Warren Buffett's 1962 Short Positions

I have collected number of article on long positions from the Buffett Partnership Limited in 1962. But that year he had also a few short positions. He explained them in his 1963 letter to shareholders:

You will note on our yearend balance sheet (part of the audit you will receive) securities sold short totaling some $340,000. Most of this occurred in conjunction with a work-out entered into late in the year. In this case, we had very little competition for a period of time and were able to create a 10% or better profit (gross, not annualized) for a few months tie-up of money. The short sales eliminated the general market risk.

The $340,000 worth of shorts were in four securities. The bulk of the amount was in Insurance Company of North America (INA) and Hartford Fire Insurance Company. INA has a long history going back to 1792 and it is known today as CIGNA. Hartford Fire still exists today and is simply known as the Hartford. The two companies were very similar. Both were large insurance companies with long unblemished histories. Both had rock solid balance sheets. Hartford traded at $68 ¹/₈.[edit] Its liquidation value was $56 per share. It wrote about $50 of premiums per share at the company level (non-consolidated). INS traded at $94 ¹/₂ and had $58 of equity per share. It wrote about $40 of premiums per share at the company level. Both companies consistently had combined ratios of close to 100%.

Clearly, Buffett was looking for large companies whose stocks weren't volatile and would not rise as much if the overall market climbed. But it isn't fully clear to me what he meant, especially when I don't know which workout he was referring to. There are a number of candidates. One is British Columbia Power (BCP). Another is Texas National Petroleum (TNP). Another is Lehigh Coal and Navigation. For more about these refer to my master list of Buffett Partnership Investments. And there could be others that I don't know about.

But Buffett has said that workouts are supposed to bring gains that are independent of the market overall. So, he doesn't need the exposure to market risk, be it to the downside or upside. So his shorts were positions designed to negate market movements on $340,000 of workout exposure. Plus the shorts give him leverage; he has $340,000 more to put into the workout situation. But I don't see how his workouts are exposed to market risk. Both BCP and TNP pay out fixed amounts of cash regardless of market conditions.

I will probably discover more about Buffett's workouts as I research more of his investments from 1962. And if anyone has any suggestions to add, please put them in the comment section.

A Look Back at British Columbia Power

British Columbia Power was a interesting story back in 1962. It was one of the biggest positions of the Buffett Partnership at 11% of total assets. It was a Canadian company going through an acrimonious court battle with the British Columbia government. At issue was the company's very existence.

The newly formed British Columbia government of WAC Bennett wanted to expropriate the assets of BCP, which was the largest electricity generator in BC at the time. The Bennett government wanted to control and expand hydro power generation in British Columbia by constructing new dams along the Peace River and eventually exporting the power to the US. To this end the government expropriated BC Electric which is BCP's wholly owned subsidiary. The government paid BCP $110M for BC Electric. And it promised BCP that in the event BCP ceases to be a going concern because of this action, it will pay a further $62M. By 1962 it was clear that BCP wanted more for its assets before it would dissolve. At 1962, the BC government was already in control of BC Electric for a year. And BCP was fighting the Bennett government in the courts for all that time. The BC Supreme court was due to render a verdict sometime in 1963. BCP had already received $110M in 1961 and distributed $89M of that to its shareholders in 1961. The company received the remainder of the $172M in 1962 but under protest. The BC Supreme court was to decide whether $172M was enough compensation, or whether it should be closer to the $225M BCP was asking. By 1962, the equity on the books was $95M. That works out to $20 per share — in this post all currency are Canadian dollars, which was equivalent to $0.925 USD back then. The 1962 high price price for BCP common shares was $20 ⁵⁄ ₈. In other words, the company was trading at book value without any money making assets. It simply had the half of BC Electric proceeds that it hadn't yet distributed plus the hope of additional compensation the court would award.

It is against this backdrop that Buffett bought his large position based on Charlie Munger's recommendation. The following is an excerpt from The Snowball by Alice Shroeder:

Munger did enormous trades like British Columbia Power, which was selling at around $19 and being taken over by the Canadian government at a little more than $22. Munger put not just his whole partnership, but all the money he had, and all that he could borrow into an arbitrage on this single stock —but only because there was almost no chance that this deal would fall apart. When the transaction went through, the deal paid off handsomely.

I don't think that description is totally accurate though. BCP was trading at around $19 USD but there was no guarantee the court would rule in its favour and even if it did no one knew exactly how much. But Munger, being a lawyer, probably had a hunch that the company would get a favourable ruling and bet heavily. In any case, there was no downside. The money for BC Electric was in the bank; so, BCP wasn't going to get BC Electric back.

In the end the court ruled that the expropriation was illegal and the two parties eventually settled on a $197M price. This is $25M more than the expropriation price. Each share would eventually get $25.50 or $22.20 USD before disollution.

I think this case shows merger arbitrage with minuscule risk. And how Buffett and especially Munger would bet big in such a situation. Buffett got a 15-20% annualized return on his investment and Munger did much better with leverage.

Hong Kong and Greek Portfolio Update

I haven't posted the results from my holdings for a while. And there has been a slew of them. Almost all of them have not disappointed. But their stock performance has been disappointing. I guess that is the hard reality of investing in out of favour markets.

The Greek crisis that has resurfaced this year has stained my nerves. But my two Greek holdings have held up very well. European Reliance (EUPIC) reported H1 revenues up 7% yoy. Such revenue numbers are very encouraging considering how the Greeks are strapped for cash. On the other hand, I am not surprised that a consumer insurer does well in Greece because it fills a void left by the very cash strapped government. The H1 earnings are down slightly from $0.15 to $0.125. The difference was mainly due to higher operating expenses, in part because the company hired more staff. The company currently trades at 1.9x book and 4.2x TTM earnings. This company is one of the cheapest stocks I own. And I am very pleased that the company recently has begun to publish all their investor information in English.

Karelia Tobacco (KARE), also based in Greece, also did very well in H1. This one is less surprising considering that the company gets most of its revenue from exports. In addition, smoking is a mostly recession-proof industry. The company report H1 revenue up 15% yoy. Net revenue (without excise tax) was up an incredible 28%. Earnings went up only 3% mostly because of an adverse court decision regarding duties. The company said that they will appeal the decision even though they have already expensed the loss. Without this decision the H1 profit would have been around $12 per share instead of the $8.52.

In following Greek news through the crisis I also learned that Greece is a society with an all powerful elite. The Karelia family sure counts as part of that group and that is wonderful. They will defend their business interest from all the nonsense happening in the country. So that if the country somehow implodes, the company will find a way to do fine and protect its wealth, and by extension my shares also.

