Lessons to learn


The book link: bureaucracy

Mises explains that the core choice we face is between rational economic organization by market prices or the arbitrary dictates of government bureaucrats. There is no third way. And here he explains how it is that bureaucracies can’t manage anything well or with an eye for economics at all. It is a devastating and fundamental criticism he makes, an extension of his critique of socialism. It has never been answered.


See the book: Omnipotent Government_Mises

At the close of the Second World War, Mises saw the destruction of the old world and the beginnings of a new one that did not look promising, especially for European politics. Socialism appeared to sweep all before it, and the social democratic variety in the West was not much of an improvement. Mises set out to explain and bitterly denounce the trends toward the total state, and demonstrate that Communism and Nazism were two sides of the same coin.


My Story: From Trader to Investor


At a reader’s request, I will relate my evolution from a commodity trader to a value investor. I started as a trader of physical (real) sugar to a futures trader at the MidAm. I have always been fascinated by markets or the interaction of economics with psychology which I now recognize as human action. I caught a big bull move in grains/soybeans in 1988. I learned that the money is made by riding big moves not by scalping or buying at the bid of 6.01 and selling at $6.02. I moved off the floor to trade upstairs because even then you could foresee that the trading pits would be turned into a food court or be eliminated.


Also, can you see doing this 6 hours a day? There are no old, bold traders. 


 


The problem is that you need to trade big moves to make money and in trendless markets you trade against the commercial traders who have the edge. If you don’t have an edge then you are the sucker. Best to pull on the slot machines for fun. About 1988, I read about the Texaco Bankruptcy (see below) and looked at their balance sheet. Texaco bonds were trading at 70 cents on the dollar but the company had more than enough assets to pay 100 cents on the dollar.  Wow, I thought, I can buy a dollar for 70 cents. Sure enough the bonds went lower to 60 cents, but I made decent returns within a year. I wanted to go where the edge was greater or where the markets more mis-priced.  Of course, you don’t have the 10-1 leverage that you do in futures but leverage will only get you to failure faster if you don’t have a verifiable edge.


So I began to read as many books on investing that I could–only Graham, Buffett and Klarman seemed to make sense. I took time out to start an Internet company with a friend (www.art.com) and others, then returned to audit investment classes at Columbia Graduate School of Business. The real learning occurs when you apply what you have learned to the harsh reality of the markets.


I have travelled a ways but have much further to go in my learning journey.


Texaco Increases Estimate Of 1987 Loss to $4.9 Billion


By STEPHEN LABATON, Special to the New York Times Published: January 28, 1988




Texaco Inc. said today that it would report a loss of more than $4.9 billion for 1987 as a result of its restructuring and the settlement of its legal dispute with the Pennzoil Company.


In a document filed with the bankruptcy court here last month, Texaco had estimated a 1987 loss of $2.79 billion. The revised figure reflects a $2.1 billion write-down of the value of certain assets.


The company also said it faces $2.1 billion in claims from the Department of Energy, which has accused Texaco of overcharging for crude oil from 1973 to 1981, when price controls were in effect. Earlier this month, Texaco disclosed that the Internal Revenue Service might seek $6.5 billion in back taxes.


The company’s lawyers have contended that the claims by the Energy Department and the I.R.S. are highly inflated. Texaco insiders said yesterday that, even if the Government prevailed, the company had adequate financing to cover most of the claims. The claims are not expected to hold up the bankruptcy proceedings. The company hopes to emerge from bankruptcy this spring.








The stock market did not react strongly to today’s disclosures. In composite trading on the New York Stock Exchange, shares of Texaco closed at $37.875, down 87.5 cents.


The Federal claims and revised income figures appeared in a newly filed version of Texaco’s disclosure statement, a document being prepared to help shareholders decide whether to support or reject Texaco’s $5.6 billion restructuring plan. The plan must win approval by holders of two-thirds of Texaco’s shares, voting in a monthlong election.


