Tuesday, December 25, 2012

Why I Own PFE

PFE is the largest pharmaceutical company in the world with $70 B in annual sales. I have owned PFE (off and on) since 2005. Back then stock was depressed because of the headlines regarding the patent cliff of 2010's. The patent cliff is a series of major patent expiration starting in 2010 which was supposed to dramatically reduce the company's sales. The company's sales are tied to around a dozen blockbuster drugs. Here I define blockbuster drugs as those with over a billion annual sales. As an example, Lipitor (a cholesterol drug) was a $10 B drug until its patent expiration in the US in 2011.

Just in 2010-2012, PFE has lost exclusivity in six billion dollar drugs (Lipitor, Geodon, Aricept, Viagra, Xalatan, Detrol). However, PFE is not alone, the entire drug industry is going through the patent cliff together. And I feel the patent cliff headlines have made all pharmaceuticals undervalued. PFE has tackled the patent cliff with consolidation and cost reductions. In 2009 they bought Wyeth, another major pharmaceutical company. This merger was to diversify PFE's sales, and mitigate the patent expirations. And fortunately, the patent expirations will start tapering off, with no major expirations in 2013 and only one (Celebrex) in 2014.

PFE now has almost $70B revenue. The stock trades at $25 and generates $2.20 per share of free cash flow. The stock's dividend yield is 4%. I bought most of my current shares below $20 during the financial crises of 2008-2009. When then as the market tanked, I was looking to buy stocks because of the overall market valuation. Which particular stock didn't matter so much as long as it was not at risk of bankruptcy. Defensive sectors such as health care fit this bill.

From the depths of the financial crises to now, PFE has roughly kept pace with the overall market. Now the PFE stock is a decent investment based on the cash flow alone. The company's R&D pipeline is said to be quite deep. Future products from R&D should at least maintain their cash flow. Furthermore, as the Wyeth merger matures, the synergies will add further to cash flow.

I don't delve into the specifics of the R&D aspects of PFE. The pharmaceutical industry is very leading edge like high tech. And I feel my analysis or opinion will add little to the general knowledge. Instead, I just admit the specifics of PFE's future is unknowable, but the market dynamics are very much in the industry's favour. The pharmaceuticals are a $1 trillion industry worldwide. As countries look to improve living standards, a key goal would be to improve health standards while reining in costs. That means the focus should not be in churning out more and more doctors, who are highly paid, but in using technology to make cheap and decent health care to the masses.

In the US, for example, the coming health care bill called Obamacare will increase health coverage for tens of millions of people. To do so, cost per person will have to go down, so the industry will do anything it can to save money. That appears to be bad for the managed care organizations (MCOs). I disagree. The MCOs cut of the health care bill is small. Cutting MCO profits will do little to dent the overall rising costs. Instead, if MCOs can improve efficiencies in delivery and trim waste, then they will reduce the overall health care cost and make a good profit at the same time.

And as for pharmaceuticals, the increase in people with coverage means more demand for medicine. More demand means more money for the R&D of new medicines. Pharma companies are driven by the profit motive. If governments trim costs by starving them of profits, then they simply cannot afford research.

So overall, the entire health care industry is a large portion of the world economy with lots of room for growth. And I am a low-risk diversified investor. That is the main reason I have held two large cap health care stocks for a while now: PFE and Wellpoint.

Saturday, December 8, 2012

GLBS Quarterly Update

Globus Maritime (GLBS) is a microcap shipping company headquartered in Greece. The company trades on NASDAQ. The company reported a loss of $0.8M for the 3rd quarter ended Sept 30.

I bought GLBS four months ago as an experiement in self-reliant small cap investing. I looked for cheaply valued small cap stocks. For the most part small caps - which I define as less than 1 billion in market cap - have no analyst coverage and very little news coverage. I used some screeners, mostly from Morningstar to get a list of candidates. Then I whittled my list down to 2 stocks: McRae Industries and GLBS. I don't regret my decision on those two given what I knew at the time. Ostensibly, McRae is doing decent while GLBS is down a hefty 33%.

Clearly, GLBS is down 33% because of two consecutive losing quarters. The two quarters' losses were small however, only a total of $3.2M of which about half was due to a previous year's receivable write-down. Compare that with 140M of equity. A long term investor should expect this kind of results in the highly volatile shipping business. The Baltic Dry Index is now hovering at 1000, which is a big drop from a high of more than 10,000 just before the financial crises of 2008.

Today, the world has gone a long way towards recovery from 2008, but the shipping sector is suffering from a from a glut of ships. Therefore GLBS management is hardly to blame for the weak results. As a part time investor working in an unfamiliar sector, I am the first to admit I don't know exactly why there is a glut of ships. But I believe it is at least in part due to unbridled spending just before the financial crises.

The glut effect caused the average daily rate per ship to be $10K for GLBS. Breakeven is around $12K. The GLBS presentation mentioned that the overbuild peaked in 2008 and is supposed to bring supply back to normal in the coming years. I really hate to rely on company supplied industry/market analysis but I make an exception now.

GLBS appears to be one of those companies that is honest and patient. Waiting for a weak moment to build up assets on the cheap. GLBS is extremely undervalued at a very depressed time for its industry. The critical question is whether GLBS is too good to pass up, or is the industry so hopeless that no company in the industry is worth it. Each GLBS share has about $13 of equity but the last close was $1.86 and its recent low was $1.63! At the current price I will hold off on buying more shares until the next quarterly. But if it falls down to around $15 I will seriously considering increasing my current position by 50%.

You can go here to see all my sources for this article. Any thoughts? Please comment!

Thursday, November 29, 2012

A Tale of Two Retailers: PETM and SHLD

Petsmart (PETM) recently announced very impressive earnings. The company earned $0.75 a share vs $0.50 the same quarter a year ago. When a company earnings rises by 50%, it earns a high P/E multiple. The expected P/E for the current year is 20. The company's revenue rose 9%.

PETM is the country's largest pet retailer; the company has 1,200 stores. It is unclear to me how much more it can expand. On top of that, I heard Jim Cramer of CNBC has been touting PETM all year. Jim Cramer is as big a contrarian indicator as I have seen. When he says buy, I hear sell! I really want to unload PETM but now that it is up 2.5x, but I am reluctant because of capital gains.

While PETM is flying high, Sears Holdings (SHLD) is going in the opposite direction. The company's sales declined yet further in the most recent quarter. Comparable store sales was down 1.6% for Sears and 4.8% for Kmart. The company lost money yet again but it does not have liquidity problems. I trust Eddie Lampert to keep the company afloat and extract the most value. They have recently spun off Sears Hometown and Outlet and then Sears Canada in two transactions. Despite Eddie Lampert saying repeatedly that he didn't invest in Sears to sell its real estate, he is selling the company piece by piece to unlock value. When just the core Sears is leftover he just may shutter the best locations and sell their real estate. That's fine by me, but many would feel sad to see the decline of an iconic retailer.

Disclosure: I am considering selling some PETM and my Sears Canada position but I haven't made up my mind.

Tuesday, November 27, 2012

Why I Own CVX

Chevron (CVX) is the second largest oil company in the US. They are an integrated oil company which means that they do exploration and extraction, as well as refinement and final sale. The majority of CVX's profits comes from extraction.

I have owned CVX for 9 years and it was been a great investment. I admit I was lucky to start buying it in 2003 when oil prices were coming off historical inflation adjusted lows. Then starting at 2004 oil prices went from less than $30 a barrel to the $80-90 range today. Naturally with a three-fold jump in crude prices come record profits for oil companies. The record oil prices allowed Exxon, the largest oil company, to make record quarterly profits for any US company. Chevron also did extremely well. I didn't expect to make big gains when I first bought them, I simply wanted to have exposure to a large segment of the world economy.

We all know that our world is too dependent on oil and we need to wean ourselves off oil. But the numbers show that we are as dependent as ever. Since the oil crises of the early 80's oil consumption is steady at about 4.5 barrels per person. At current crude prices, that means we spend about $2.5 trillion dollars on crude in a year. I estimate the end product of crude sold is twice that which means we spend $5 trillion dollars a year on oil. Chevron earns $25 billion a year, which is only 0.5% of the world's oil consumption. Furthermore, CVX's business is split half and half between oil and gas. For this reason I feel now is a great time to invest in non-renewable energy. It is a huge market and investors don't give it enough credit I believe because they have this perception that oil will be phased out.

Pessimists out there emphasize that we are at the point of maximum oil consumption due to limited supply. This theory is dubbed "peak oil". I don't really have an opinion on peak oil, but I do know that we are finding oil everyday. It is getting more and more costly, but we are finding it. And at current prices, a lot of new sources of oil will become viable. Maybe we will reach peak oil in 2020, maybe 2030. But right now CVX has a P/E of 9 and it has more than 10 years worth of reserves of oil and natural gas. By 2020 or 2030 I would have extracted plenty of value from my initial investment even if peak oil happens.

My CVX investment has gone up 3x in the last 9 years. In addition to that is 3% dividends, for a total of about 17% annual return. I picked Chevron after reading a Morningstar recommendation, which said that CVX is an overlooked but solid oil company. Of course I am relieved today that I chose CVX and not BP!