The Hong Kong stockmarket is down in sympathy with the turmoil in China's markets. I feel Hong Kong has some of the most undervalued stocks anywhere today. My two Hong Kong stocks are currently trading at very depressed values. Soundwill Holdings (HK:878), which owns some of the best retail properties in Hong Kong, reported H1 earnings that were similar to last year. Considering the China turmoil I am very happy it wasn't worse. Soundwill typically depends on the mainland China shoppers to to buy the luxury products and dine sumptuously at their prime rental locations. So, there will be downward pressure on rents now that the Chinese government has clamped down on illicit income and China's economy is slowing down. Anecdotal evidence says that some rents in prime locations are down 10-15%. That said Soundwill's rental income has actually increased yoy, albeit slightly. So, I don't see why the stock is trading at a ridiculous HK$9.50 today! Below I show how much the balance sheet is worth per share. Compare that with Hk$9.50 per share!

Soundwill		HK $ per share
Assets	Property under development	12.00
	Other current Assets	3.39
	Investment property	56.00
	Other non-current assets	1.00
Liabilities	All Debt	8.08
	Other liabilities	4.88
	Equity to shareholders	58.34
	Minority Interest	1.09
6 Month EPS		1.02

Someone who is still turned off by the stock can point to the overpriced real estate market. An overpriced real estate market means Soundwill's assets are overstated. Still the margin of safety is so big I believe Soundwill is a steal. And the company is regularly turning over its real estate. In the H1 report, the company said it will convert HK$0.75 per share of this investment properties into cash through a sale that is expected to close in the latter part of 2015.

My other Hong Kong stock is New Century Group (HK:234). The company is profitable and also has a tremendous balance sheet. It trades at 14.1 ¢! Below shows the balance sheet and note that the vast majority of the debt is an interest free loan from the majority owners.

New Century Group		HK ¢ per share
Assets	Equity investment	6.6
	Other current Assets	1.3
	Investment properties	10.9
	Other non-current assets	1.5
	Cash	8.9
Liabilities	All Debt	2.7
	Other liabilities	1.1
	Equity to shareholders	25.5

The company announced recently that it will acquire a cruise liner in addition to the two it already owns for about HK$170 M. That is approximately 1/3 of the company's available cash. But the purchased cruise liner has generated charter income of about HK$20 M in each of the last two years. So that is a greater than 10% return on investment if it continues. I think it is a very reasonable way for the company to deploy its cash.

My Recent Reading List

Study of Walter Schloss investing style. Walter Schloss is one of my favourite investors.

A really sad and poignant cartoon: The Employment .

A interesting interview with a small-time hedge fund manger.Torin Eastburn of Monte Sol Capital.

A good explanation of the implications of the Shiller PE ratio.

A unique view on taxes and their opportunity cost.

An article discussing why stocks consistently outperform bonds by a large margin.

Charlie Munger wise words at the Daily Journal 2015 annual meeting.

Howard Marks of Oaktree: It's Not Easy.

A list of practically all of Yahoo tickers for those that may find it useful.

Bronte Capital's John Hempton questioning whether Alibaba is being truthful with its numbers.

My 4th Annual Schedule of Investments

Wow, so three years on, I am still regularly posting. On each anniversary of my blog I list my dozen or so largest holdings.

Position	Category	Business
Wellpoint (ATHM)	US Large cap	Health insurance
Senvest Capital (TSX:SEC)	Canadian Smallcap	Investment Company
IEH Corp (IEHC)	US Microcap	Manufacturing
Seaboard Corp (SEB)	US Mid cap	Food Conglomerate
McRea Industries (MCRAA)	US Microcap	Footwear
Tachibana Eletech (TSE:8159)	Japanese Smallcap	Electronic Distributor
New Century Hong Kong (HK:0234)	Hong Kong Small cap	Hotel, cruise line
Installux SA	French microcap	Manufacturing
AIG (AIG)	US Large cap	Insurance
Bruce Fund (BRUFX)	Mutual fund	Mid-cap value
European Reliance (ATH:EUPIC)	Greek smallcap	Insurance
Pacific Healthcare Organization(PFHO)	US microcap	Healthcare services

My largest positions have a few changes from a year ago. I sold Hanover Foods and Putprop at a loss. I sold ITIC at breakeven. And Petsmart exited by going private. I normally hold on to winning position in non-retirement account as I prefer to avoid taxes. But the company made the decision for me by going private. My new investments on the list are Senvest Capital and Pacific Healthcare.

Anthem (formerly Wellpoint) had a great year along with other health insurance companies. Seaboard jumped to as high as $4640 per share early this year. But I hesitated selling because I was to attend the annual meeting in April. That was a big mistake because it didn't stay that high for long. Now it is back to $3330 today. My best position TTM was IEHC because I doubled my position after attending the annual meeting.

I have held the three largest stocks plus the Bruce Fund for a while. But all the rest were purchased within the last 3 years. And I am still waiting for a lot of them to breakout. For example EUPIC, Senvest and New Century are trading at nowhere close to book value. And these three are perfectly fine and profitable companies. So, I think this portfolio has a lot of potential energy to release, when given enough time.

Why I Bought Pacific Healthcare Organization

Pacific Healthcare Organization (PFHO) is a tiny company that handles workers compensation claims in California. It does not provide the funding and therefore is not an insurance company. The company got its start in this business 15 years ago by bringing in Donald Balzano to run Medex Healthcare, the company's main subsidiary. Workers compensation is a business fraught with regulation. And Mr. Balzano is a lawyer with extensive experience in this area. Mr. Balzano is less involved with the PFHO now but he owns 7% of the company. The main owner of the company is Tom Kubota, who owns 60% of the company. The company has a small buy back program which has reduced the float slightly. The company management appears to be only focused on growing the company and not taking advantage of minority shareholders.

Healthcare services companies like this are not exciting investments. They are companies that do labour intensive work and they increase business slowly by building relationships. They typically aren't going to have some breakthrough that will cause revenue to surge. On the other hand, PFHO earnings did take off from 2010 to now mainly because it started from a very small foundation. The company revenue went from $2M to $10M over that time.

The following chart shows the roller coaster ride that shareholders suffered. I think the underlying reason was the surging growth from 2010 to 2014. And when the earnings fell flat in the last twelve months overly optimistic shareholders sold at any price. The company lost some significant "overflow" business and one significant customer. The overflow business was temporary extra work that another company could not handle and the work ended in the first quarter. These things happen. The company will, from time to time, gain customers and lose customers. I don't know and I don't try to predict the company revenue, other than that I don't expect revenue to decrease.

PFHO Stock

I have never used workers compensation nor have I ever thought much about it. So I am learning about works compensation as I go. California has the highest workers compensation expenditures of any state, at 180% of the median. This is understandable to me because California is a egalitarian state with a very wasteful government.

Worker's compensation is a statutory requirement for all employers. But the government is not involved in administration. A company can use an insurance company or self insure. PFHO provides the administration for both types of insurance.

I sincerely believe that health insurance companies and companies that handle other benefits such as workers compensation benefit the user by providing reasonable service with less waste. The government cannot do a better job. Where there is benefit to all there is demand; so these type of companies constitute a growth sector. In fact, in one 10K management said that the greater the regulation and the pressure to cut costs the more these companies will benefit. And California can certainly improve.