Texaco entered bankruptcy proceedings last April after it lost a Supreme Court appeal over whether it had to post a bond of more than $10 billion to continue contesting the Pennzoil award.


A Texas jury in 1985 said Texaco’s acquisition of the Getty Oil Company had improperly interfered with a merger agreement between Pennzoil and Getty. Pennzoil was awarded $10.3 billion. As part of the reorganization, the Pennzoil claim would be settled for $3 billion.


At a hearing today in Federal Bankruptcy Court, the Securities and Exchange Commission questioned the adequacy of the proposed disclosure statement. Nathan M. Fuchs, a lawyer from the S.E.C.’s New York office, told a Federal bankruptcy judge that the statement failed to describe adequately the 16 stockholder derivative lawsuits that have been filed in New York, Delaware and Texas.


Most of the lawsuits accuse Texaco executives of mismanagement and have sought to recoup the money Texaco will lose in the Pennzoil dispute. Getty Executives Named


Several of the stockholder derivative suits also filed claims on behalf of Texaco against former executives at Getty and the J. Paul Getty and Sarah Getty trusts, both of which held large amounts of Getty stock.


Some of the suits also name as defendants the First Boston Corporation and Goldman, Sachs & Company. The two investment banks provided advice during Texaco’s negotiations with Getty. The suits charge that the advice led to the acquisition that sparked the dispute between Texaco and Pennzoil.


As part of Texaco’s reorganization plan, the company has said it will drop all of these derivative actions and will shield all of its employees from legal liability.


But Mr. Fuchs of the S.E.C. and three shareholders’ lawyers asserted at the hearings that Texaco had not provided an adequate explanation in the statement about why the company would want to drop a potentially valuable asset such as the right to assert claims against other parties. Statement From Lawyer


”The shareholders might actually be strengthened if they recovered $3 billion,” Mr. Fuchs said. ”The biggest weakness of the disclosure statement is that it does not say how Texaco can conclude that these derivative cases are without merit.”


After the hearing, a Texaco lawyer said the company was in discussions with the S.E.C. and expected to change the disclosure statement. ”If Mr. Fuchs is not satisfied, then we will continue to work with him until he is,” said the lawyer, Francis Barron.


Melvyn I. Weiss, a lawyer repesenting shareholders in one of the derivative suits, told Federal Bankruptcy Judge Howard Schwartzberg that the sole reason Texaco executives had decided to drop the derivative cases was to protect themselves.


”Texaco’s management is involved in a conflict of interest,” he said. Seeking an End to Litigation


Harvey R. Miller, Texaco’s lead bankruptcy lawyer, said the decision to drop the derivative suits was an effort ”to finally put an end to all the litigation in the case.” Lawyers for Pennzoil and the committee of Texaco creditors said they supported Texaco’s moves to drop the derivative suits and indemnify company executives.


Judge Schwartzberg requested that the shareholders’ lawyers meet with Texaco to propose new language for the statement. Another hearing will be held on the disclosure statement on Friday.


In an important amendment to the earlier disclosure statement, Texaco reserved the right to request that the judge approve the reorganization even if the plan is rejected by shareholders.


Conspicuously absent from the new disclosure statement were any objections by Carl C. Icahn, the chairman of Trans World Airlines Inc. and Texaco’s largest shareholder. Last week, a court ruled against Mr. Icahn’s effort to present his own plan to Texaco shareholders. The Icahn plan would have stripped Texaco of its takeover defenses.


David Friedman, a lawyer for Mr. Icahn, said his client was re-evaluating his earlier position and had not yet decided his next move.


The disclosure statement also estimated that Texaco would earn $626 million in 1988, $729 million in 1989, $941 million in 1990, $1.1 billion in 1991 and $1.2 billion in 1992.



							

	
			

					
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Graham on Growth-Stock Investing Part II


			

				Posted on November 7, 2012 | 3 comments
			


				

				
Part 1 of Graham’s Chapter 39 Newer Methods for Valuing Growth Stocks (Security Analysis 4th Ed.: http://wp.me/p2OaYY-1qQ


Also, what Graham said prior to this chapter on growth-stock investing:Growth in 2nd Edition


We will have another valuation case study next post to break-up this fusty theory.   Read on.