I don't worry much about CVX and I won't sell it any time soon. It is something I put in a tax sheltered account and forget about. As I have been actively investing for more than ten years, I have seen cycles. The tough part of investing is the long time horizon, and to experience a true cycle can take a decade or more. Few are ready to give investing that much time for results. I think that is the main reason for the volatility and the poor results of the average retail investor. Oil prices are at a cyclical high, and I caught the cycle at a great time. Oil prices could continue going up for a decade or more. But after that CVX probably will not be able to get such profits and oil prices. Similarly I feel that big out-of-favour techs like Cisco, Intel and Microsoft are experiencing long period of undervaluation from the early 2000's and that's why I am sticking by these tech stocks. Hopefully I am right — about tech — and eventually the cycle will reverse itself.

Thursday, November 22, 2012

Quarterly Update: WLP, Cisco and JOE

Wellpoint (WLP) announced they earned $2.15 per share, including investment gains, versus $1.90 in the same quarter last year. They lost 2% membership in the last quarter. And WLP has a high medical expense ratio at 85%. All this needs to improve under the yet to be named new CEO.

WLP is my second largest holding and I wouldn't start selling any shares until it goes over $70. And then I would only sell to have a smaller exposure, not because I am trading the stock or that I don't believe in it.

Cisco announced they earned $0.39 per share. That is an 18% increase over the same quarter last year. Their overall revenue increased 6%. Cisco paid $0.14 in dividends. At the moment before the announcement the stock traded at $16.80. But this news was definite surprise as the stock has since jumped 10%. I have had Cisco for over a decade. I have recently wanted to close this position, but as I mentioned in a previous post, the valuation always draws me back. I have bought the stock many times when it was very undervalued, and then sold after a 10-20% gain. The idea is to reduce the exposure when the stock goes up, until zero if the share price is high enough. I don't want Cisco to be a long term investment anymore because I generally do not like technology. Technology is just too unpredictable. I cannot do a basic analysis of the financials and make a high probability bet on a good return. But Cisco right now is simply too undervalued. They have over $10 per share in cash and short term investments. They are increasing revenues and earnings.

As far as I can tell, Cisco is so undervalued because it is no longer in vogue. Their story is they sell the backbone of the internet to the world. They have done this very well for the last decade. But the stock has declined to 1/4 of its high, because that story is old. The market wants to hear about things like personal devices, the cloud and emerging technologies. I want Cisco to chase those only if they can give back a good return on investment. Short of that, I prefer Cisco to buy back shares and keep dominating the backbone. I don't think the market gives Cisco enough credit for still being in the same position as it did during it's heyday; i.e., owning 3/4 of the router market. But one day, something will happen that will make the market perceive that Cisco is hot again, something like a sea change in opinion like with cigarette companies in the last 10 years.

St. Joe (JOE) announced quarterly earnings that was very well received by the market. The company simply eked out a small profit and that was enough. I read they sold some non-strategic land for $5655 per acre. That gives me an idea of the prices they would fetch for their lower end land right now. Given that they have over 500,000 acres, their book value appears to be more than the market cap of about $2 billion. As I said in a previous article, JOE is a simple play on land for me. I bet Berkowitz, who is chairman of the board, can stem the drop in the stock price and turn the company around. So far it is working.

Saturday, November 17, 2012

AIG and McRae Industries Quarterly Update

AIG and McRae Industries are two recent purchases (meaning within the last half year). These are my two recent new ideas so I am watching them closely to see signs my thesis was correct.

I own AIG because it is a profitable business that trades at half of book value. In the 3rd quarter they earned an after-tax profit of $1.00 per share. The company breaks down the company into four segments: life insurance, property and casualty insurance (P&C), aircraft leasing and others (including mortgage related insurance). The good news is that all four are profitable. The only worrying sign to me the 105% combined ratio of the P&C segment. Combined ratio is the ratio of total insurance payouts and costs divided by the total insurance premium. A combined ratio over 100% does not necessarily imply an loss in the business however, because the business can eke out a profit through investment gains on the premiums held. In the coming quarters, we will also have to see the effects of Hurricane Sandy, but right now AIG cannot predict its affects.

But overall I am very pleased with the quarter and I am surprised that the stock price dropped more than 10% since the earnings announcement. Of course great investors all advise others to tune out the short term noise. So I try to ignore the crowd and remind myself that AIG has $69 of equity per share yet trades at $32. I may add to this position if AIG drops more.

McRae Industries is one of my two small cap holdings. Its market cap is a little over $50mil.

McRea makes high quality work/western boots and military boots. The company just finished its 4th quarter this summer and announced it earned $2.27 per diluted share for the year, versus $1.84 the previous year. Revenue was flat, so it indicates the company is able to increase margins. The stock trades on pink sheets recently at around $17. Its book value is about $20.50. And its net-net value is about equal to the market value. With such a strong balance sheet and a P/E of 7.5, what is there not to like?

I only found this stock after I started this blog and I documented it in this entry. So my entire history with it has been and will be documented on this blog. We shall see how it goes.

Saturday, November 10, 2012

SEB 3rd Quarter Update

This blog has been up three months. And I am still here writing! Three months is also the length of a quarter. I have relatively small amount of holdings, so even with a full-time job I have time to focus on my larger holdings.

Seaboard Corp. (SEB) is my largest holding and last week they announced earnings. It was surprisingly good considering the economic climate. As I wrote in my first SEB post, SEB is a conglomerate with business lines related to commodities. I own SEB because I believe it has good management and the management's interests are aligned with those of long-term shareholders.

The market feels that the world is in a slowdown mode and cyclical sectors such as commodities will lose revenue. To make things worse, we had a record drought in the US which raised corn prices. Corn is the largest component of pork feed. And pork is the largest SEB segment. All this meant I was expecting a bad quarter, but instead they managed to earn $61.92 per share. At this rate they would earn $250 for the year. That means they would have earned over $250 in each of the past three years, which gives them a average P/E of 9 over that time!

The table below breaks down the results in their various segments. The operating profit is revenue minus cost of sales minus administrative costs. It does not include taxes, interest, etc., nor does it include profits from investments. All amounts are thousands of dollars.

Segment Revenue Op. profit
Pork 413,077 29,863
Commodity Trading and Milling 675,649 16,662
Marine 242,330 13,006
Sugar 69,025 13,615
Power 75,778 18,649
All Other 3,557 93
Total 1,479,416 91,888

The table shows that SEB operates low margin businesses. If management makes some missteps, a segment could lose money. For example, the pork segment lost money in the years around 2008. Now pork profits are stable (quite a relief to me!). The marine segment impressed me because shipping is suffering a slowdown worldwide. In 2011, the power unit sold two power generating plants but has since built new plants and this segment has the best margins in the company. So from the quarterly numbers, I think management has managed well the margins in all segments.

If management can keep up this kind of earnings for several more quarters, I think SEB can break through $3000 for the first time. And don't forget, SEB adds $250 of equity every year.

Sunday, November 4, 2012

On Predictions and Housing

Back at the start of the new millennium, an now-infamous New York Times article asked 10 superinvestors for their one stock pick to hold for the next decade. Now ten years on, this basket of stocks in a equal wasted would have gained over about 35%, versus about -10% for the S&P 500 index. This is cumulative, not annualized. But the period from 2000-2009 was a terrible decade for stocks with two big crashes. On the surface it seemed like the 10 superinvestors did decently. As a group they did what we expect them to do, beat the market with their expert knowledge and skill. However, looking at the list closely. It outperformed the market only because one stock, Henry Schlein, carried the entire basket, rising 600% over the decade. Only one other stock, Waste Management, gained money. The remaining eight lost money. Overall, this basket did beat the market and in theory I would be ahead if I put my money with these experts. But the ten stocks individually tell me a much different story. I believe the experts picked ten easily justifiable stocks. An average reader can't fault them for their choice, they picked the high fliers of their day and they stated the known bull case. Yes the article was unfortunately written at the peak of the dotcom bubble. But the great investors must perform through both good times and bad. The New York Times, as with any other financial outlet, makes money by getting readers to their articles. The momentum view attracts the most readers because it agrees with the most readers. In essence, the media is biased towards the status quo. As are most mutual funds. But a follower of the status quo pays a heavy price. This article is one of my best case in point for contrarian investing. It illustrates the risk of following the consensus or the crowd. One of them, JDS Uniphase, even dropped 99%!

Another example of dubious predictions comes from Barron's yearly forecast. Barron's gathers a dozen or so of the well-known expert investors and ask them for their opinions of the market in the coming year. Each makes a prediction of the S&P 500 index value in one year. Invariably they predict the market will finish up around 8% of where it started. Why 8%? Because that is about the typical return of the stock market. If I was forced to predict the S&P 500 one year from now, I would postulate a probability distribution that centers around 8% also. I know that my prediction has a small chance of being right on. The outcome could be higher or lower that my prediction, but I just don't know which. I do know most likely my prediction is wrong! Benjamin Graham's philosophy is the future is unknowable, therefore do not try to bet on it, instead build a margin of safety for whatever happens.

I used to read the Barron's yearly predictions until I realized it is just a pointless exercise, it's a waste of newsprint.

The future is unknowable, I often remind myself when I invest.