	PFHO	Corvel
Price	$ 22.650	$ 30.490
Market Cap	$ 18.05 M	$ 636.94 M
P/E TTM	9.2 x	22.3 x
Div yield	0.0 %	0.0 %
P/BV	3.30	4.98
Gross Margin	28 %	20 %
LT Debt/Equity	0.00	0.00

PFHO trades at 9 times earnings. But a year ago it traded at 25 times earnings. It is hard to know what the schizophrenic market is thinking. So I looked at one of its competitors, CorVel Corporation, to get a reference for this type of company. CorVel (CRVL) also exclusively does workers compensation administration. However, it is a nationwide company. Interestingly, I cannot see which states it covers from its 10k. The two companies are similar in many respects. They both have no debt, have growing earnings, pay no dividends and have been buying back shares. But the stark difference is that PFHO trades at 9 times earnings and CRVL trades at 22 times. And PFHO has better margins.

PFHO had a lot of good press on Seeking Alpha last few years. Those articles expound in detail why PFHO is a great investment. So, I feel no need to repeat it here. But the interest is quite exceptional considering the company's market cap. And now unfortunately, I believe the enthusiasm for this stock is disappearing. It is capitulation.

I may be wrong of course. In fact,the stock bumped up a bit on the most recent trading day because management decided to pay a special one-time dividend of $1.25. The money was earmarked for share buybacks but the company cancelled it. Maybe the company felt it was too difficult buying back such a thinly traded stock.

Buffett Partnership Investment: Stanrock

Stanrock Uranium Ltd. was one of the bigger positions in the Buffett partnerships in 1962. It was 5% of the partnership. Stanrock Uranium Ltd. was a Canadian mining company with rights to uranium around Elliot Lake in northern Ontario.

In the 50's uranium was a hot commodity with the proliferation of nuclear weapons in the cold war and the advent of nuclear power. The company traded on the American Stock Exchange as well as in Canada.

The company incorporated in 1956 and declared bankruptcy and went into receivership in early 1959. For some reason which escapes me, the uranium industry hit on hard time in the turn of the decade. Many miners went under. Before bankruptcy the stock traded at around $ 1½. The company fully operated in the early 60s but did not get out of receivership until 1964. During that period the company paid some $41 M to their lenders. In 1961 the company earned $0.9M.

My guess is that Warren Buffett bought the stock just after bankruptcy in 1960 when it traded at around ½ . He must have seen something in the bankruptcy that indicted the company was valuable and the market will see that once it emerges from bankruptcy. When that happened he probably had a easy double in a few years.

Buffett biographer Alice Schroeder mentioned Stanrock in the book the Snowball briefly. But the Buffett Partnership's 1962 statement showed the partnership owned 36760 shares at 13½. Where that price came from is a mystery to me. I know I have the correct company. But the partnership may have not have owned the common stock but the defaulted bonds. Unless Warren Buffett speaks up, this fact will probably be lost to time. The following is the information available from the receiver for 1961.

Why I Bought Lewis Group Ltd.

In the last year or two the US economy has been looking stronger and stronger. It is quite clear by now that it is in the mature stages of a recovery from the recession that began in 2008. Unemployment is going down as smoothly as a plane coming in to land. The fiscal deficit is down from the abnormal levels at the height of the recession. Housing inventory is no longer full of bank-owned foreclosures. US manufacturing and consumer confidence are all up. The US dollar is at the highest level in four years. The market appears to be fully aware of this and the US market valuation reflects this economic situation. So though the economy still has room to run, US companies are probably fully valued. Indeed, I am finding it harder and harder to find those knock-out bargains of two or three years ago. That is why I have been buying outside the US recently. This all a drastic change from 5 years ago, when news pundits were saying that the US premier position in the world will be eclipsed by China and Europe. Well there is a saying I keep: You're never as good as everyone tells you when you win, and you're never as bad as they say when you lose.

I find it also interesting that the market has taken the opposite view of the emerging markets six years ago and today. In the last year or two, money has consistently flowed out of emerging countries. The headlines are full of bad news everywhere you look. Russia doesn't respect shareholder's and will steal or confiscate at will. China has a colossal property bubble. Hong Kong is too close to China to be immune. In fact that goes for every other country in Asia. Japan is growing old and will forever be in recession. The commodity slump and mismanagement have meant that Brazil, Indonesia and South Africa all have high inflation and capital flight This juxtaposition of emerging markets and the US may be partially based on fact but I think it is also very much a matter of psychology. Someone always has to be a darling and someone always has to be the dog.

So, it is with this idea in mind that I decided to dive into my third South African stock: Lewis Group Ltd (JSE:LEW). Lewis Group is a large furniture retailer in South Africa and nearby countries. The company is extremely profitable and very shareholder friendly. I know of no other company that regularly pays a 8% dividend. The down side is that the company is very susceptible to the South African consumer. The company serves lower and middle class South Africans, and 70% of them buy from the company on credit. The company makes relatively low margins on the sale and makes most of its money from financing, interest and insurance on the debt. This model has worked well for Lewis as well as its competitors. But recently, over expansion has hurt furniture retailers. One big competitor with a thousand stores, Ellerine, filed for bankruptcy last year. Its one thousand stores have been sold to various competitors. Lewis Group bought 63 stores under the Beares name.

	JSE:LEW
Price	ZAR 57.800
Market Cap	ZAR 5178.01 M (USD $ 424 M)
P/E TTM	6.2 x
Div yield	8.9 %
P/BV	0.89
Debt / Equity	0.27
ROE	14.4 %

Now critics of companies like the Lewis Group may point out that such companies take advantage of those less well-off. I can't say I disagree with such critics. And now government is on to the company. In early July, the South Africa National Consumer Tribunal, fined the company ZAR10M for misrepresenting the insurance they sold. This apparently was the catalyst for the stock to drop by 40%! The fine was only 1% of last year's earnings but it reminds us there is regulatory risk. And that's all. It shouldn't be significant. But in reality it has had a big impact on the stock price, which gives me a buying opportunity.

Today at ZAR 58 it is back where it was a year ago before Ellerine's bankruptcy. Since then I feel things are much more clear for the industry and Lewis group. The company has had record earnings, although the economic situation in South Africa is considered negative because of the global slowdown in commodities.

Lewis Group Stock TTM in ZAc

Lewis Group has over 700 stores in three segments. The largest with 80% of sales is the Lewis chain of furniture stores. The Best Home and Electric chain sells electronics. And the just-purchased Beares chain sells furniture to slightly wealthier demographic.

The company's balance sheet looks strong. The largest asset item on the balance sheet is accounts receivable, which stands at ZAr 5400M. That is almost equal to the company's equity. Needless to say, customer debt management is a crucial aspect of the business. Almost 70% of the debtor customers pay their obligations in full. The company bad debt / impairment costs are about 13% of total debt. I am not an expert on consumer finance, but 13% seems like a very adequate number for a developing country like South Africa.

Below is part of the credit summary from Global Credit Rating Co., a local credit rating agency.