Part 2: Valuation of DJIA in 1961 by this method.






In a 1961 article, Molodovsky selected 5 percent as the most plausible growth rate for DJIA in 1961- 1970. This would result in a ten-year increase of 63 percent, raise earnings from a 1960 “normal” of say, $35 to $57, and produce a 1970 expected price of 765, with a 1960 discounted value of 365. To this must be added 70 percent of the expected ten-year dividends aggregating about $300—or $210 net. The 1960 valuation of DJIA, calculated by this method, works out at some $575. (Molodovsky advanced it to $590 for 1961.)


Similarity with Calculation of Bond Yields


The student should recognize that the mathematical process employed above is identical with that used to determine the price of a bond corresponding to a given yield, and hence the yield indicated by a given price. The value, or proper price, of a bond is calculated by discounting each coupon payment and also the ultimate principal payment to their present worth, at a discount rate of required return equal to the designated yield. In growth-stock valuation the assumed market price in the target year corresponds to the repayment of the bond at par at maturity.


Mathematical Assumptions Made by Others


While the calculations used in the DJIA example may be viewed as fairly representative of the general method, a rather wide diversity must be noted in the specific assumptions , or “parameters,” used by various writers. The original tables of Clendenin and Van Cleave carry the growth-period calculations out as far as 60 years. The periods actually assumed in calculations by financial writers have included 5 years (Bing) , 10 years (Molodovsky and Buckley), 12 to 13 years (Bohmfalk), 20 years (Palmer and Burrell), and up to 30 years (Kennedy) . The discount rate has also varied widely –from 5 percent (Burrell) to 9 percent (Bohmfalk).


The Selection of Future Growth Rates


Most growth-stock valuers will use a uniform period for projecting future growth and a uniform discount or required-return rate, regardless of what issues they are considering (Bohmfalk, exceptionally divides his growth stocks into three quality classes, and varies the growth period between 12 and 13 years, and the discount rate between 8 and 9 percent, according to class.) But the expected rate of growth will of course vary from company to company. It is equally true that the rate assumed for a given company will vary from analyst to analyst.

It would appear that the growth rate for any company could be established objectively if it were based entirely on past performance for an accepted period. But all financial writers insist, entirely properly, that the past growth rate should be taken only as one factor in analyzing a company and cannot be followed mechanically in setting the growth rate for the future. Perhaps we should point out, as a cautionary observation, that even the past rate of growth appears to be calculated in different ways by different analysts.


Multiplier Applied to “Normal Earnings”


The methods discussed produce a multiplier for a dollar of present earnings. It is applied not necessarily to the actual current or recent earnings, but to a figure presumed to be “normal”—i.e., to the current earnings as they would appear on a smoothed-out earning curve. Thus the DJIA multipliers in 1960 and 1961 were generally applied to “trend-line” earnings which exceeded the actual figures for those years—assumed to be “subnormal.”


Dividends vs. Earnings in the Formulas. A Simplification


The “modern” methods of growth—stock valuations represent a considerable departure from the basic concept of J.B. Williams that the present value of a common stock is the sum of the present worths of all future dividends to be expected from it. True, there is now typically a ten-to-twenty – year dividend calculation, which forms part of the final value. But as the expected growth rate increased from company to company, the anticipated payout tends also to decrease, and the dividend component loses in importance against the target year’s earnings.


Possible variations in the expected payout will not have a great effect on the final multiplier. Consequently the calculation process may be simplified by assuming a uniform payout for all companies of 60 percent in the next ten years. If T is the tenth-year figure attained by $1 of present earnings growing at any assumed rate, the value of the ten-year dividends works out at about 2.1 + 2.1 T. The present value of the tenth-year market price works out at 48 percent of 13.5T, or about 6.5T. ? Hence the total value of $1 of present earnings –or the final multiplier for the shares—would equal 8.6T + 2.1.


