Tag Archives: Tweedy Browne

Michael Lewis: Pointless Skeptics (Derivatives, 2007), Management Fee

trump-vs-clinton

In 2007, Michael Lewis laughed off concerns about derivatives and excessive leverage

I enjoyed Michael Lewis’ recent Daily Show interview about his new book, The Big Short. Lewis summarized the crisis nicely and mocked the ignorance of most of the banking world, saying they hid the risk so well they fooled even themselves.

But Lewis faltered when he said almost no one saw the financial crisis coming. Lewis said “A very small handful of investors, I mean, ten to twelve, made a giant bet against [subprime mortgages]” and virtually everyone else on Wall Street was “dumb money”:

“They [financial institutions] figured out there’s an awful lot of money to be made lending money to people who shouldn’t be lent money. And when you do that, you create lots of risk. And the only way you get that risk out [of your firm] and get other people to take it is to disguise it. So they got really good at disguising the risk, and they got so good they disguised it from themselves, they fooled themselves.

Lewis apparently fooled himself too because, in January 2007, Bloomberg reporter Michael Lewis wrote an entire article — titled “Davos Is for Wimps, Ninnies, Pointless Skeptics” — complaining about all the foolish worry at Davos over excessive risk-taking and derivatives contracts:

It’s become almost obligatory for the world’s most important economic people, at the beginning of each year, to travel joylessly to the base of a Swiss ski slope and worry…. Davos is where people with no talent for risk-taking gather to imagine what actual risk-takers might do. Davos Man needs to sit in judgment; Davos Man needs to brood. So great is this need that he will brood about virtually anything, no matter how little he knows about it.

Ah, Michael? How much did you know about derivatives or bank leverage ratios in 2007? You sat in judgment of many of the world’s top financial experts and mocked them for their ignorance when, it turns out, they were right and you were wrong. Look at the insiders whose worry you mocked:

“The system is becoming very complex. The risk of some crisis happening is rising,” says Nouriel Roubini, chairman of Roubini Global Economics. “The world isn’t pricing risk appropriately,” says Steven Rattner, co-founder of Quadrangle Group. “Excessive borrowing and risk-taking,” intones Juergen Stark, chief economist for the European Central Bank.

“The last time we talked,” says William Rhodes, senior vice chairman of Citicorp Inc. (in case you didn’t hear him the first time), “I mentioned we’re going to get some adjustments some time in the future. So this is a time to be prudent.”

..So why do these people waste so much of their breath and, presumably, thought, with their elaborate expressions of concern? Even if these global financial elites knew something useful that you and I don’t — that, say, 50 hedge funds were about to go under and drag with them half the world’s biggest banks along with a third of the Third World — they would be unlikely to do anything about it.

Lewis especially mocked Davos’ concerns about explosive growth in (completely unregulated) derivative contracts:

Derivatives seem to be this year’s case in point. Davos had hardly been up and groaning about the dangers of being alive before Bloomberg News reported what appears to be the general Davosian view: “The surging demand for derivatives is making financial markets more vulnerable to any slowdown in the global economy.”

The piece came with supporting quotes from European Central Bank President Jean-Claude Trichet, Bank of China Vice President Zhu Min and the deputy chief of India’s planning commission, Montek Singh Ahluwalia — but not a worrisome fact in sight. None of them seemed to understand that when you create a derivative you don’t add to the sum total of risk in the financial world; you merely create a means for redistributing that risk. They have no evidence that financial risk is being redistributed in ways we should all worry about. They’re just — worried.

But the most striking thing about the growing derivatives markets is the stability that has come with them.

Now, I realize we all make mistakes. Most of us occasionally make really, really big mistakes. Perhaps we even publicly ridicule everyone else for making a serious mistake when, in fact, they’re right and we’re wrong.

But, if we make a huge mistake, laugh at others for being wiser and more prudent, and later write about how stupid “everyone” was for making the mistake we made, that’s intellectually dishonest. Lewis complained very publicly that the world’s financial experts were idiots for worrying about leverage and derivatives… then he turned around several years later and pretended only a handful of brilliant investors saw the crisis coming while everyone else was blind to the dangers. Which Michael Lewis should we believe?