Lewis´ liquidity has strengthened over the past year. This has been a result of the initiation of its listed debt programme, which has increased its financial flexibility and enabled it to increase unused bank funding lines. Note is also taken of the sizable cash balances reported at FYE14, as well as the fact that the group´s asset base is entirely unencumbered; further boosting financial flexibility. In addition, the ability to tighten underwriting criteria and reduce credit origination is a tool available to management to improve cash flows if needed. Thus, despite continued working capital pressure associated with growth, Lewis has reported positive operating cash flows over the review period. With limited capex (as stores are typically leased and not owned), this has enabled moderate gearing levels and sound debt serviceability to be sustained. Further to this, net gearing and net debt to EBITDA were slightly lower at 24% and 105% respectively at FYE14 (FYE13: 30% and 111%), while net interest cover remained sound at 10.5x (F13: 12.8x).

I think Lewis Group is the financially healthiest furniture retailer in South Africa. Any shakeout would make the company stronger. Any bad macro economic scenario is covered by the company's cheap valuation.

Earnings from IEHC, New Century and Hanover Foods

IEHC reported 2015 earnings of $0.79 versus $0.63 a year earlier. Revenue increased to $16.4 M from $15.4 M a year earlier. Gross margin was was slightly better; 37% versus 36% M a year earlier.

Today, IEHC is a growing company trading at 7.7x earnings. It has no long-term debt. And it trades at book! If it trades 25% higher at 10x earnings it would still be undervalued.

A new blogger NoName Stocks has written a tremendously detailed post on the earnings results. So, I feel no need to repeat what he wrote. But I'll summarize and emphasize some important points. The company increased book value by $1.8 M as a result of the increased retained earnings. This amount is not reflected in cash however. It is instead reflected mostly in inventory and, to a lesser extent, accounts receivable and PP&E. The report stated that order backlog is up to $8.7M from $5.9M a year earlier. All this indicates that the company is experiencing a secular increase in demand for its products. The company needs to increase production capacity and it is in the midst of doing that. The company purchased several new machines. While it is doing that however, margin may temporarily compress. So, it is good news that margins have been flat at 37%.

New Century Group Hong Kong (HK:234) reported earnings of 1.71 HK¢ versus 0.52 ¢ a year earlier. The stock spiked to 25.5 ¢ on the news. See the chart below. The stock has twice spiked in the last year, each time on earnings results — in November 2014 and May 2015.

The stock carries 25.5 ¢ of equity per share. And the balance sheet is liquid. 43.2% of the balance sheet is investment properties, 35.2% is cash, and 26.3% is in stocks. So the market value should be close to the book value. Anyone looking at the chart must be puzzled as to why the stock can drop to the 13 ¢ range. The last time it happened was just a few weeks after the earnings announcement. And maybe the following picture of a typical brokerage firm shows why. While in US markets retail investors make up around 40% of stock ownership, in China it is 80%. Many of the retail investors buy stocks in those types of operations. They are basically people who want to do online trading but who do not have home computers setup for it.

	HNFSA
Price	102.500
Market Cap	76.49 M
P/E TTM	12.1 x
Div yield	1.1 %
P/BV	0.34
ROE	2.8 %

From what I can gather, these investors are not really investors, but speculators. And that is why the Chinese stockmarket has gone through record highs followed by a 35% crash. I guess that this effect has also infected Hong Kong, either through the Shanghai and Hong Kong interconnect or some other means.

Hanover Foods reported another underperforming quarter. So far in Q3 the company is on track to earn around $8M for the year. The company's operating margin was 3.3% versus 2.9% a year ago. But this is such a drop from 5% just a few years ago. I have no idea why this company has such low margins. The company also had almost no cash flow because it spent all the year's profits on inventory buildup. Again, I have no idea why. On the plus side the stock trades very low relative to book and at least is still profitable. Sooner or later it will turn around and improve its margins — or at least I hope. But in hindsight, I wish I never got involved with this stock.

Why I Bought Soundwill Holdings

The situation in Sears Holdings is sad. I have watched the confidence of Eddie Lampert and Bruce Berkowitz for 8 years. Meanwhile the situation at Sears is getting worse and worse. The company is starting to monetize its real estate holdings. But it seems to be swimming against the flood of losses quarter after quarter. In the most recent quarter, the company had about negative $500M of cashflow! Now by selling assets or rights to assets to a newly created entity Seritage, SHLD gets some badly needed cash. But to do what? Pay off the negative cash flow for a few more quarters?

I just cannot now see how this will end well for SHLD holders. Maybe it will end well for Seritage shareholders, but not for SHLD. The bullish narrative on SHLD is that the company's real estate is worth much more than the carrying value on the balance sheet. And this mispricing is not reflected in the stock price. I even wrote a piece on it. The underlying reason is that US companies use GAAP, whereas the rest of the world uses IFRS standards. GAAP accounting for the most part treats real estate property at cost, minus impairments. However, IFRS allows real estate to be revalued yearly. Any fair value gains becomes non-cash income. But I'll stop mentioning SHLD now because this post isn't actually about SHLD. I am writing about my latest purchase, Soundwill Holdings (HK:0878).

	HK:0878
Price	HK$ 15.080
Market Cap	HK$ 4245.02 M (USD $ 547 M)
P/E TTM	2.6 x
Div yield	2.0 %
P/BV	0.25
ROE	9.8 %
LT debt/Equity	0.1 %

Soundwill Holdings (HK:878) is a real estate company that has been around for more than 20 years. Today, this company's earnings are fantastic because of the hot Hong Kong real estate market and the use of IFRS accounting rules. As the side box shows, the numbers are fantastic. And it is primarily due to their real estate fair value gains.

Soundwill holdings develops and owns properties in Hong Kong. The company rents out retail properties in very expensive areas. Some prime real estate can fetch USD $5000 per sq ft per year! The company's flag ship location is Soundwill plaza. Occupancy is at or near 100% and rents have skyrocketed in recent years. This explains the real estate value gains. IFRS allows real estate values to be adjusted to the current fair value on the balance sheet. Current fair value is generally based on projected cash flows from rents and the prevailing discount rate.

The company also has another segment which develops property for sale in China, usually in partnership with other companies. This business is scary because many believe China is in the midst of a housing bubble. I don't really have an opinion and my opinion doesn't really matter anyway. Such macro issues are not what I dwell on. I think China is really a market too difficult for someone like me to understand. I don't want to participate in it, but it is the company's secondary business. The company has no more than 15% of their assets in China.

The company is 69% owned by Foo Kam Chu. Her daughter, Chan Wai Ling, is a major executive in the company.