In August I explained in my blog my WLP holding and why despite Obamacare I am bullish on WLP. Several posters called me ignorant, except they didn't use the word ignorant. WLP is depressed (it has a P/E of 8 after all) so the majority sentiment is negative. The prevailing sentiment today is to shun risk for safe havens. Safe havens are US government bonds, gold and high yield stocks. I recently wrote about another holding: Intel. Intel's earnings also yield 10%.

Both Intel and WLP are active buyers of their own stock by issuing debt. Their bonds mostly yield less than 4%, and their earnings yield 10%. So why not pay 4% to get back 10%? This is possible because investors, despite monetary easing by the Fed, are crowding out safe havens. I don't see how this won't end badly. Bond buys are eventually going to suffer zero or negative returns if inflation picks up to the 3-4% range.

I want to be on the other side of this trade. A lot of my investments, like Mircosoft, Wellpoint, Intel, AIG and Sears Holdings are issuing debt and buying back stock at the same time. I also like housing as a way for a small investor to easily do the same thing. Housing can be a dangerous investment, as the world has recently learned. But now, I like US owner occupied housing as a way for a small investor to easily be on the other side of the debt trade. In the US now, housing is roughly at the 2003 nominal price level. But considering real values by factoring inflation, housing is 19% cheaper than in 2003! US homeowner mortgage rates now are about 2.75% and 3.50% for 15 and 30 year terms, respectively. Typical property tax rates are 1% of home value. But US homes interest is tax deductible. So for a typical working person, the cost of borrowing a large amount of money to buy and live in a house is about 3% a year. That includes interest, taxes and insurance minus the effect of tax deductions. That is about the inflation rate. So a homeowner whose house rises with inflation essentially lives in his home for free! The only catch is the risk of a house price drop. Recently I heard Gary Shilling, one of the most bearish voices on housing, predicting houses could drop another 20%. So I take that 20% is a floor on price. In this scenario, I expect houses to then go up after this worse case drop. Many experts like Warren Buffett have said housing is a great investment, but it is impractical for someone with his capital base to take advantage. I can. I believe housing today for the small retail investor can play the role of gold. The major currencies are all in bad shape. That's why gold is at all time highs. But just as these fiat currencies can possibly have a bad fate, so can gold. Gold has no intrinsic value, it's value is so arbitrary, I can see a scenario where the US government gets its act together and holds down the debt. In that scenario I see that gold can drop by half its value. That kind of risk is speculation. Isn't housing a lot better bet?

Thursday, October 18, 2012

Why I Own Intel (INTC)

Intel (INTC) is the most profitable chip maker in the world. I bought Intel last year when it hit $20 a share. Intel dominates the x86 processor market with a 80% plus market share. x86 processors go on all PCs running Windows and Macs. So, these processors are everywhere, in the majority of homes and offices in the world.

Intel has established a wide moat around its business. And this is not typical for technology companies. It has a wide moat because of a number of barriers to entry. This technology has been refined for over 30 years and key aspects are patent protected, only AMD and Intel have the patent rights. Intel has unmatched name recognition and marketing clout. And most of all, Intel is the leader in chip manufacturing technology. For these reasons, we have seen the x86 architecture and Intel thrive for 30 years. Very few other technology companies have had that much staying power.

But Intel is a very cheap stock right now because of a perception that the chip processors of the future will be mobile, which are smaller and less power hungry than Intel's chips. The best selling design right now is by ARM. But ARM's product is an Intellectual Property (IP); i.e., code. ARM gets royalty from this code inside billions of mobile phones and tablets. But code, especially less complex code, can easily be copied or replaced. So there is no guarantee that ARM processors or some derivation will be in our mobile devices 10 years from now. And Intel has mobile offerings that are getting more power efficient. It is conceivable to me that, given enough time, Intel's x86 code can evolve to be as efficient as ARM.

But Intel's biggest technological advantage lies in Intel's fabrication (manufacturing) capabilities. They have their own exclusive in-house fabrication that is the most advanced in the world. Their fabrication is one full generation ahead of the rest. Intel's competitors using ARM and Advanced Micro Devices (AMD) all must use third party fabs. Fabrication of the coming generation has simply gotten so expensive that only Intel can do it on its own. Intel being one generation ahead means their chips have transistors - transistors are the most basic building blocks of a processor - that are cheaper, less power hungry and faster.

The fab advantage is most evident on the other extreme: in server processors. Intel has a 90% plus market share. AMD, Intel's only competitor in servers, is trading at 3 year lows due to poor sales and execution. This removes pressure from Intel to reduce server margins, which are the biggest in the processor space.

As for the Intel financials, they are similar to Cisco and Microsoft. Intel earns $2.40 a share. Its free cash flow is about $2.00 a share. Its dividends are $0.90 a share per year. All this on a stock price of less than $22! Their balance sheet has plenty of cash and they are buying back stock.

The recent headline news is depressing Intel share price because 2012 is clearly a bad year for computer sales. And a bad year simply means an earnings drop of less than 10%. But I don't think of a short term problem as a big deal. I've read some analysts project a long-term 6-8% growth. That's fine by me. Intel is a net-net company. This means their financial assets exceed all their debt. Intel has equity of $10 a share. This is the value of all their fixed assets and intangibles. Intel can easily issue bonds at interest rates below 3% but buyback Intel shares that yield 10%. Intel has bought back significant stock and continues to do so. I hope it does so before the stock gets much higher than $20.

Disclosure: I also own Cisco and Microsoft. I also own a negligible amount of AMD.

Wednesday, October 10, 2012

Sins of Omission (Part 1)

Many successful investors analyze their past mistakes as well as their successes. In fact, they probably believe their mistakes teaches them more than their successes. Any investor will vividly remember his worst stock purchases, because the loss from the stock is real. These are the sins of commission. But an investor may not vividly remember the situations where he found a good stock but didn't buy. In this case the opportunity cost is really equally high. These are the sins of omission. I am going discuss several of my sins of omission.

Fairfax Holdings (FFH)

Fairfax Holdings (FFH) is a Canadian property and casualty insurance company. It operates similarly to Berkshire Hathaway, only smaller. It is run by an India-Canadian, Prem Wasta. Some have dubbed him the Warren Buffett of the north. One difference between FFH and Berkshire, other than size, is their volatility. Berkshire is a company with much more consistent gains than FFH. Prem Watsa joined Fairfax in 1985. It had a great run before hitting a bad patch in the early 2000's, which is when I bought in. I call this FFH a sin of omission because I sold it shortly after buying in, and missed out on the subsequent runup.

In 2004 when I bought in, FFH was just listed on the NYSE and it was receiving a lot of bad press. Many argued that a number of shorts were attacking FFH, and was responsible for much of the bad press. Shorts are people who borrow shares and sell them with the intention of buying them back when the share drops. They have a vested interest in seeing the stocks drop. I read the bad news on the message boards. There was primarily a negative spin on every piece of news. And the worst part was that FFH lost money in 2004 and needed a $300Mil transfusion through a private placement. I knew that there was a big short interest at the time but didn't know who to believe. The stock went up a bit and dropped to my buying price of $150 in late 2005. I sold then.

I was in the habit of reading financial reports but I wasn't as wise then. In their, 2004 shareholder letter, Watsa wrote:

Investment performance in 2004 was hampered by our very conservative position which included not reaching for yield, maintaining large cash positions and hedging a significant portion of our common stock holdings against a decline in the equity markets. The $81.5 million unrealized loss in our hedges flowed through our income statement as realized losses.

In 2004, FFH lost $17Mil, so all of it was due to an unrealized loss based on a bearish bet on a bullish stockmarket. I think I read their financial reports but probably didn't recognize the significance of that.

An in the 2005 annual report dated April 2006, Watsa gave an ominous warning:

.... we are very wary of the risks prevalent in the U.S. As we have mentioned ad nauseam, the risks in the U.S. are many and varied. They emanate from the fact that we have had the longest economic recovery with the shortest recession in living memory. Animal spirits are alive and well and downside risks have long been forgotten. Having lived through the telecom bubble recently and the oil bubble in the late 1970s and early 1980s (and perhaps again today), we see all the signs of a bubble in the housing market currently.

Two years later, the world learned that Watsa was right on. FFH profited handsomely in 2006 and onwards, in a lot due to credit default swaps (bets) against the US stockmarket. Today it is $380 / shr.

The following table shows the FFH annualized appreciation of its stock and book value over the years. After this experience, I am more grounded in what I believe. I am much more subjective when I choose who to listen to.

Since I sold
Dec 2005 — Oct 2012
Since Inception
1985 — Dec 2011
FFH Book Value23.5 %
FFH Stock Price14.1% 20.7%
S&P 500 0.1 % 7.9 %

DR Horton (DHI)

DR Horton (DHI) is my second sin of omission. DHI is the largest homebuilder in the US. Like all homebuilders it was very profitable in the early to mid 2000s. By 2008, the housing was a disaster beginning to unfold. But I thought this is a good time to take advantage. I bought DR Horton after it was already down 50% from its peak in early 2007. By the time the market really crashed in 2008-2009 DR Horton was down to $5. But still, this was much better than some banks, AIG, Fannie Mae and Freddie Mac, which effectively went to zero. But by 2011, DHI was hovering above $10 for 3 years. I threw in the towel and sold it at $12 in 2011. Now, with the beginning of a housing recovery it is over $20.