Lewis should express humility and contrition for so falsely slamming those concerned about leverage and derivatives. His opinion matters, especially when he is writing for Bloomberg. And he should stop pretending that only a handful of people saw the crisis coming because he himself told us otherwise just a few years ago.

Posted by James on Thursday, March 18, 2010

The Greats Struggle

Who can tell me why? q316-longleaf-partners-funds-shareholder-letter and fundcommentary-q3-2016-final   What should your management fee be to solve their underperformance problems?

One More Time on Facebook Investor Psychology and Valuation

The budget should be balanced, the treasury should be refilled, public debt should be reduced, the arrogance of officialdom should be tempered and controlled, and the assistance to foreign lands should be curtailed lest Rome become bankrupt.

– Cicero, 55 B.C.

As expected, investors who either did not know what they were doing or refuse to acknowledge that they paid too much, seek to absolve themselves of responsibility and blame others: http://www.nypost.com/p/news/business/facebook_claims_

Facebook CEO knew about overpriced IPO and dumped shares, new lawsuit claims

Mark Zuckerberg is losing even more friends.

Another group of disgruntled Facebook investors has reportedly sued the the social media guru, saying he made out like a bandit over the site’s botched IPO.

This latest class-action lawsuit claims Zuckerberg knew Facebook was horribly overpriced at $38 per share when trading began last month, TMZ reported today. He used that inside information to quickly unload shares, in a dirty billion-dollar move, the lawsuit claimed. FB closed at $27.72 a share and was down 27 percent since going public this past Friday.

Editor: Surprise! Insiders were selling on an IPO.  Of course, they believe the price is high enough to exchange shares for cash. Investors who do not shoulder their responsibility then lessons are lost and they can’t improve.

 Valuation of Facebook’s Growth

Tweedy Browne did a good job placing Facebook’s (FB) valuation in perspective. Go to i-7 of their annual report: TBFundsAnnualReportMarch2012 and an interview of Tweedy’s principals:VIIFundReprint_033112

As you can see in the above chart, you could buy roughly the same amount of earnings that Facebook produced in 2011 by simply buying Heineken Holdings for $13.5 billion, and you would then have $86.5 billion left over to go shopping for other companies in our Funds’ portfolios. For the remaining $86.5 billion, you could buy Emerson Electric, Devon Energy, G4S PLC, Torchmark, NGK Sparkplug, Daily Mail, and Teleperformance, and still have roughly $700 million in walking around money. When all is said and done, for Facebook’s IPO price, you could purchase the above group of leading companies in their respective fields at a price/earnings ratio of 10.4 times estimated earnings. As a group, these companies produced nearly ten times the earnings of Facebook in 2011, and paid dividends of over $2 billion. According to our calculations, Facebook would have to compound its current earnings at an annual rate of approximately 35% over the next ten years to catch up to the amount of earnings produced by the selected companies held in the Tweedy, Browne Funds, which are compounding their earnings at a more realistic 7% per year.

Now, it might very well turn out that Facebook performs as expected and compounds at even more attractive rates, producing superior returns when compared to the stocks selected above from the Tweedy, Browne Funds’ portfolios, but the stakes are high given the lofty IPO price. Very high expectations are built into stocks that trade at 100 times earnings. If it disappoints, the results for its investors could be disastrous.

Lest we forget, just six years ago, media and tech savvy News Corp., run by Rupert Murdoch, a rather shrewd investor, acquired MySpace, then the most popular social networking site in the US for $580 million, which valued the company at over 100 times earnings. Last summer, after a string of disappointments and corporate losses, News Corp. sold MySpace for $35 million to a company fronted by Justin Timberlake. At the time of the sale, MySpace had approximately 35 million users, which meant a purchase price of roughly $1 per user. Applying that metric to Facebook would give it a valuation of approximately $1 billion instead of the $100 billion, which is anticipated for the red hot IPO. News Corp. experienced a permanent loss of capital on its MySpace investment of 94%. From all indications, few expect Facebook to be such a flash in the pan. After all, it’s hard to question its efficacy at bringing people together, and in some instances it has even been a catalyst for political revolutions such as the Arab Spring. That said, expectations are extraordinary, and anything less than spectacular growth going forward could lead to disappointing stock market performance.