Table 39-1 gives the value of T and the consequent multipliers for various assumed growth rates.


Growth Rate Tenth-year earnings (T) Multiplier of present earnings (8.6T + 2.1)

2.5%     $1.28      13.1x

4.0          1.48       14.8x

5.0          1.63       16.1x

6.0          1.79       17.5x

7.2          2.00      19.3x

8.0         2.16       20.8x

10.0       2.59       24.4x

12.0       3.11        28.8x

14.3       4.00       36.5x

17.5       5.00        45.1x

20.0      6.19         55.3x


These multipliers are a little low for the small growth rates, since they assume only a 60% payout. By this method the present value is calculated entirely from the current earnings and expected growth; the dividend disappears as a separately calculated factor. This anomaly may be accepted the more readily as one accepts also the rapidly decreasing importance of dividend payments in the growth-stock field.

To be continued……


An Apparent Paradox in Growth Stock Valuations

							

	
			

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


			

				Posted on November 6, 2012 | 7 comments
			


				

				


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


Our Nation Today




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


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


Investment vs. Speculation


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


Below are several case studies by Fairholme:



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


Try not to be swayed by stories but by facts.


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


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


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


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


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


Ponzi Finance






Carlo   Ponzi, Alias Uncle Sam by Gary North Reality Check(Nov. 2, 2012)Carlo “Charles” Ponzi was a con man who was the Bernie Madoff of his era. For two years, 1918 to 1920, he sold an impossible dream: a scheme to earn investors 50% profit in 45 days. He paid off old investors with money generated from new investors. The scheme has been imitated every since.Every Ponzi scheme involves five elements:1. A promise of statistically impossible high returns

2. An investment story that makes no sense economically

3. Greedy investors who want something for nothing

4. A willing suspension of disbelief by investors

5. Investors’ angry rejection of exposures by investigatorsStrangely, most Ponzi schemes involve a sixth element: the   unwillingness of the con man to quit and flee when he still can. Bernie Madoff is the supreme example. But Ponzi himself established the tradition.


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


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


All fractional reserve banking is a Ponzi scheme.

All central banking is a Ponzi scheme.

All government retirement programs are   Ponzi schemes.

All government-funded medicine is a Ponzi scheme.

All empires are Ponzi schemes.

All Keynesian economics is a Ponzi scheme.


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


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


 







 

							

	
			

					
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Bob, the Suicide Trader, A Lesson in Ego


			

				Posted on November 5, 2012 | 5 comments
			


				

				


Part 1 (Bob, Suicide Trader)  Scroll down http://blog.marketpsych.com/2012/10/resentment-investing-soros-emotional.html


Part 2 (Bob, Suicide Trader) http://blog.marketpsych.com/2012/11/hurricane-psychology-buying-pessimism.html


Moral: Don’t let your ego crush you.


My Experience


John Chew: I was once a pit trader at the Open Board of Trade in Chicago (MidAM, today)




Yes, that type of pit. I remember the other traders nicknames like Little Man (the guy was 6′ 4″ and 310 pounds), Dog Face, Pretty Boy, Ice Man (He traded 1,000 lots of Bonds or $100 million of US 30-years bonds at a crack), and Sun Tan (An Albino).


Never will I forget when an older trader clutching his chest, crumpled into the center of the trading pit while having a heart attack. No one moved to help, they were too busy trading. In fact, side bets immediately went up for $500–was he or wasn’t he going to make it out of the pits alive.  “For God’s sake, is anyone going to call for an ambulance?” a female trading clerk screamed.


I knew one trader (Joey D) who took $4,000 up to $370,000 in six months during the 1988 bull market in soybeans. He used leverage upon leverage and caught a massive bull run. He was going to get married but the trend changed. Joey D knew enough to take losses but buying rallies and selling dips in a choppy market is a losing strategy, but momentum trading had been imprinted upon him during the massive rally in beans.