After these two investments, I have learned to pay more attention to stocks that I consider selling. It is true when they say selling is harder than buying.

Tuesday, October 2, 2012

Why I Own SHLD

I first bought Sears Holdings (SHLD) in fall of 2007 at around $135 (it is $57 today). Back then the financial crisis was just beginning to reveal itself. That summer, we heard the first tremors of the earthquake from the large banks, but by the fall of that year the S&P 500 was actually at new highs. I, like many others, did not heed the warning and pull out. Instead I was looking for new ideas for investment growth. I knew the market was priced quite rich. So, I had to look in harder for companies with good earnings, cash flow or book value. Without realizing it, I was looking at more risky companies which had good numbers on paper. That was one thing I learned from the financial crisis: don't force yourself to have some investment target, if the market doesn't offer you any bargains just sit out.

Anyway, back to SHLD, I opened my position in 2007 mainly because of a very bullish Barron's article, which you can find here. The article actually doesn't add much more than what is known about the company. SHLD is a retailer run by Eddie Lampert. Its main holdings are Kmart and Sears, two underperforming retail chains with storied histories. Lampert is someone who avoids the limelight. He does not give guidance. He does not give interviews. But he does give shareholders his thoughts in his quarterly letters to shareholders.

Ever since he took over Kmart during bankruptcy in 2002, Lampert has been slashing investments in the stores while using its cash flow to buy back shares. This strategy has allowed him to increase his stake in the company. Now he owns 64% from less than 50% before (Kmart took over Sears in 2004). The financial performance is another story. The annual revenue has declined from $50Bil to closer to $40Bil now. SHLD is trading at around 1.2x book value. The market cap of $6Bil is less than the inventory on the books. SHLD has been moderately profitable in past years but that may end this year. The market wonders how this can continue. While stores like Walmart and Target are investing in stores that make shoppers experiences pleasant, SHLD is minimizing spending.

The one ace in SHLD is the real estate value of their 2700 stores in USA and Canada with 250Mil square feet of space. Many articles have touted this, including the 2007 Barron's article. The market speculated that Lampert planned to monatize the real estate when he first merged Sears and Kmart. But that did not play out. Instead Lampert first tried various retail concepts, Sears Essentials, Sears Outlets, novel store formats, etc. But they all performed mediocre at best. And then the 2007 recession hit. Last year, sales lagged to the point where Lampert agreed to sell 11 stores for $270Mil and also close another 120 stores.

Lampert clearly wanted to make retailing work, but on his terms. And his experiments met with disappointment, he then tried to unlock the value of his holdings by spinoffs and store sales.

I think Lampert has done a decent job of being a capitalist. Although investors who ride with Sears Holdings, like myself, may have been disappointed, he does what he needs to do to further his wealth. 1/3 of the company's float is short. That means a large segment of the the market is counting on Sears to go bankrupt. I do not for a minute believe that will happen. I believe Lampert's share of Sears will appreciate. But I also believe Lampert will allow the Sears brand to keep sliding. Meanwhile, all of us shareholders have no say in Sears, except Lampert, and I am very unclear as to what he will do next. His letters to shareholders do indicate that he is a committed retailer but gives little hint as to a long term exit strategy. I don't believe he will cheat us minority shareholders, but SHLD is too unpredictable for my taste. So over the years I have gradually sold off all my shares. I have about broken even now. And I only keep my remaining shares to avoid a tax gain.

Disclosure: As well as owning SHLD, I have in the past received shares of OSH in their spinoff. I have sold those. I also recently received SHOSR shares — SHOSR are rights to purchase the future spinoff of some Sears stores under the ticker SHOS — [update] I found out I couldn't trade SHOSR anymore so I did the next best thing, I exercised my right to buy the SHOS shares at $15 and I intend to sell SHOS as soon as I receive them.

Thursday, September 27, 2012

My Investing Costs

I think reducing costs is one key aspect to investing success. I estimate my costs to invest is around $1430 anually. I break down my costs as follows.

Brokerage transaction fees: $500.
Mutual fund fees: $300.
Magazine subscriptions and books: $300.
Morningstar premium subscription: $130.
Printing costs: $200.
Knowning that I don't pay financial advisors to underperform the market: priceless.

Sunday, September 23, 2012

Why I Own AIG (Again)

In a future blog I will list my worst purchases. One of them is AIG. I bought AIG back in 2007 at about $65 and saw it go to $2. It is one of four stocks I bought that suffered an unrecoverable catastrophic loss. The other two are Alcatel, Citigroup and a startup where I worked.

So why on earth would I dive back in AIG? The answers I give are surprisingly psychological and subjective.

Firstly, AIG is not the same company that almost drove itself to insolvency in the summer of 2008. Back in the summer of 2008, the mortgage defaults from lax lending standards was driving down the price of various mortgage-backed securities (MBSs). This hit AIG doubly hard because it provided "insurance" on the MBSs, called credit default swaps (CDSs). The insurance AIG sold in theory hedged the possible loss for exposure to MBSs. And as with any insurance, the insurer collects a small premium in exchange for a small chance of a big loss. But AIG miscalculated on the small chance and the correlated MBSs were collectively a toxic mess that made CDSs a huge liability. And with the increase of these liabilities, the collateral payment requirements of the CDSs drove AIG to the point where it almost could not make the payments. This was when Federal Reserve called AIG too-big-to fail and stepped in — at a steep price. The Federal Reserve took over 80% of the company in exchange for funding an entity to hold all of AIG's toxic CDSs and MBSs. This entity is called Maiden Lane.

Now four years on, I am quite convinced the US financial system will not collapse. And I am beginning to believe in my gut that AIG is viable. Now, it certainly helped that the US government recently announced that all of Maiden Lane has been sold — and at a profit to the Federal Reserve! This is one psychological catalyst for me to feel good about AIG again.

AIG also really got my attention in the last six months when I found that Bruce Berkowitz has has invested 36% of his $7.7Bil Fairholme Fund in AIG. I always knew he was bullish on the financials, but I have never heard of a 36% investment in a single stock by a fund.  Berkowitz is one of my most respected investors with a tremendous track record. I wrote about Berkowitz in an earlier post here.

The Fed action of 2008 effectively wiped out my AIG holding. And although it stung, it didn't sting as much as my losses in the dot-com bubble. Following the dot-com bubble I vowed never to invest in tech stocks again. But over the subsequent years I have seen the cheap valuations tech and have come back to it in a big way. And I have realized my statement "I will never buy tech again" is in itself a contrarian indicator. I said that because I was reacting to the sting of my losses in my tech investments, but so are million of other investors and they too are saying "I will never buy tech again". This kind of knee-jerk thinking has caused the market to unfairly discount tech. So this time I purposely try to embrace AIG precisely because I was burned.

And so, in June of this year, I took a look at AIG (one source I used is Berkowitz's presentation on AIG).  I learned that AIG is now a plain vanilla life insurance, property and casualty insurance and a financial services company.  And I opened a position in AIG, again.

Saturday, September 22, 2012

Why I Own the Bruce Fund

I have a small position in the Bruce Fund (BRUFX). It is the only actively managed fund I own. BRUFX is a mutual fund run by the father and son team of Robert and Jeffrey Bruce. It has been around 29 years. Its long term track record puts BRUFX in the top 1% of mutual funds in its category. The following table shows this so clearly.

Date 1YR 5YR 10YR 29YR
BRUFX 1.0%3.6%16.6% 12.4%
S&P 500 5.5% 0.2% 5.3%9.9%

This is one of the best-of-the-best mutual funds for long term.

The fund is has about $350M under management. So this is a medium to small fund. And Bruces are very modest. As far as I know, they don't advertise. They don't have brokers. They don't give interviews. So there is very little media coverage.

Their investment style is conservative allocation. So I consider BRUFX as a hedge against the general market. It is a defensive play; and the fund allocation shows that. As of their last report, it has only 41% of their fund in common stocks. The rest are a mixed bag of bonds and preferred shares. And their stocks are mostly names I have never hard of. I have always believed in taking firm control of my investments to learn and to save fees. But BRUFX is one exception. BRUFX is truly providing a service that I cannot emulate. And it goes against the grain to be consistent in good and bad markets. I bought BRUFX in early 2008, just before the financial crash. And from then to now, they have gained around 40%, while the market has about broken even.

A person considering buying BRUFX should know that their management fee is below industry average at 1%. But to invest in BRUFX one must open an account with their custodian. So one cannot invest in BRUFX with just any broker. Their custodian is Huntington National Bank, this means that a reputable company manages the funds money and keeps their books. Their auditor is Grant Thornton. So this is unlike Bernie Madoff's fund which had Madoff as custodian, clearing house and in control of the auditor.

Thursday, September 20, 2012

Why I Own McRae Industries

I recently opened a position in McRae Industries (MRINA). MCRINA is a microcap company based in North Carolina. They make work boots and military boots. Their market cap is $40M. I believe MRINA is a great value. I bought MRINA as a long term value investment. Having said this, I want to warn the reader that microcap stocks often have limited coverge in the media and can be subject to fraud and/or manipulation. We all should be extra vigilant when dabbling in microcaps. Furthermore, the information in this blog should never be the basis anyone's investments. The reader should do his own research and/or consult a professional for investment advice before buying MRINA.