I have annual reports going back 15 years. Fifteen years ago the company was into real estate as well as telecommunications. The company acquired a stake in another company called Vision Telecommunications. Interestingly, the stake was purchased from Mrs. Foo and Mrs. Chan in exchange for about 15% of Soundwill stock, which was priced at HK$0.63 a share. Other unscrupulous CEO's have similarly sold entities that they own to their companies at inflated prices. The inflated amount is reflected on the books as goodwill. I am not saying that the Vision transaction is one such case. I don't have much information about the transaction as it happened more than 15 years ago. However, the Vision purchase goodwill of HK$151M was enough of a concern that the company auditor Moores Rowland qualified the 2001 Annual report by stating that they cannot verify the goodwill. And in the next year, after the fiscal year had ended and presumably Moores Rowland had begun the audit, they resigned. And Grant Thornton came in as a late replacement auditor. Then the goodwill controversy diminished somewhat when the company wrote down the entire Vision goodwill in the 2002 financial statements. When I looked at this history, it certainly raised my eyebrow. Then it gets more interesting. In 2006, the management tried to replace Grant Thornton with a smaller firm. The management said they were only making the change for cost reasons. But then a month later, they backtracked on their decision and rehired Grant Thornton because the company bankers raised concerns over the succession of recent auditor changes. Well, at least the bankers are doing their jobs.¹

By 2003, Mrs. Foo owned 60% of Soundwill, and the company was suffering. The company lost close to HK$500M in each of the last 5 years! And in that year, the company did a 50:1 reverse split. Meanwhile, the company quietly dropped mention of telecommunications.

From 2004 onwards the company turned around. It quickly posted earnings with help from lots of capital injection mostly through loans. The loans were mostly made by Mrs. Foo and were convertable to stock. Of course with the stock fortunes improving, Mr. Foo quickly took advantage of the conversions to increase her stake in the company to 69%. I have tabulated data from the financial statements of the last 15 years.²

	op profit	gain from sales of subsidiaries	fair value gain	earnings	equity	cash flow
2001	(91,516)	0		(237,830)	460,800	234800
2002	(323,382)	4,712		(411,771)	293,500	(48,200)
2003	116,800	1,100		61,800	921,500	14,900
2004	76,100	(200)		28,300	1,805,500	36,800
2005	707,300	8,400	564,900	548,600	2,177,900	90,700
2006	570,000	101,900	361,600	423,100	2,602,500	(52,800)
2007	288,700	62,500	1,093	1,063,000	3,677,400	(521,500)
2008	266,900	33,600	(135)	159,400	3,873,000	(337,000)
2009	370,600	18,300	964,400	1,053,400	4,943,800	421,300
2010	467,233	16,400	1,769,600	1,738,900	6,716,800	457,700
2011	321,100	461	2,032,900	2,119,000	10,277,700	588,000
2012	915,000	3,311	2,692,300	3,321,300	13,802,200	878,900
2013	447,300	0	1,276,500	1,338,200	15,037,000	1,356,300
2014	1,376,500	114,300	638,800	1,644,600	16,662,000	1,801,000

The IFRS accounting rules did not take affect for all of the last 15 years, which is why there were no fair value adjustments in earlier years. As the table shows, most of the earnings are from fair value adjustments. However, in the last several years cash flow has been increasing significantly, which is very encouraging. Soundwill is obviously riding high on the real estate bull market in China and, to a lesser extent, Hong Kong. This cannot go on forever. But on the other hand, Soundwill is extremly cheap compared to its seemingly inflated assets. The company is still trading for a quarter of book! And it has zero long-term debt. Even if its assets drop by half, the company would still sell for less than book.

Over the three year life of this blog I have searched hard for bargain smallcaps. But it is getting harder and harder given the elevated equity markets. This is why, for the first time, I have exposure to mainland chinese real estate. Many wise investors advise to be disciplined and resist lowering one's standards when markets are elevated. Time will tell whether my choice to invest in Soundwill is a mistake because I couldn't find anything better.

---

1. Today the company auditor is BDO because BDO merged their HK operations with Grant Thornton.
2. I copied this information from their yearly financials and the numbers very likely have some errors. Please read the disclaimer on the right.

More Reading Material

Prof Damodaran on GM. This was a real eye opener for me.

Great article on Michael Burry's investment outlook back in 2001

Very informative article about share buybacks and the S&P 500 index.

One international fund's view of investing in Russia.

Hong Kong market undervalued.

A great talk by Thomas Barrack of Colony Capital back in 2009 . I find it great for a sense of perspective.

A humorous article confirming what most of us already know. Gurus cannot accuractly predict markets.

Great insight by Paul Mcculley, former guru at PIMCO.

Why I Bought Karelia Tobacco

I believe the biggest hardest thing to do for the average advanced investor is to put matters in perspective and being objective. Warren Buffett used to ignore all outside analysis when he evaluates a stock. And he would make relative comparisons of two comparable investments, so that the analysis is more objective than in a vacuum.

I've owned Philip Morris International (PM) for 15 years, although in the last few years I have reduced my position considerably. The market used to regard tobacco as a sickly industry with a lot of litigation and regulation risk. But today PM has grown to 17 times earnings. This large a PE means the market sees tobacco as a growth industry, at least in the international markets where PM operates. Worldwide cigarette consumption is almost 6 trillion cigarettes per year. The international tobacco industry has grown steadily in recent years. But more importantly cigarette makers now have the pricing power to grow faster than inflation. That is in no small part due to the addictive properties of nicotine.

With PM so richly priced I turned to look at other public tobacco companies and noticed that they had even higher valuations: for example, American Reynolds (NYSE:RAI) trades at 27 times earnings! The one exception to the nosebleed valuations is Karelia Tobacco (ATH:KARE), a small cigarette maker in Greece. The company has a hundred year history, and when it joined the EU it began to expand globally. Today Karelia gets 85% of its sales internationally. Karelia has 0.3% of the world market versus 15% for PM. So obviously Karelia has much more room to grow than PM. This is the size handicap that Buffett so often talks about.

	Karelia	PM
Price	€ 225.000	$ 84.500
Market Cap	€ 621.00 M	$ 130.71 B
P/E TTM	9.8 x	17.1 x
Div yield	4.1 %	4.6 %
ROIC	61.1 %	23.1 %

Both Karelia and PM have increased sales at the same rate over that last five years — about 20-30% total. However, PM has increased EPS only 20% over the last five years while Karelia has almost tripled! The difference is from improved margins at Karelia. Karelia has worked to improve efficiencies through automation and sales channels. PM on the other hand increases earnings through a ton of share buybacks. Share buybacks trade equity for earnings. It's equity is now –$11B! Also comparing PM and Karelia is not all straightforward as PM reports in USD and Karelia reports in Euros. PM's bottom line has suffered from the strong dollar while Karelia has benefited from the strong dollar.

I like tobacco because it is a simple industry. Tobacco companies sell an addictive product, so they have steady reliable demand. And contrary to what some may believe, world cigarette consumption has not decreased in the past. I would guess that will continue for the next 10 years. Sure, it is down in developed countries, but the crucial market for tobacco is going to be developing countries. Just like many other industries, emerging markets is where growth will come.

The one downside to tobacoo is litigation risk. But I don't see a litigation risk discount. The other risk is illict cigarette sales that circumvent excise taxes. Taxes are the biggest part of cigarette sales, and the governments that impose it are also the biggest nemesis to tobacco companies. So the nemesis is also the biggest financial beneficiary of tobacco. That's why I am confident that governments will protect their golden goose by keeping a lid on illicit cigarette sales.

