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.