I found MRINA while screening for low P/E and low book-value smallcap companies. What stuck out about MRINA immediately is their impressive balance sheet and earnings. Their net-net value is about $15.50 per share, and their share price is $16.40! Their P/E is 8 and they have zero long term debt.

MRINA was founded in 1959 and in the succeeding years they built up a solid balance sheet. Their dividend yield of 2% is small relative to earnings. They buy back some shares. But mostly they mostly retain their earnings as equity on their balance sheet. In this manner they have zero long term debt. This is the only company I know of that sells hard goods and have zero long term debt. What a concept!

So MRINA is a small company that operates without outside financial assistance. They make work boots for civilian and military use. Their military segment is 25% of their revenue. I believe they have been adversely affected by the recent downturn in construction. No doubt this segment of sales will improve once construction returns to normal. The management says that military contracts are very competitive and they could lose when when they bid in the future. But military is still a relative small portion of their business.

MRINA is a tiny company that has little (if any) financial coverage, so I have to really do all my own research. I researched to old SEC EDGAR filings. The EDGAR online system has been around since around 1994. So their filing would go back to that time. I found the annual report in for 1995. In the report, they refer to performance going back to 1991. So 1991 is the earliest information I could find on MRINA. Back in 1991, MRINA was not only a boots maker, but also a seller of copiers, and maker of bar code readers. The three segments were evenly split back then. Seems like they have dabbled in this and that over the years. They

Warren Buffett has always measured the Berkshire Hathaway's growth return to shareholder by the change in its book value. You can find this at the front of each of Buffett's letters to shareholders. I will also measure MRINA by its value, but instead of book value (which is equity) I will use net-net value, which is a more conservative (smaller) value than book value. Also, I include the dividends. See table below.

Most Recent Qtr 2011 2007 2005 2000 1995 1991
Net-net per share 15.40 13.80 11.509.705.904.503.70
Dividend per share 0.36 (projected) 0.36 0.330.300.360.350.32

This table shows that MRINA has grown in its net-net plus dividend value at more than 10% per year. And they have not really had to increase revenue, they have kept revenue always about the same. They simply manage the business well and thereby returning cash to the balance sheet or the shareholders. However, this current model cannot work indefinitely into the future because their balance sheet is ever growing while sales and their business stays the same size. To best serve the shareholders in the future, they must either allocate that capital to grow profits, or they must distribute the cash to shareholders. And I bought MRINA expecting them to take either action.

Investors in MRINA should know MRINA is more than 50% owned by the McRae family. McRae family members also run the company. This means to me that the interest of management is aligned with the shareholders.

McRae is traded over-the-counter (OTC). This means it is not traded on a central exchange. OTC prices can fluctuate greatly.

MRINA is classified as Pink with Limited Information. This means MRINA is not required to file with the SEC, and their financials are not at the level to be considered current by the OTC Markets Groups. MRINA's yearly and quarterly financials are found on their website. Their yearly financials are audited by Grant Thornton, one of the largest auditors in the country.

MRINA was traded on the AMEX exchange up to 2005 when it voluntarily delisted to save on costs.

Friday, September 14, 2012

Why I Own JOE

When analyzing the St. Joe Corporation, I say it basically boils down to who do you believe: David Einhorn or Bruce Berkowitz?

First as a background, Bruce Einhorn is 44, and has run his hedge fund Greenlight Capital since 1996. He started Greenlight with a million dollars from friends and family and has parlayed that to a billion dollar personal fortune. He is a both long and short money manager. But his most famous moves have been shorts against Allied Capital and Lehman Brothers. He often publicizes his short positions with jazzy powerpoint presentations in conferences. One of his current (or recent) shorts is St. Joe Corp. (JOE). Here is his presentation from the Value Investors Congress in 2010.

On the other side of the bet is Bruce Berkowitz, who founded and manages the Fairholme fund since 1997. Berkowitz was named the Morningstar manager of the decade in 2009. Fairholme fund returned about 12% over that decade. That beats the benchmark about by about 10% per year! I have followed him for the last half dozen years and he is one of my most respected investors. He has been a long time JOE investor and recently he has put his reputation and money on the line by buying up 27% of JOE and becoming the chairman on its board.

This is truly a clash of the titans. It is not only enjoyable to watch but also educational. But I am betting on Berkowitz, here's why.

JOE has a market cap of $2B with a tiny staff. It is simply a landowner and all its value is tied to the land it owns. JOE owns about 570,000 acres of land in northwest Florida which is right now full of timber and a few small residential communities. Based on their market cap their land is worth about $4k per acre. As a point of reference, good farmland in Iowa sells for about $10-20k. Farm land values has been rising recently.

Einhorn says the land on their books is overvalued, interest in the land is minimal, He says if we wrote down the value of JOE's land to its true value, JOE would be worth $10 a share. I surmise that this is my floor on the downside.

No doubt Berkowitz does not agree. Berkowitz has positioned himself in control of the company and he has a clout and resources to make sure JOE sustains itself in the near term. So JOE is under no financial or shareholder pressure. Berkowitz can and is willing to wait it out.

As an investor, I don't like to get bogged down in details when analyzing stocks. I hear JOE's pros and cons. But like religion, one can argue JOE's pros and cos for ten hours without changing anyone's mind. Instead, I look for the views the market may have misjudged. In JOE's case it is about land. Two prominent investors have recommended investments in land. Michael Burry is buying up farmland. And Jeremy Grantham is recommending timber land. Grantham states we are going to be in a harsh world full of resource shortages. I am not as pessimistic as he, but I see a lot of truth in his argument. JOE is the most liquid pure play on land and timber that I know of.

I am not a short person.... hmmm I mean I don't short stocks. But I do appreciate the value of shorts in financial markets. Nonetheless, I also realize that shorts think more short term, when they short they have interest to pay and they will only realize their gain if the stock drops. Thus they have a heavy interest in a big quick drop. A long term investor who buys a share of business can in theory retain his share without caring what the market prices his share.

So Berkowitz has positioned himself to wait out Einhorn. The company made a small profit in the most recent quarter and has minimal expenses. We are (hopefully) past the depths of the housing recession. JOE should participate in the housing comeback.

And lastly, I feel very comfortable with Berkowitz's investment ability and style. and I have followed some of his other investments: AIG and SHLD. So when JOE was $18 in July 2011, I bought. At $18 JOE would drop 40% to reach the $10 value that Einhorn gave. Today it is over $22.

Wednesday, September 12, 2012

Active and Index Investing

A few weeks ago I received the following comment from DTEJD1997 on yahoo stock boards. I want to share it here because it just warmed my heart.
Keep up the good work.

I was going to say that working for yourself will likely beat most mutual funds over a long period of time. Of course, you have to be willing to work several hours per week, EVERY WEEK.

Think about this...I personally know some investors who are totally self directed. All they do is buy stocks, bonds & options. Never a mutual fund or any actively managed device (well maybe 1% or 2% of assets in funds).

They will trade 1-10 times a month. They very frequently hold positions for YEARS, sometimes DECADES. They use an online discount broker that trades for $10/leg. They probably spend $300 to $600 a year on commissions. This is for a SEVEN figure portfolio. Compare that to an actively managed fund that charges 1.5% or 2% of assets a year. We could be talking about $15k to $25k a year in fees and expenses! How much does that add up to over 5,10,15 years?

If you have the patience and are willing to work at it, over the decades you will become VERY wealthy following the "value" discipline.

Keep up the good work!
His sentiments reflected mine. The person he described can be a retiree. The retiree can have a 7 figure portfolio, and is willing to do her own work. She can save $15-25k a year after tax! That along with retirement benefits such as social security is enough to live on comfortably. Or it could be someone who chooses to work part-time and invest in the remaining working hours. That's enough to live on comfortably pre-retirement.

I think the general public does not realize how much the financial industry gouges us common folk for their very mediocre service. Numerous studies have shown that 85% of mutual funds lag the general market, which for Americans would be the S&P 500 index. So unless an investor is positive she can consistently find that 15% of above average funds, she might as well just buy an index fund. This is the Jack Bogle's investment thesis (Bogle is the founder of Vanguard funds, a pioneering in the index fund industry).

So I started investing by making some foolish mistakes which I won't mention. Then I settled on indexing. But later, my methods evolved to more active investing. Active investing to match the market index has inherent advantages. Firstly, it saves on management fees which, although are low for index funds, are still my money. Secondly, it allows for greater tax efficiency such as realizing tax losses when I need it, or allocating certain stocks to tax-sheltered accounts and the rest to non-tax-sheltered accounts. And thirdly, it allows me to learn to be an active market-beating investor. If I don't do active investing, I will forever be paying others to invest my money.

So, I started active investing by trying to track the market. In another sense, I am just trying not to lag the S&P 500. But the S&P 500 is a basket of 500 stocks. I cannot practically own 500 stocks. I don't think I can even own 30 stocks of the Dow Jones Industrial Average. But then I found that studies have shown one can track the market with as little as 12 stocks, so long as they are diversified. And so I bought a dozen or so stocks that are generally indicative of the US stock market. And to this day I own one or two stocks in each of the following big categories:
  • consumer staples
  • consumer discretionary
  • high tech
  • foreign stocks
  • energy
  • basic materials
  • healthcare 
And I can see that as a result of this strategy my returns have matched or beat the S&P 500.