For us, Facebook serves as a convenient reminder that stock market prices can and do at times become significantly delinked from underlying value.

Inflation, Price Controls and Rome; Tweedy Browne, TAVF

My last mention of the Roman Empire, http://wp.me/p1PgpH-vM.

The fall of the Roman Empire ushered in the Dark Ages (Wow! Now THAT is a bear market–an age of fear, despair, fiefdoms, and darkness)  http://en.wikipedia.org/wiki/Dark_Ages_(historiography)

If Only Edward Gibbon Could Have Read Mises

By Daniel J. Sanchez at www.mises.org

Monday, June 4th, 2012

Thanks to Ed Smith for pointing out this passage in the Decline of the Rome Wikipedia article:

Historian Michael Rostovtzeff and economist Ludwig von Mises both argued that unsound economic policies played a key role in the impoverishment and decay of the Roman Empire. According to them, by the 2nd century AD, the Roman Empire had developed a complex market economy in which trade was relatively free. Tariffs were low and laws controlling the prices of foodstuffs and other commodities had little impact because they did not fix the prices significantly below their market levels. After the 3rd century, however, debasement of the currency (i.e., the minting of coins with diminishing content of gold, silver, and bronze) led to inflation. The price control laws then resulted in prices that were significantly below their free-market equilibrium levels. It should, however, be noted that Constantine initiated a successful reform of the currency which was completed before the barbarian invasions of the 4th century, and that thereafter the currency remained sound everywhere that remained within the empire until at least the 11th century – at any rate for gold coins. According to Rostovtzeff and Mises, artificially low prices led to the scarcity of foodstuffs, particularly in cities, whose inhabitants depended on trade to obtain them. Despite laws passed to prevent migration from the cities to the countryside, urban areas gradually became depopulated and many Roman citizens abandoned their specialized trades to practice subsistence agriculture. This, coupled with increasingly oppressive and arbitrary taxation, led to a severe net decrease in trade, technical innovation, and the overall wealth of the Empire.[8]

The passage of Human Action in which Mises discusses the decline and fall of Rome was recently featured as a Mises Daily.

Tweedy Browne Annual Report:

http://www.tweedy.com/resources/library

_docs/reports/TBFundsAnnualReportMarch2012.pdf

Third Avenue Value Funds 2nd Qtr. Report: http://www.thirdave.com/ta/documents/reports/TAF%202Q%202012%20Shareholder%20Letters.pdf

Warren Buffett Lesson on Franchise Investing–The Qualitative Difference

I have excerpted the conclusion of a Tweedy Browne research study on A Great 10-Year Track Record; Great Future Performance Right? because it illustrates the importance of assessing the qualitative information that drives financial numbers.  If financial numbers alone predicted future growth, then, as Warren Buffett has said, all librarians would be rich.  …..And that, folks, is why we will spend time on studying franchises and their competitive advantages.

Interesting investment research articles on Value Investing from Tweedy Browne: http://www.tweedy.com/research/papers_speeches.php

Research paper on the predictability of long-term earnings and intrinsic value growth: Great 10-Year Record = Great Future, Right?

http://www.legend-financial.com/files/Great%2010-Year%20Record%20Great%20Future,%20Right.pdf

The conclusion of this study explains why an investor must focus on the qualitative aspects of a business–what drives the financial performance?

Thoughts/Observations:

The easy-to-calculate Implied Growth Rate (i.e., return on equity times the percentage of earnings that is reinvested in the business and not paid out to stockholders as a dividend) did not predict future earnings growth, on average, for companies that had been highly profitable over the last ten years. Return on equity for these companies, as a group, tended to decline over the next seven years. Financial pasts were not related to financial futures for the companies as a group.