As his account dwindled, his self-worth declined perhaps even faster. As he said to me, “If the account goes to $0, then I will be worth $0. Got any way to commit suicide painlessly? I sat at the bar explaining that it was only money; take a break and besides, killing oneself ain’t easy. Joey said that he couldn’t pay for the wedding; he would have to postpone; his fiance left him three weeks later–“I guess adversity wasn’t her thing,” Joey lamented.


Joey D’s fears began to mount until he finally blew out and had to leave trading for himself. His last day as a pit trader (local) all the other traders gave him a wide berth like he had leprosy since most traders are superstitious. I asked him how he felt and he said, “You know, I have never felt so free and relieved in my life. I feared this and I feared that. My fiance left, but perhaps that was a good thing. Who needs a gold-digger? The sun still came up, the birds still chirp and the Cubs are playing today at Wrigley. Most of my problems were all in my head.


Joey left to work as a broker before two years later returning to a successful career. Hope you are well Joey D.


 

							

	
			

					
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Einhorn on the Fed; Lecture on Cause of Financial Crises by De Soto


			

				Posted on November 5, 2012 | 4 comments
			


				

				
Einhorn on the Fed’s Insane Policy




Editor: Mr. Einhorn recognizes the dangers of the Federal Reserves Zero (manipulative) Interest Rate Policy. Where I take a different view is that the Fed’s Zero interest rate policy hurts savers and thus capital accumulation. Less capital hurts productivity and future economic growth. Regardless, no centrally planned economy has ever worked so why expect the Fed’s manipulated price control of interest rates to not end in tears? I do agree with Einhorn’s assessment of Bernanke’s theory of lowering interest rates to increase the “wealth” effect. Only a Ph.D can lack so much common sense.


Klarman ain’t happy either: http://www.businessinsider.com/seth-klarman-goes-nuts-on-the-fed-2012-10


Those guys have been reading csinvesting or von Mises.


Dr. De Soto on the Cause of the Current Financial Crises




Jesús Huerta de Soto, author of the thought-provoking book on economics ‘Money, Bank Credit and Economic Cycles’ and Professor of Political Economy at Rey Juan Carlos University, Madrid, explains the motivations behind British Prime Minister Robert Peel’s Bank Act of 1844. Prior to this Act, the free issuance of bank notes with claims on gold bullion wasn’t limited by British law, resulting in wild economic cycles that often led to bank runs and large gold flows out of the country as foreigners sought to exchange claims on gold for actual bullion.


He discusses why Robert Peel’s Bank Act of 1844 was a failure, despite its good intentions. Although the Act placed legal limits on banks’ issuance of paper notes, its failure to place the same limits on deposits allowed banks to pyramid deposits, which ultimately led to the fractional reserve banking that we have today.


The professor also explains the problem with the practice of fractional reserve banking, and why it leads to credit expansion that ultimately results in “boom and bust” economic cycles. “Virtual money” that is created easily by banks in the process of credit expansion during the boom contracts just as easily during the bust, resulting in recession.


Furthermore, he discusses the importance of capital theory and the nexus between interest rates, savings and prices. Huerta de Soto argues that Austrian Business Cycle Theory offers the best explanation of how and why economic cycles work, and the best explanation of the pay-offs between present consumption and long-term investment.


Also, he explains how artificial credit expansion leads to a temporary economic boom, and why it inevitably results in recession. Huerta de Soto uses the example of his native Spain, and how European Central Bank credit expansion distributed unevenly around the Eurozone, resulting in housing bubbles in periphery Eurozone countries like Spain, Greece and Ireland.


He lists the six microeconomic effects that result in the crack-up boom. Crucially, credit expansion leads to over-investment in capital goods. The credit expansion leads to first rising prices and then higher interest rates, and thus lower prices for capital goods. There are not enough real savings to support the demand for the increased number of capital goods, leading to recession.