Within the tobacco industry I only see Karelia as cheap. Compared with PM, Karelia earns much more per share. Karelia has € 263M of cash and no LT debt. But PM has $27B of LT debt and negative equity.

Karelia could also be an attractive buyout target. The tobacco industry worldwide has only a few huge players. I am sure the company has had offers in the past that no one knows about. But it is 90% owned by the founding family, so that makes it an unlikely prospect. But who knows, it can happen.

Earnings on Tap: Senvest, Seaboard and Installux

Senvest 2015 Q1 earnings showed that book value per share went to CDN$312 from CDN$264 just 3 months earlier. The company attributed some of the gains to favourable currency effects. The Canadian dollar was worth USD$0.79 at Q1 period end and today it is worth about USD$0.80. On the other hand, the Senvest Israel hedge funds is up 8% in April. So I can loosely say that Senvest further gained value up to today. So, the stock today at CDN$181 trades at around 55% of book! In my experience as a DIY investor, companies with liquid assets rarely trade below 60% of book. So the 50-60% range is my floor on Senvest stock. And typically, companies that trade at those levels reside in countries that have questionable corporate governance. But I don't think Senvest has such severe corporate governance issues to warrant such a discount.

The company's funds mostly focus on small and mid-cap companies. And they have outperformed the Russel 2000 index. The company also has CDN$736M in short positions. That is 29% of the balance sheet versus 27% the quarter earlier. This partially explains how the company can outperform the market. They mentioned one successful short of a financial company. The company was exposed to the Swiss de-pegging to the Euro. The management did not take credit for predicting the Swiss de-pegging and their short was based on other factors. But to me it shows that they did their homework and put in a sufficient margin of safety, and odds are things like that will happen.

Seaboard Corp reported Q1 earnings of $28.49 per share versus $40.55 per share a year earlier. The earnings was a disappointment but not a surprise when considering that pork was one of the worst performing commodities in Q1, even worse than oil. Pork prices reached a high of $1.20 last year during the swine flu epidemic, but last quarter had fallen to $0.60. Now it is back to around $0.80. The pork segment earned an operating profit of $19.1M versus $60.5M a year earlier. But this is not an apples to apples comparison as the company sold a 50% stake in a pork subdivision to Triumph. Management also mentioned that low feed prices were helpful for the results. Corn prices are at 8 year lows and I am hopeful that it will stay that way.

Seaboard's Marine Division earned an operating profit of $7.5M versus -$7.4M a year ago. This is one area where the company's performance exceeds the performance of a commodity industry. The company hopefully will benefit from increased trade with Cuba as they operate a huge facility Miami with a new 25 year lease.

	STAL
Price	€ 233.000
Market Cap	€ 70.72 M (USD $ 80 M)
P/E TTM	8.3 x
Div yield	3.4 %
P/BV	0.99
ROE	12.0 %
ROIC	13.1 %
LT Debt/Equity	0.07

The Searboard Trading and Milling Segment had a $9.2M loss from a affiliate in Brazil. This affiliate looks to be a continuing problem. We shall see how management handles it in the coming quarters.

Installux reported year end 2014 results that shows an improvement in profits despite a difficult economic climate. Sales were basically flat. My contrarian mind tells me that Europe could be the surprise in the coming several years. With the continuing QE by the European Central Bank money will flood Europe just like it did for America. I believe this will result in multiple expansion throughout Europe. Installux at 8.3x earnings is certainly a candidate for significant expansion. An expansion to 12x is very reasonable, and that would mean a 50% rise in stock value.

European Reliance vs. Genesee Valley Gas

The Greek crisis seems like a never ending drama. My stake in Greece is my European Reliance (EUPIC) position. So I am watching the drama unfold with keen interest. First a little background. Greece faced a major financial crisis in 2011. but gradually came out of the crisis by 2014. Even though its GDP by had shrunken by 40% and unemployment was at 25%, the government deficit was almost nil. Then in the 2014 election campaign the leftest party Syriza ran on a platform of rolling back 5 years of austerity. And they won in early 2015.

Initially after the election, Greece was given temporary support while the new government comes up with a new plan to reform its economy. This hasn't happened so far. So, it looks like Greece will not get further outside help to service its debts, let alone get new loans. But regardless of whether it stays in the Eurozone or not, foreign companies will need to be paid in Euros or dollars or some respected currency. Greece can leave the Eurozone and print Drachmas in the way Zimbabwe printed their currency with reckless abandon. But it won't do any good in paying for imported goods and services. Right now Greece has a deficit about 10% of GDP. Greece cannot have a trade deficit if it cannot borrow money. So, Greece will to go through a lot of internal struggles if it thumbs its nose at the rest of the Eurozone and defaults on its debt.

	ATH:EUPIC	Genesee Valley Gas (1953)
Price	€ 1.26	$ 5.00
Market Cap	€ 34.65 M	$ 0.118 M
P/E TTM	2.8 x	1.9 x
Div yield	0.0 %	0.0 %
P/BV	0.49	0.40
ROE	17.8 %	21.1 %

Against this backdrop, EUPIC has been hugely profitable. It has earned € 0.37, € 0.35, and € 0.33 in 2014, 2013, and 2012 respectively. This means the company earns a high-teens return on equity. And the company has ample equity for its business. Its assets are € 330M, its equity is € 70M and its premium revenue is € 166M. So the company is not overextending itself by writing excessive policies.

I believe the company has done well in part because of Greece's bad economic situation. In a society where the government is on the brink of insolvency, people can hardly rely on government social assistance. Therefore, I believe people who have the means would rely on the private sector to provide what used to be from the government; such as insurance for health and pensions. And in the event of a Greek government default or a Grexit, people will rely even more on the private sector.

As I try my best to evaluate EUPIC objectively, I try to imagine what a young Warren Buffett would do if he saw a similar company. That's one main reason why I've been posting so much about his partnership days. And it just so happens that Buffett did see a somewhat similar situation in his early twenties, when he was playing around with a small capital base. He recounts in 2005:

You have to turn over a lot of rocks to find those little anomalies. You have to find the companies that are off the map - way off the map. You may find local companies that have nothing wrong with them at all......

Other examples: Genesee Valley Gas, public utility trading at a P/E of 2, GEICO, Union Street Railway of New Bedford selling at $30 when $100/share is sitting in cash, high yield position in 2002. No one will tell you about these ideas, you have to find them.

So, then I got very interested in Genesee Valley Gas and found it in the Moody's Public Utility Manual. I found that in one year, 1953, the company earned $2.61. Genesee is a tiny cap company even by 1950s standards and so it is very illiquid. In fact I don't know where it was traded let alone the price. But Buffett did say that it was trading at $5. He did not say which year. But using his $5 price in 1953 then the stock was trading at a P/E of 2. However, Buffett failed to mentioned that 1953 was the only year it made that much. In other years earnings was was lower. See chart below. But still it was a very cheap stock.

Genesee Valley Gas is a small-time utility serving Western New York. It only served 28,000 people. During the depression it went into backruptcy protection and was reorganized. I suppose the legacy of that still affected the company almost 20 years later.

