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.