After I was able to match the market, I gradually evolved to trying to beat the market with large cap value investments. My way is to follow the big active value investors. All fund managers managing $100M or more are required to file quarterly with the SEC. So anyone can copy the legendary active investors with just a 3 month lag. How easy is that? The only hard part is knowing who the legendary investors of our time. Legendary value investors to me must have a long track record of outperformance through good and bad market conditions. The following are some that I can think of right now:
  • Warren Buffett, Berkshire Hathaway
  • Bruce Berkowitz, Fairholme Fund
  • Francis Chou, Chou Fund
  • Bill Ackman, Pershing Square
  • Don Yacktman, Yachtman Fund
  • Robert Bruce, Bruce Fund
  • Prem Watsa,Fairfax Financial

By buying what these masters own, especially if multiple own the same stock, I think I can do better than the market . After all these investors have all proven they can beat the market for 10, 20 years or more. And all this is with low fees, low risk and low maintenance.

Recently, in fact in the month since I started this blog, I have evolved yet again. Now, I have begun to invest in small caps, where I hope there is big underpricing. I hope to beat the market with such stocks because this is where where the big guys cannot participate; the gains are just too small to matter to those with billion dollar portfolios. But that's the topic of another post.

Monday, September 10, 2012

My Schedule of Investments

For a month now, I have posted about several of my investments. Now, it is time I post a summary of all my investment as a percentage of my total net worth.

Investment Amount as pct.
Misc (mutual funds, a bit of this, a bit of that)6.61
Bank deposits and short-term bonds27.43

Also as a follow up on my most recent post about GLBS: I was engerly anticipating the 2nd quarter earnings which just came out today at the market close. I was worse than what I hoped. Earnings was -$2.4M, mostly due to receivable writeoffs of $1.7M. So the company is hovering at breakeven in a terrible year for shipping overall. I am bracing myself for what will happen to the stock at the market open tomorrow. Oh well, sometimes things don't go my way. But this is where Benjamin Graham's "margin of safety" really comes in handy!

Wednesday, September 5, 2012

Why I Own GLBS

In my August "Why I Own SEB" post I mentioned Warren Buffett's claim of riches in small caps. Last week, I decided to test his claim by opening a new position in Globus Maritime (GLBS). GLBS is actually a microcap shipping company. As I will explain, I feel GLBS is very undervalued and I hope to double or triple my money in a few years. I bought GLBS as a long term value investment. Having said this, I want to warn the reader that microcap stocks often have limited coverage in the media and can be subject to fraud and/or manipulation. We all should be extra vigilant when dabbling in microcaps. Furthermore, the information in this blog should never be the basis anyone's investments. The reader should do his own research and/or consult a professional for investment advice before buying GLBS.

GLBS is a operator and owner of large dry bulk ships. GLBS started operation in 2006. It is tiny company with a market cap of $26M right now, and they own 7 ships. Their offices are in Greece but their ships are registered in other countries and they trade on NASDAQ. I found GLBS while doing using a screener for small-cap low P/E and high book value companies. In my screener, apparently more than half of the qualifiers are Chinese companies. I dismissed them because I perceive a lack of transparency and rule of law in mainland China. Then I saw GLBS. And the more I looked at GLBS the more I liked it. The first thing I notice about GLBS is the fantastic valuation metrics:
  •  price to tangible book value: 0.20 
  •  P/E: 4
  •  dividend yield: 13% 
  •  dividend policy is to pay out at least 50% of net income. 
The stock is at $2.60 / shr now but it has been as high as $12 in the last two years.

My next thought is what's the catch? I looked at most of their past financials -- which is easy considering they existed only 6 years. They were founded in 2006 with $40M seed money. They went IPO in what is called the Alternative Investment Market (AIM) in London in 2007. The IPO raised $50M which they used to purchase ships. Then they moved to the NASDAQ in 2010, without raising new cash. I don't know why they moved from London to USA but right now I am not too concerned by that fact. The have always maintained a fleet of around 7 ships. The following shows the earnings and some other key financial figures. All numbers are in millions USD.

2011 2010 2009 2008 2007
Income 6.96.0 -10.142.812.0
Assets 256 218 188284286
Liabilities 116100 65163189
Equity140 118 11312297

The numbers show good earnings performance in a challenging economic environment. They have grown their equity. And they have paid dividends.

A peculiar reason I like GLBS is the fact that its office is in Greece. Being in Greece would certainly depress the stock price, but it is actually immaterial to the company operations. GLBS has customers are worldwide. So this is a mispricing by the market where I can take advantage.

Another reason I like GLBS is that it is majority owned by the board chair George Feidakis. This means that the board is motivated to keep an eye out for any improprieties; the board chair has his skin in the game.
I also like the documentation on GLBS. For such a small company investors must rely on management to be transparent and forthright, and that is the case for GLBS. Their website show all their financials going back to when they formed. Their reports are all very direct and easy to understand. For example I read a clear one page summary explaining their losses for 2009. It was due to a $20M impairment writeoff as they lowered cash flows projections of two of their ships going into a recession.

The downside to GLBS is that it is in a pitiful industry. The industry currently has a glut of ships which are depressing rates. The Baltic Dry Index has been at the lows of the 2008-2009 recession. I worry if GLBS can stay profitable this year. So far in the quarter ending in March, they earned $1.7M, which is actually on track for a good year. If the rest of the year deteriorates to breakeven I would still be satisfied. But if they have a loss I would have to revisit my decision to hold GLBS.

GLBS reports 2nd quarter earnings on Monday Sept 10. I'll be watching that closely. If there is any significant news I will post.

Disclosure: I just started buying GLBS last week and may continue to add to my position in the next few days.

Thursday, August 30, 2012

Am I a Trader?

The other day I saw this article which said that Warren Buffett is not a long term investor. It claims he is just looking for a good trade. I disagree with the article. A trader to me is a person who bets against another person on the price of a security, typically another trader. A trader puts less weight on the underlying value of the security in their decision making. You can spot a trader from his phrases like:  "risk on risk off periods", "stay out of the market until the dust settles".

A value investor like Buffett doesn't think about what the market is doing; he just cares about the fundamentals of his security relative to the price. Buffett has said many times that he doesn't care if the market closes for a year. He buys his investments because he expects them to be profitable as investments, not as trades. Many people misunderstand his turnover (trading frequency) as a sign that he is not a long term investor. Buffett is a value investor, he will go wherever there is value. If he sees a great value he would use his cash or sell his least desirable investment and use the proceeds to buy that great value. So would I. So a value investor can do a lot of trades. It isn't likely but it can happen.

As a example of value trading, I have traded Cisco (CSCO) often for the last 4 years. CSCO is the world's dominate networking gear maker, I have owned it since the high flying dotcom bubble. Since then its shares have gone from $82 to about $19 today. It has a P/E of 14. And it is still a growth company with wonderful margines. Sure, gone are the days when high-tech had all the glamour. But these days people forget that high tech companies credit for their growth. And the P/E of 14 is even more impressive if you consider Cisco's balance sheet. Cisco has a net-net of $5 a share. Net-net is the equity on the balance sheet if you valued all intangibles and fixed assets at zero. Therefore the $5 per share is money back to the shareholder. If you subtract that out of the stock price you get a P/E of 10!

CSCO right now at $19 would appear to be a great buy, but just imagine that a month ago it was $15. I decided $15 was too good to pass up and bought. In fact, in general I have used this reasoning to buy CSCO at below $19 and to sell above that since the fall of 2008. The following table shows my CSCO trades in the last 4 years.

Date No. of Shares Share price Net stock position Net cash position
Initial reference 0 0
11/12/08 bought 750 16.8 750 -12600
08/11/09 sold 750 22.3 0 4125
03/23/10 sold 120 26.7 -120 7329
04/07/10 sold 125 26.5 -245 10641.5
04/12/10 sold 150 26.5 -395 14616.5
04/12/10 sold 125 26.4 -520 17916.5
04/20/10 sold 125 27.3 -645 21329
04/23/10 sold 150 27.5 -795 25454
12/07/10 bought 130 19.17 -665 22961.9
02/10/11 bought 550 18.93 -115 12550.4
03/11/11 bought 500 17.81 385 3645.4
03/15/11 bought 505 17.44 890 -5161.8
04/11/11 bought 550 17.5 1440 -14786.8
06/07/11 bought 450 15.9 1890 -21941.8
08/08/11 bought 500 14.3 2390 -29091.8
10/27/11 sold 500 18.48 1890 -19851.8
11/07/11 sold 435 19.88 1455 -11204
07/25/12 bought 800 15.1 2255 -23284
08/28/12 sold 800 19.2 1455 -7924
If later I sell remainder 1455 19.1 0 19866.5

Note I said I traded CSCO often, for traders that may not seem like a lot, but it is for me! The second last column show how much is my stock position from the trades. The last column shows how much cash I have spent (if it is negative) or how much I have gained (if it is positive). Right now from the last 4 years I have 1455 shares. The last row shows that if I closed out these CSCO trades tomorrow, the result of all these trades would be a $19,866.50 gain.