Now compare that with EUPIC today. EUPIC is just as solid and it has much more consistent earnings. The PE range is about the same. And both companies sell for considerably less than book. The big drag on EUPIC is of course the Greek macro situation. But as mentioned above I don't believe it will be a total castrophy if Greece defaults or even if it leaves the Eurozone. In either or both cases this company will continue to operate because Greece will no doubt continue to function. If I am right maybe some successful money manager will one day recount how back in the day, when Europe and Greece were in crisis, we could find bargains galore so long as we turned over enough rocks.

I think a young Warren Buffett would approve of EUPIC.

Warren Buffett Partnership Investments

Warren Buffett is becoming a person bigger than life. He is 84 years old now and very coy about when he'll step down from Berkshire Hathaway. He is, however, focusing on the direction of the company after he passes on. I am very skeptical that anyone can control what happens after they die. But if Warren Buffett can, all the more power to him. I just don't think about it too much. Today, my Berkshire position has dwindled down to a small part of my portfolio. And I don't really pay that much attention on what he does for Berkshire today. He is a whale in the business world, and he buys entire large caps such as Heinz, Kraft and Burlington Southern. The domain where he looks for investments is a crowded space. Quality large caps are well covered and sought after. This results in a efficient marketplace where only geniuses like Buffett can generate alpha. I don't try to duplicate Buffett in this arena as it is too hard and risky.

It is hard because the space is crowded with people who are smarter and have more insight and more time than I do. Also, it is risky because I am not a young person starting out. If I was starting out in my twenties and had a small pot of savings I could do this. I can give it a try and possibly make it the start of a great career. And if I fail at it, no real harm I have plenty of time to recover and find my niche. But I am not twenty and I cannot take an excessive risk of failure. So I must choose a path that is more proven and which makes my abilities less of a factor in the method to success.

This is the reason I've settled on the more Ben Graham's cigar-butt type of investing. Ben Graham was Buffett's early mentor and the Graham's partnership ended when Buffett's partnership was just starting out. So both Graham and Buffett ran partnership's in the same era. And during that era both were looking at cigar butts. But while the mentor was beating the market by around 2% per year, the student, in his own words, "Killed the Dow". I think Buffett did better because he thought more about the quality of businesses. So, I think the opportunity for the least work with the least intelligence with the maximum payoff is to do what Warren Buffett did in the 50's and early 60's.

To do this I need to start with as much information about the investments as possible. This post lists sources of information for Buffett Partnership (BPL) investments of the 50s and early 60's. A copy of Warren Buffett's list of his 1962 BPL investments is displayed in the book Of Permanent Value by Andrew Kilpatrick. I want to get coverage on 75% of the 1962 BPL's total equity by the time I am done.

This list is a work in progress. Enjoy!

Stock	year	Description	Source / Link
GEICO	1952	He called GEICO his first love	Buffett writeup
Western Insurance Securities	1952	Buffett sold GEICO to buy Western, which was even cheaper on paper	Buffett writeup
Genessee Valley Gas	1953		bovinebear blog
Union Street Railway	1956		compoundingmachines The Snowball by Alice Schroeder
Sanborn Maps	1961	Workout situation; Buffett bought company to unlock its stock portfolio	csinvseting case study The Snowball by Alice Schroeder
Berkshire Hathaway	1962	A pretty soggy cigar butt (2.4% of partnership)	compoundingmachines
Dempster Mills	1962	Control situation (23.0% of partnership)	csinvseting case study
British Columbia Power	1962	Workout situation, recommended by Munger (11.2% of partnership)	bovinebear blog The Snowball by Alice Schroeder
Texas National Petroleum	1962	(5.7% of partnership)	Trade Like Warren Buffett by James Altucher
Stanrock Uranium Ltd.	1962	Workout situation (5.0% of partnership)	bovinebear blog
Young Spring & Wire Corp	1962	(5.0% of partnership)	compoundingmachines
Grinnell Corp	1962	(2.9% of partnership)	bovinebear blog
Crane Co.	1962	(2.1% of partnership)	bovinebear blog
Black, Sivalls & Bryson, Inc.	1962	(1.8% of partnership)	compoundingmachines
Alco Products	1962	(1.0% of partnership)	bovinebear blog
Hartford Fire Insurance, INS	1962	(-2.4% of partnership)	bovinebear blog

Earnings on tap: McRea Industries, Senvest, EUPIC, CMH, Putprop

McRae Industries (MCRAA) recently reported H1 2015 results. Revenue in H1 was $57.31 M versus $58.26 M the previous year. And the gross margin was 28.1% versus 30.9% the previous year. This resulted in a H1 income drop of $3.80 M versus $4.55 M the previous year. Despite the slight disappointment, management tone was upbeat. They attributed the lower margin to two main factors. The first is higher costs associated with hiring and training new personnel, which is encouraging because it says they are expanding capacity. The second is due to higher import costs, which is worrying. One would expect that with the dollar getting stronger and stronger that import costs would decrease. On the other hand if most of their imports is from China then that would not apply as the Yuan is actually appreciating versus the dollar. The company did express optimism that demand remain strong in all product segments, so this year results should be on par with last year's record results.

Senvest just reported 2014 results which was as expected given the company posts the results of its funds monthly. Shareholder's equity at year end stands at CDN$738 M or CDN$264 per share. The company currently trades at 64 % of year-end book value. However, it should be even lower considering that after Q1 2015, the Senvest main funds Senvest Partners is up 7% and the Senvest Israel Partners is probably up around the same. The stock today probably trades at less than 60% of book!

Senvest	year end 2014	year end 2013	year end 2012	year end 2011
Common equity (CDN$ M)	738	565	331	263
yoy equity gain	31%	71%	26%
Employee compensation (M)	32	43	12.5
Compensation as a percentage of equity	4.3%	7.6%	3.8%

Senvest is a steal in my opinion. But, there is a lively debate in stock forums and the blogosphere whether the stock is indeed undervalued. The debate centers on whether the management deserves the compensation for the alpha, or lack of, that they generate for their portfolios. The above table shows the employee compensation (management fees) for the last 3 years and their percentages of equity. The fees are from the consolidated balance sheets which is shared by not just the common shareholders but also the outside owners of the Senvest funds and the minority interests. I estimate that the outside owners pay about 1/3 to 1/4 the management fees. And the minority interest is another 10%. So overall, the common shareholders directly pay around 60% of the total employee compensation. So, with this in mind, the fees are around 2.5% in a bad year, when incentive bonuses do not kick in, and it is around 5% in a good year, when incentive bonuses kick in. I think that is reasonable. Back in the day, when I was still buying mutual funds in Canada, the mutual fund management expense ratios could run as high as 2.5%!

I'll be watching the employee expense numbers closely in the coming quarters as the company also said it is expanding its work force in New York.