Similarly, companies that experienced the highest growth in e.p.s. over the 12/31/90–12/31/97 seven-year period had prior 10-year average profitability, as measured by average return on equity, that ranged all over the map. The pattern looked random to us. The financial future, as measured by seven-year e.p.s. growth, was unrelated to the financial past. Many companies with poor return on equity track records perked up and produced significant earnings increases, and many companies with excellent return on equity track records stumbled and experienced a large decline in earnings.

The previously described study by Patricia Dechow and Richard Sloan suggests that when the average company experiences a growth spurt in sales per share over a five-year period, the growth in sales per share over the next five years will tend to revert to about the mean average for most companies. Similarly, the Dechow and Sloan study suggests that the average company that has had five years of exceptional earnings per share growth will tend to have e.p.s. growth over the next five years that is about equal to the average for all companies.

The drivers of growth in intrinsic value (as measured by 10x EBIT (i.e., earnings before deducting interest and taxes), plus cash, minus debt and preferred stock, divided by shares outstanding) are growth in EBIT and cash generation (that results in an increase in cash or a decrease in debt). Aside from increases in EBIT that can be generated by price increases or cost cuts, which are often one-time turnaround type changes, the engine that drives EBIT growth over the long-term is sales growth. And more sales generally require more operating assets such as inventory and property, plant and equipment. A company that experiences significant growth in unleveraged intrinsic value of, say, 18% per year, over a long period of time, such as 10–20 years, has to have a high return on the capital that is being reinvested in the business to support the 18% growth rate. Just look at Walmart’s or Coca-Cola’s long-term record as examples of sustained high returns on equity and high reinvestment in the business. Companies that grow a lot over a long, long period of time, have to have sufficient opportunities to reinvest earnings at high rates of return in order to generate more sales and earnings. The math is easy.

Not only do investors have to understand growth but also what the expectations of growth imply for future returns.

This is an important article for understanding how to invest in growth companies and franchises. One conclusion of the research is financial numbers. Isn’t it a paradox that most of what is written about investment analysis in textbooks and journals is about quantitative information, and so little is written about digging up and analyzing the qualitative information that ultimately drives the financial numbers? Customers drive sales, sales drive profits and, ultimately, a company’s competitive standing, or advantage, its “franchise”, determines the sustainability of sales and profits. If long-term growth can be predicted at all, it would appear that the prediction must rely upon insights relating to qualitative information that has been used to assess the sustainability of a competitive edge. When Warren Buffett is considering an investment, he doesn’t just study the company that he is considering. He studies the company’s competitors as well. Historical financial numbers alone do not predict growth. If financial numbers alone predicted future growth, then, as Warren Buffett has said, all librarians would be rich.

In recent years, Warren Buffett has said that you shouldn’t consider buying an interest in a business unless you are willing to own it for at least ten years. He and Charles Munger have also mentioned that the futures (and future growth) of very, very few businesses are predictable with certainty. As a corollary, they believe that the competitive landscape in ten years can only be predicted with certainty for a few businesses. They like a business that they can “understand”, and they don’t like a lot of change in a business. Warren Buffett and Charles Munger classify Coca-Cola as an “inevitable” that they believe is certain to grow. As a corollary, they must believe that Pepsi Cola, Cott, Virgin Cola and other competitors’ future actions and responses over the next ten years will not impair Coca-Cola’s future profitability or dent its 15%+ growth prospects, and that customers’ choices among many competing beverages will continue to favor Coca-Cola’s offerings. Similarly, in emphasizing the rareness of businesses that are “certain” to grow at 15%+ rates over a long period of time, Warren Buffett and Charles Munger describe having an opportunity ticket that may only be punched ten or fewer times in a lifetime. Because there are so few businesses that are certain to grow at high rates that are also available at an attractive price, Warren Buffett and Charles Munger believe that you should load up and concentrate your portfolio on that “opportunity of a lifetime” when you find it. How many businesses are you certain about ten years from now?