I put the table here to show that at I tend to buy when the shares dip below $19. It is just too good a value then. When it is above $19 it is still a good value but I do want limit my exposure so I sell some. The higher it rises above $19 the more I want to reduce my position to the point where I would completely sell everything at some point in the high $20's. I don't call myself a trader because I do this, I feel I am a value investor who trades CSCO frequently.

Disclosure: In addition to the shares I own in the table, I also own some shares as leftovers from my purchases during the dotcom bubble. I ignored those old shares from the discussion.

Thursday, August 23, 2012

Why I Own PETM

I own Petsmart (PETM) but I don't really follow it much these days.  I don't follow it because it has risen to 70 for a P/E of 24.  And it isn't a good value to me anymore.  Petsmart is a nationwide pet product retail chain.  PETM is not small, it has around 1300 stores.  Yet PETM can get such a high P/E because it has had phenomenal growth.

I got into investments of pet specialty stores back in 2005 with Petco.  Petco was (and is) the number two chain and I bought it because I wanted to get into the pet industry. The main reason is demographics, people in general have less children and more wealth. So pets are more and more pampered like children. Pet retail is a huge growth industry. And what could go wrong?  Well, in 2006, one year after I bought Petco, it  went private at a 33% gain.  Although 33% sounds great, I hated the idea of being forced to realize a gain. And that would leave only one public pet retailer: FETM.  So in 2007 I said what the heck, pet retail worked for me once, I'll try it again.  So, I bought some PETM. Today that position is up about 180% !  The following chart explains PETM's past growth and current valuation.

I would have sold it probably at 100% gain if not for capital gains taxes.  But as often happens the thought of capital gains taxes makes me hold longer.  It has worked out really well so far.

As for the future, I don't know what to do with PETM, I want to deploy my capital elsewhere. But I can only get away from capital gains taxes by cancelling the gains with all my available capital losses. And I really want to save those capital losses for other gains in a rainy day.

As a final side note, I will have a future post "Sins of Commission, Sins of Omission" where I discuss how I arrived at the aforementioned capital losses. This blog isn't just about how I have been making good investments.  I have had my share of bad ones too, all will get their full attention on this blog!

Monday, August 20, 2012

Why I Own SEB

The other day I saw an article about Warren Buffett. In it he discusses how the investing world favors the little guy. For Berkshire Hathaway's size, he says there are only about 200 companies that he can meaningfully invest in.  But for a small investor, investing in small caps can yield much higher returns.  This idea is nothing new. But he really startled me when he said he can guarantee a 50% return on a million dollar portfolio. Now I can picture him starting over with a million dollar and easily getting a 20-30% return, but come on Mr. Buffett, 50%? I firmly believe Buffett is a person of integrity not prone to empty boasts, and I could only wish I can invest like he does, but I cannot imagine how he can return 50%.

In the article, Buffett tells where he has found bargain stocks in the past and where he can find them today. He gives an example of looking through a list of Korean stocks in 2005 and finding many bargains. I finished the article with a little better sense of how he can quickly scans a list of stocks and find bargains. It is mostly earnings, cash flow and tangible book value. Gosh I wish I could do that!  He does say you have to look away form the beaten track.  I am already starting to look on the internet, for example here is a website I found for all traded Korean companies. It gives the data that would help me emulate Buffett, which is a concise description of the company and their financials.  But I don't know of a free automatic screener of all international stocks. I suspect it is still best to manually look at the stocks one by one.

In the whole I like to stick with large companies that are well covered. The only exception that could fit the above the aforementioned Buffett criteria is Seaboard Corp. (SEB).

SEB is a diversified conglomerate. Their biggest business line is meat production (primarily pork). Their other business lines include power generation, trading of agricultural products, container shipping, sugar production and milling.  This is a company that is easy to analyze, their financial reports are barebones and straightforward.  I'll summarize their trailing twelve month numbers:

- Recent share price: $2257
- Working capital per share: $964
- Tangible equity per share: $1766
- Retained earnings per share: $1958
- TTM earnings: $204 for a P/E of 11
- Dividends: negligible

Seaboard also has a good growth rate.  The chart below shows their earnings and free cash flow going back 10 years.  The FCF has been less than their earnings because they have use cash flow from operations to fund growth.  So, they have little debt.  They also actively acquire companies to support their growth.  They buy back their shares but not a lot.  All these facts along with their strong balance sheet shows shrewd money management.

The arguments against owning this company is that their earnings can be very cyclical and their pork business margins can be thin or negative. Also, the company was founded by the Bresky family back in 1918 and the Bresky family still owns 75% today.  The Bresky family doesn't bother to give guidance to analysts.  So it is no surprise no one covers this stock.

So I imagine several conservative exit scenarios for SEB.  I assume the Bresky family keeps chugging away growing and generating cash. The Bresky family could later take the company private. Or they can easily distribute $1000 per share without affecting the business.  The resulting business should get a reasonable PE multiple of 10.  That gives a current buyout value of about $3000.

I do admit such concentrated control worries me. The Bresky family may not act in the minority shareholder's interest, or something worse such as deceit in the books.  [1] KPMG is the SEB auditor for the last 10 years.  But, in the end I think I worry mainly because there is little SEB coverage in the media. So, in the end I am comfortable with owning SEB.

1. I have NOT heard of any accusations of any significant impropriety regarding SEB

As a follow up to a previous post titled "What is My Net Worth?", I got a reader's feedback and decided to take it down. Seems like it may not be necessary, people don't need to know what I am worth and I like it better that way. I will keep discussing my stock holdings, but from now in terms of percentage of my net worth.  In the end, I just want to do whatever to bring the readership up! For your thoughts on this, email me!  thanks!

Disclosure: SEB is my largest holding at about 11% of my portfolio.  I first owned it in 2005.


Wednesday, August 15, 2012

How Do You Know We aren't in a Bubble?

The title of this post is from something that happened to me in about 2005.  At that time, I was by myself driving when I noticed a funny bumper sticker that said: "Please God, just one more bubble". I looked at it and chuckled a bit and then went back to driving. Then a short time later a thought occurred to me which made me want shout out: "Wait, how do you know we aren't in a bubble?"

In hindsight we were indeed in a bubble in 2005: a housing bubble.

I mention this here because there is a moral to the story.  In investment we often are seeking a pattern to relate current situation to something that happened in the past, without thinking deeply to understand.  This is not good value investing thinking.  Value investing should be about being a owner in a business. And that requires understanding that business.

We didn't realize we were in a housing bubble because we had never seen one. Housing always went up.  By simply reverting to a pattern of housing always rising, we didn't try to contemplate falling housing prices. A lack of critical thinking caused complacency.

Now fast forward to today, the economic situation is very hard to grasp. It is the opposite situation, we are looking at a world that is clearly in uncharted territory.  We are looking for a pattern and we don't see one, so we are very susceptible to emotional arguments and sensational headlines.  So the market has priced in a very bleak future, the everyday retail investor is staying away from stocks.

But just because this is uncharted territory doesn't mean it is going to have a bad outcome. Yes, I am aware of the headlines.  Europe is in a mess with the euro. America has an enormous deficit and debt burden.  Banks are hobbled by regulation and their excesses of the financial crisis period.

But the world is rapidly changing and we always will have new problems. We are overlooking the positives, such as the growth of the middle class all over the world, a reasonable inflation rate and good corporate profits.

Good investing requires taking advantage of unprecedented situations. The good value stocks today won't fit the same criteria of the Graham and Dodd era. Each stock in each era requires its own criteria and sound judgment.

A case in point is my purchase of Philip Morris from 12 years ago.  I purchased MO just after the Engels verdict - the Engels verdict fined the US tobacco companies $150 billion in the summer of 2000, it was later overturned - Such a large verdict had no precedent in history.  However, US law forbids punitive damages that would bankrupt a company.  After the Engels decision, all the bad news was out, it is as bad as it gets, or the next step would be bankruptcy.  So at that moment, I bought in and the rest is history. MO has since been relatively successful at fighting off lawsuits and raising prices.  Now the original MO is split into three companies: Philip Morris USA (MO), Philip Morris International (PM) and Kraft (KFT). I estimate the gain to now has been 7-10x. (It is hard to add up all the dividends of all three companies).

As a final note to this story, the market has now changed its opinion 180 degrees! Tobacco companies are now the flavor of the month because they pay fat dividends and they have addicted customers.  These days tobacco is hardly cheap, MO and PM have P/E's above 15, more than MSFT or CSCO! Imagine that!

So nowadays I am slowly reducing my position in MO and PM, and trying to find my next big mis-priced stock to bet on.  This stock will probably be in an unprecedented situation, maybe it's hidden in plain sight.

Disclosure: I own PM, KFT, CSCO and MSFT. I have actually exited my MO

Monday, August 13, 2012

Why I Own MSFT

In this time of global economic uncertainty, we instinctively flee to safety. I feel one of the safest investments is Microsoft. It is one of my top 4 holdings.

MSFT is truly a global franchise. It dominants operating system portion of the PC market. It leverages that to create its biggest money maker: the Office Suite. Its balance sheet is straightforward and thus makes the company easy for us non-professionals to analyize. MSFT has $50 bil in tangible book value, which is $5.80 / shr. Earnings are also simple and extremely attractive. The following shows the last 10 years of earnings and free cash slow per share.

The earnings are wonderfully consistent with the exception of the last 12 months because of a $6.2 bil writeoff for the 2007 purchase of aQauntive. The cash flow picture is even better.