European Reliance of Greece (EUPIC:ATH) reported earnings of € 0.37 in 2014 versus € 0.35 a year ago. Equity grew to € 70M from € 58M a year ago. This means that the company is now selling for 1/2 book! No doubt the underpricing is due to the ongoing Greek debt crisis. I definitely need to think of the company's contingencies in the event of a Greek exit from the Eurozone, because if I can access the downside I can have a better gauge of whether this company should really be priced at 1/2 book.

Next up are my two South African holdings. CMH, an auto retailer, pre-announced that 2014 headline earnings would be between R2.04 and R1.88 versus R1.58 a year ago. Actual EPS would be between R1.73 and $1.57 versus R1.57 a year ago. Beyond that the company didn't give any more details. So it appears that the company has some one-time charges in the last year, which lowered earnings in a otherwise excellent year. Today the company trades at 9x earnings.

My other South Africa holding Putprop reported sales in line with last year. But a flurry of news made me just too scared and I sold. I think real estate companies are not for my style of investing and it'll be a while before I'll buy another. In the last six months Putprop reported its primary customer was in arrears with rent. It also announced it was doing a rights offer at R6.30 when the stock was trading at R7.00. However, when the rights offering time came, the stock was trading at R6.20! And several board members were replaced at around the same time. All these borderline red flags and the stock's poor performance made me give up on Putprop.

Latest Reading Material

Michael Lewis on Ireland Crisis .

Robert Vinall's fund website contains lots of very insightful and instructive articles.

Warren Buffett's annual letter to Berkshire shareholders. This year includes a blurb from Charlie Munger.

The Education of a Value Investor, by Guy Spier. An extremely candid book about a person's journey towards being a better and better value investor.

Stress Test, by Tim Gneithner. Probably the best first hand account of the financial stress ever to be written. It is eloquent and full of substance and thoughtful ideas for the problems of the financial world. However, I resented the way he dismissed Brooksley Born and her heroic efforts to reign in the derivatives industry in 1999.

How I Lost a Million Dollars. by Jim Paul. A candid story about a persons rise and fall betting in the Chicago Mercantile Exchange.

Interview with Allan Mecham., a rising star in the hedge fund world.

An entertaining article about the Kelly Criteron.

Buffett Partnership Investment: Grinnell Corp.

The 1962 Buffett Partnership had a 3% position in Grinnell Corp. Grinnell Corp at the time was a big player in the fire sprinkler and alarm business. It owned 76% of ADT. Today both companies are part of Tyco.

1962	Grinnell Corp
Price	$ 74.500
Market Cap	$ 97.93 M
P/E TTM	11.7 x
Div yield	2.7 %
P/BV	0.86
ROE	7.3 %
LT Debt/Equity	0.00

Interestingly back in 1960s it was mired in lawsuits with the government. The anti-trust authorities accused the company and several subsidiaries of effectively forming a cartel. They collectively owned 87% of the central fire and alarm business. The court battle went all the way to the Supreme Court in 1964 where the company finally lost. By 1966 Grinnell had to divest ADT and two other subsidiaries. If I were Buffett, all this would not detract from the appeal of the company. In fact, all this tells me Grinnell was doing something right!

Below is the consolidated income statement and balance sheet from the 1963 Moody's Industrial Manual. The financials there do not include companies which are not wholly-owned subsidiaries. That would mean the financials exclude the full ADT financials. But what this in 1962 means to me is unclear. There are two ways to do this today. One is the equity method in which the income but not revenue shows up on the income statement. The other method is to exclude both income and revenue from the consolidated income statement, and instead just include the dividend paid to Grinnell as income. If it is the latter case then the income statement significantly under-reports income because Grinnell's share of income is $3.2M and its dividend is $1.1M, an understatement of $2.1M. If someone knows the answer please comment. In either case, the company group has great earning potential, and the balance sheet is also understated because it lists the value of all non-wholly owned subsidiaries at only $23M.

I understand the attraction of Grinnell in 1962.

Buffett Partnership Letters: Crane Co.

Crane Co. is the second company I am covering from the Buffett Partnership.  Back in 1962 Crane Co. was 2% of the Partnership portfolio. It held $200k worth of shares.

Crane Co. (NYSE:CR) is still an independent company today with a $3.7B marketcap. Back in 1962 it manufactured mostly pipes and valves and heaters for industry. Crane Co. was like Alco It traded significantly below book. But being a capital intensive company it wasn't a net-net. And it was a netnet. Below is the company balance sheet from the 1963 Moody's Industrial Manual.

1962	Crane Co.
Price	$ 40.250
Market Cap	$ 51.7 M
P/E TTM	18.2 x
Div yield	5.0 %
P/BV	0.39
ROE	2.1 %
LT Debt/Equity	0.18

In terms of profits we'd expect Crane to be better than Alco because Crane is still alive today whereas Alco was defunct by the end of the 1960s. The company's results looked a bit odd. The sales were highest in 1956 and then dipped before coming back in 1962. Income was down from a high of $10.9 M in 1958 to $3.2 M by 1962. Still it paid almost all the income out as dividends.

The 1950s and 1960s were a time of rapid expansion for the company. They acquired several companies over that time and the ups and downs may reflect the understandable problems during mergers. What is certain is that Crane was a player in the emerging industries of that time such as space and nuclear. And they have done alright because they are still around today. So maybe Buffett saw something in the growth prospects as well as the margin of safety on the balance sheet.

Seaboard Corp Reports Record Earnings

Peter Lynch said that an investor should keep tabs on his investments. And this is why I make quarterly posts of my largest holdings. They help me keep abreast of progress in the company. And they allow me to periodically double check my investment thesis.

	SEB
Price	$ 4039.00
Market Cap	$ 4725 M
P/E TTM	12.9 x
Div yield	0.0 %
P/TBV	1.74
ROE	13.4 %
ROIC	11.9 %

Seaboard is my second largest holding and luckily for me, its stock has been on a tear for the last two years. The company is steadily expanding its footprint in the food industry. But it's core business is still pork. And Seaboard had its most profitable year last year because of great results from the pork segment.

Revenue for 2014 was $6.47 B versus $6.67 B the previous year. Income was $0.37 B versus $0.21 B the previous year. So sales did not grow but profits grew to the highest ever on margin expansion. This margin expansion was all from pork. Pork revenue was $1.72 B versus $1.71 B the previous year. Pork income was $0.35 B versus $0.15 B the previous year. Pork's recent performance was confluence of favourable pork and corn prices. See below.

US Hog Farm Prices

US Corn Prices per Bushel

Corn is the largest component of pork feed and I believe corn price recently is part of a natural decline in commodity prices. Commodity prices are cyclical and the high oil, gold and food prices of the last several years have to go down by definition. Pork prices on the other hand had a temporary boost due to a widespread virus t.hat luckily did not affect Seaboard. As the chart shows pork prices are coming back down in the last few months. But I think the corn and feed price drops will more than offset that.

The other Seaboard segments were generally good. The company's interest in turkey producer Butterball did well reflecting similar dynamics with pork: higher product prices with lower feed prices. And the marine division broke even last year versus a $26 M loss in 2013. I feel the improved fuel costs should help the marine segment to be profitable in 2015.