The professor questions why central banks even exist, and why there is no free market in interest rates and money supply. Huerta de Soto wonders why people are happy with socialism for the banking system, and why more people are not correctly blaming central banks and fractional reserve banking for the financial crisis.


Huerta de Soto also explains why recessions are a necessary corrective to the excesses of the boom period. Huerta de Soto argues that in his native Spain, job losses in the construction and housing sector are necessary owing to over-investment in housing during the boom. He also criticises “stupid” politicians who thought that they had abolished boom-and-bust.


He criticises those who argue that currency devaluation is a cure for the recession, and argues that his native Spain is far better off with the euro than the peseta. Huerta de Soto argues that the euro is forcing politicians and the public to make honest choices about spending and is acting, beneficially, as a kind-of gold standard.


Further he argues that the European response to the financial crisis is preferable to the wildly expansionary policies chosen by the United States. Huerta de Soto argues that for this reason, he is more optimistic about the euro than the dollar.


Huerta de Soto wraps up with three key measures needed to improve our financial system. First, Peel’s Bank Act needs to be completed which means a 100% reserve is required for demand deposits. Second, central banks need to be abolished. And lastly, the issuance of money should be privatised, leading to a free gold standard.


Bank Runs




Another Ponzi Scheme: http://www.huffingtonpost.com/2012/11/04/donald-french-ponzi-scheme-youngest-actor_n_2070515.html

							

	
			

					
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Behavioral Finance: The Politics (Investing) of Delusion


			

				Posted on November 2, 2012 | 7 comments
			


				

				


The ignorant mind, with its infinite afflictions, passions, and evils, is rooted in the three poisons, Greed, anger, and delusion–Bodhidharma


The Politics of Delusion 


 


Notice any psychological traps for an investor? Beside anchoring and rationalization?


Don’t forget to sign up for David Kessler’s GREAT Value Investing Newsletter email him at kessler@robotti.com to receive news, free course links and brilliance.

							

	
			

					
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Normalizing Cisco; Greenwald Notes on Growth Investing; Graham’s Advice to an Analyst


			

				Posted on November 1, 2012 | 3 comments
			


				

				


Century Management Video Presentation October 2012


Valuing Csco: http://youtu.be/vf2bBV-YSYg?t=24m20s   


The presentation is short and leaves out many details, but using the last crises in 2008/2009 as a marker or stress test for how the business will fare in tough times is a technique you can use.


Greenwald’s Notes on Growth Investing


Intro to VI Valuing Growth 2007      


Ben Graham’s Words of Wisdom for Aspiring Security Analysts


The qualified analyst, he wrote, would: possess “good character.” To him, the word “character” captures not just how you act but how you think. ”Character” is a synonym for “rationality.”  Graham explains how he uses the word, “intelligent” as meaning “endowed with the capacity for knowledge and understand.” It will not be taken to mean “smart” or “shrewd,” or gifted with unusual foresight or insight. Actually the intelligence described is a trait more of character than of the brain.


And, in 1976, he summed up investing with these words:


“The main point is to have the right general principles and the character to stick with them.”


“An analyst,” Graham said, “must possess good character and have a hunger for objective evidence, an independent and skeptical outlook that takes nothing on faith (especially one’s own beliefs), the patience and discipline to stick to your own convictions when the market insists that you are wrong, and serene imperturbability—the ability to stay calm and keep your head when all investors about you are losing theirs.


Graham’s advice to young analysts:


I would tell them to study the past record of the stock market, study their own capabilities, and find out whether they can identify an approach to investment they feel would be satisfactory in their own case. And if they have done that, pursue that without any reference to what other people do or think or say. Stick to their own methods.


Editor: Great advice, though tough to follow consistently with our human frailties.


A great post on Buffett Partnership Performance


http://www.oldschoolvalue.com/blog/special_situation/how-buffett-made-money-in-bad-and-volatile-markets/


Good Book on Capitalism: The Case for Legalizing Capitalism  By the way, what’s capitalism?


 

							

	
			

					
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