So, at the current price of $30/shr, we pay $24/shr for about $3.50/shr of free cash flow.  Warren Buffett has said that the value of a company is the present value of all future cash flows.  So, if we can assume that the next 10 years will be at least this rate of cash flow, and management returns this money to its shareholders in the form of generous dividends and stock buyback, then this stock would pay for itself in that time.

So far my argument is easy to straightforward because I stayed away from the technological merits. I feel this is the Warren Buffett way. I doubt Buffet gave much thought to technological details of IBM when he took his $10 billion position.

But I will make some basic comments about technology. In the above analysis, I have assumed MSFT will lose market share in operating systems (as is the conventional thinking).  But I feel it is primarily because our computing devices are more varied, we use desktops, ultrabooks, tablets, smart phones to name a few. So the market will have more operating systems, but with it also comes a larger market of devices.  I also feel the market is under-estimating the switching costs for companies and home PC market.  But despite all this, I will conservatively say that a worse case is MSFT will only maintain its revenue for the next 10 years.  After 10 years other paradigms like cloud-computing could erode MSFT windows dominance, and then I cannot say where MSFT will stand. But, by then the cash flow would have paid off my current investment.

On the optimistic side, Microsoft also appears to be trying its hands at many different initiatives to stay dominant in computing and entertainment; i.e.  Office, Outlook, Bing, XBOX, Skype to name a few.  Don't be surprised if MSFT can lead in some of those areas. MSFT has demonstrated time and again that even if it loses the initial round in a technological battle, it can catch up and later dominate.

So one way or another, I think investing in MSFT will pay off.

Disclosure: Despite my bullishness of MSFT stock, I like Linux much more than Windows, and I primarily use Linux at home and work.

Thursday, August 9, 2012

Why I Own WLP

Wellpoint (WLP) is one of the biggest MCO (managed care organization) in the US. They offer the Blue Shield/Blue Cross name in 14 states. WLP is my second largest holding. I have owned it for 8 years since when it was originally Anthem.

The US spends 1/6th of its GDP on health. So health is a big sector US equity market which is looking very hard for inefficiencies. MCOs are in the business of increasing efficiency. (some may argue this is all at the expense of the quality of service, but I will stay away from that as this post is about the investments merits of MCOs)

I chose WLP in part as a play on the overall healthcare and MCO sector. Blue Cross/Blue Shield is a great franchise, and they are well managed. What amazes me about WLP is the P/E of 8. Usually when companies have P/E that low they have some big inherent risks such as huge debt or loss of market share or they are highly cyclical. WLP is not cyclical, their earnings have been rising. They are not overly burdened by long term debt. The balance sheet does show that their tangible book value is about zero. This means the company's value is in the franchise, the organization and its scale.

So where is the catch? Well the catch is supposedly Obamacare. The pervasive feeling is that the government will regulate and restrict the sector. And companies like WLP will not have freedom to raise rates as freely.

This fear is a valid one, but one must also consider the flip side of this. Obamacare will bring 30 million new members to MCO likes WLP. It is somehow very counterintuitive to me that the industry will suffer even with 30 million new members. For now I will give this argument the benefit of the doubt, but even then I think the P/E of 8 overly discounts the risk.

As for recent news, there was a lot. WLP was trading at about the $70/shr range for the last year, until June when the Supreme court released the verdict that upheld Obamacare. That caused it to drop to $60. Then WLP released earnings in July, they disappointed which drove the stock to as low at $50. That puts the current P/E at 7! The earnings report showed that membership was lower, and they also gave a lower than previous earnings guidance of 7.35. Overall, I read the stock movement as a knee-jerk reaction to the unknown. Sure the managed care landscape is changed forever, but uncertainty can bring danger as well as opportunity. I have found that the market reacts to big negative headline situations by unnecessary panic selling. Which brings me to my next point.

Every year or other year some unprecedented negative media attention comes to a company. The news is due to some event that is pretty much out of the company's control. It isn't the management's fault, it is just the risk of doing business for that company or its industry. But because the bad press is sudden and pretty much unprecedented, the market doesn't can't digest it quickly enough. This in turn comes can cause some wild swings. I feel this is a case where I can try to take advantage. This type of situation does require patience, like a predator stalking its prey. It could take years of waiting but there is money to be made.

To show my point, I have listed the cases that I know of and how one could have made money.
Date of Low Company Event Low Price Later Price
8/2000 Philip Morris Engle's class action suit against big tobacco awarded $145 billion to the plaintiffs, later overturned. $26 now: up approx 7-10x after 2 splits to make PM and KFT and dividends
9/2004 Merck Vioxx recalled. This anti-flammatory drug was purportedly responsible for many deaths. Taken off the market then reinstated $26 $46 two years later
6/2006 Bausch and Lomb ReNu solution seemed to be related to dozens of cases of blindness due to a fungus, relationship never proven $45 taken private in 2007 for $65
6/2010 BP Gulf of Mexico spill $27 $40 today
6/2012 WLP Supreme court ruling in favor of Obamacare $50 TBD

Disclosure: I own KFT and PM.

Wednesday, August 8, 2012

PIMCO's Bill Gross and Other Contrarian Indicators

The other day I read an article by Bill Gross of PIMCO about the death of equities. The general gist of the article is that times are uncertain, world is in a ton of debt, etc. and equities are destined to return a real rate equal to GDP growth -- GDP tends to run at the 2-3% range.  If not then, Gross says, owners of equity will own the world if given enough time. Gross assumes that every investment penny earned over the GDP will be reinvested and will earn returns at this higher-than-GDP rate. But that is not the case, we do not reinvest everything we earn from investments, we also spend the money and enjoy fruits of wealth.  People who do not have so much wealth will not leave a rich estate to their children. They will typically use up all their money when they die.  Therefore, they do not fit in that model of forever investing, making capital gains and reinvesting all their dividends.

This counter argument of mine is not original, it has been mentioned in the media.  But what is most notable to me is that this highly public statement is a classic contrary indicator.  It is almost a reprise of the 1979 Newsweek article on the death of equities.

Mind you, Gross has been dismissed during the mid to late 2000's for sticking to bonds when equities were high fliers. Credos to him for sticking to his views.  But now it is precisely the reason that he was right about bonds for the previous 30 years, that we should discount his views now. He was right for 30 years, so he can't possibly be right for another 30! The market ebbs and flows around a baseline, what statisticians call reversion to the mean.  Bond and stock returns will be no exception.

Jeremy Grantham  of GMO is another notable money manager who feels that we will have very low market returns in the coming decade. Again he is one who's bearish views were right for the last 10-20 years. But I look at the world, and I mean really step back and look at the world income distribution, we have 20% of the world living in abject poverty, meaning $1 a day.  We have global environmental problems from global warming to destruction of rain forests. We have many parts of the world plagued with ethnic and religious strife. Much of these conflicts can be traced to poverty or lack of economic opportunities. All these problems are waiting for entrepreneurs to solve. These entrepreneurs are motivated by the profit motive like all people. They will not invest their efforts or money when the return is the 2-3% of GDP. Suppose for example, silicon valley pre-IPO investors were told they collectively will expect 2-3%?  They wouldn't both to invest! Hence the supply of able entrepreneurs will dry up.  Then guess what, no Google, no Cisco, no Microsoft. When an person can make a steady income at a large corporation, and society offers that person the alternative of 2-3% return on his invested capital to be an entrepreneur, he/she wouldn't bother.

Our capitalist society will give entrepreneurs and innovators and creative people in business the financial incentive to solve our world's problems, and we need solutions for the foreseeable future.

It is a combination of this line of thinking and just the pervasive pessimism in the market that makes me very bullish for the short term. By short term, I mean in the coming 6 to 18 months.  I wouldn't be surprised the S&P challenges its all time high of 1552 in this period. Don't laugh, it is only 10% away at the 1404 closing today.

And so in closing, I will be increasing my long position on the market.

ps. If you haven't I strongly recommend reading the "Death of Equities" in Businessweek for a real sense of perspective.

Tuesday, August 7, 2012

Yet Another Value Investing Blog

Hello world, today this value investor is coming out and announcing to the world: we need another value investing blog.

My blog will focus on my investing thoughts of as it pertains to my portfolio.  My portfolio is not inherited, it isn't the result of a jackpot IPO, it is just my money invested for more than a decade. For now, I shall remain anonymous. I will say I am 41, somewhere in North America. I have a graduate degree and I work in IT. My passion is investing and so far I have only invested my own money. I hope to change that one day.  But I need people to know me first.

My returns of the past decade plus has been.... decent, shall I say. I estimate it has exceeded the market by 2-3% per year on average over that time.  In future blogs I'll gradually reveal my portfolio and my thinking.  We'll see how this blog and my returns goes.  Both sure will be interesting, in part because we live in very interesting times.  Who knows maybe if they both go well I'll blog and invest full time!

Without further adieu let this blog begin!

***** Disclaimer *****

This blog is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation for any security, nor does it constitute an offer to provide investment advisory or other services by me.  I will disclose any significant position in any security mentioned in this blog.  Any views expressed on this website by me were prepared based upon the information available to me at the time such views were written. Changed or additional information could cause such views to change. All information is subject to possible correction.