Anne Scheiber, the Secret Millionaire

I first heard of Anne Scheiber from a magazine article about her in 1995, shortly after she passed away aged 101. Anne Scheiber was the first example I have heard of a hidden millionaire.  Hidden millionaires are low profile people who grew up in average circumstances and did not rise up very high in their careers, who lived very ordinary frugal lives. They are the sort that others never expect to be rich. But when they die, people with something to do with their estate are surprised to find out they were multimillionaires.

Scheiber died with a $22M fortune.

Because Scheiber was low profile and did not have any close relations, there isn't a lot known about her century of life. She got attention in the news because she donated her fortune to the Yeshiva school to help women like her. The school had never heard of her. What is known is that she spent her entire working life as a IRS auditor. She was great at weeding out corporate tax cheats. But despite her contributions, she never got promoted at the IRS. After she retired in the 1940's she lived a simple life in New York until her death. According to the article, she learned from years of auditing that the wealthy all invested. And that inspired her to focus on investing in retirement.  The articles described Scheiber as a miser and a recluse.

The part of the story that estimates her returns gets a bit fuzzy. The story is that she started with only $5000 in retirement and turned it into $22M which would give her a 17.5% rate of return!  That beats the like of Walter Schloss!  But after digging around in Wikipedia, I read that she probably started out with much more at retirement. And her return was probably around 13%. Her return is still phenomenal because out-strips the US market by about one percentage point. Incidentally, that's exactly the type of returns I want. Her investment style is the Warren Buffett style of buying quality companies and holding for the long term, like a lifetime!

I read about her before I had ever invested. And that article had a tremendous influence on my thinking towards investment. It helped me to start early down the investment path. Although value investing and stock picking didn't come until much much later.

I've thought about her many times since I first read about her, and my burning question is whether she was happy in her retirement years while she was accumulating her secret millions. My best guess is that she felt a tremendous sense of purpose and it was that purpose more than anything else that helped her to live to such a ripe old age.

Although Scheiber was the first secret millionaire I've heard of, she is not the only one. Every once in a while I hear of others. Like Ron Read of Vermont who was a veteran and who worked as a janitor and gas station attendant. He died at 92 worth $8 M. And I am sure there are many more that we have never heard of.

What is The Point of All This?

I own several brokerage accounts with different discount financial companies. And I occasionally get calls from them seeking to build a relationship with me so that they can sell me some service. The first step in the conversation is to ask me about my financial goals. And I have trouble articulating it. I say something to the effect of trying to make as much money as possible. I don't mention the goal is to spend it to achieve some lifestyle. I instead say the money is the goal in and of itself.

For those who think this may seem like a strange answer, to me it is very similar to a person working towards a master title in chess. I do admit that unlike chess, building a nest egg does have the added benefit of providing retirement security. But considering that I live frugally and my savings are performing at or better than the market, I will probably have more than what I need in retirement. So working hard at investments at this stage for me must have more purpose than simply retirement security. So I say making money is the end in itself.

So working hard towards financial success over a lifetime should produce more money than one needs, if that person is frugal. Today I am going to describe how I think it can be done relatively easily. And what are the risks that can derail that.

Survival = Success

In this endeavor, the first thing to keep in mind is that it is a long road and to survive is to succeed. The one thing that can derail success is to have a loss and a lesson that one does not recover from. Even if one can theoretically recover a big loss over a lifetime, the psychological damage may discourage and/or prevent one from doing so. This is what others often call looking after the downside. And to me that means first and foremost, diversification. Diversification means spreading the risk across industries across asset classes and across geographies. A second useful thing is to have reasonable expectations. I have read the writings of various young investors in the blogsphere and I often sense an implied goal of 20% returns.

But in a lifetime achieving such returns on average would make that person one in a million! To get an idea how awesome 20% is, consider a 30 year old who has studied valued investing and who has some kind of a lasting edge. If that person has USD$100K and can save around $18 K per year (that's the limit for 401k retirement contributions) then that person will have $20M by age 60. That is very unlikely. I have never heard of a person who is worth $20M who didn't start out with a large capital base and who didn't work in finance or run a business but simply saved and had phenomenal returns. Instead the goal should be to simply match the market and possibly add one or two percent. So if the market does 8% for the next 30 years, then the target should be 10%. In the above scenario that 30 year old will have $1.8M at age 60. That's a huge difference, but it is also much more realistic.

Think Different

To get above average returns, I think it is necessary to have a different world-view than the greater investing community. That may seem so obvious that it needn't be said. But the actions and mood of the retail investment community seems to indicate people don't know it or forget it.

To make above average return in the market one must think differently from most people because the money made that is above average must come from others. And it is concentrated in a few; think of all the rich like the top 1%. They own a disproportionate amount of the wealth. So the rich minority make above average returns from the majority.

And surprisingly it is not hard to see errors in thought that many people make. It just takes work and practice to think differently. I can point out a few example off the top of my head.

A persistent theme in American politics is that life is getting no better or worse for the current generation than the previous. But that just flies in the face of facts. People think crime is up in this generation compared to the last. In fact, once on TV, the former House speaker Newt Gingrich did not dispute the fact that crime is down but said that it is a problem that people think US crime rate is up. I thought the job of a government entity or company is to achieve something for an end, not make you think that it is achieving something without actually doing it. Here thinking differently is echoing what Warren Buffett has been preaching: that the opportunities and life in the US has never been better.

The last US election dramatically demonstrated common faulty thinking in many ways. One reason people voted for Trump despite so much of his nonsense is that the voters simply wanted change. But society is a fragile institution, change for the sake of change will almost certainly be negative. Just look at history. Many decent societies were made a wreck by flashy orators without substance. I can think of Nassar of Egypt, the Perons of Argentina, Castro of Cuba, and on and on. These people can initially create a sense of euphoria in the general population. But their people's lot hardly gets better. And eventually that fact becomes obvious because the new leaders have taken whatever is right in their society and replaced it with something that is not well thought out and clearly worse.

So far my examples have been about politics, but it is just as applicable in investing. Take Japan for example. The common narrative is that Japan is a greying xenophobic country that restricts immigration. But it is a culture that has been very successful in the past, and they just have a labour shortage because of a low domestic reproductive rate. But I have never heard anyone mention any other way to describe the Japanese mentality. In twenty or thirty years, I believe it is possible that Japan will be forced into allowing some limited forms of immigration to replenish the population. The countries wealth and success can easily bring in as much cheap labour as needed. For example, Japan can allow a few million Chinese or Koreans legal immigration status for periods of five to then years. That can easily revive the economy when they find they have no choice. I am not saying this scenario is a certainty. But I am saying that I have not heard anyone even contemplating such a thing. The uniformity of thought in the investing community towards Japan is palpable. In my opinion, that creates a mispricing of Japanese equities in general and that is why I invest in Japan.

Be Objective

For most of us who are part of mainstream society, we are conditioned to interact harmoniously with others. That is a necessary condition to be successful in our communities and organizations. The way we are taught as children illustrates this point. Many of us have heard the saying, "it's not what you say that matters, but how you say it". I believe, in the business world, the best way to get success requires the following mix. The soft skills are personal attributes that allow someone to interact effectively and harmoniously with other people.

I do not espouse the correctness of efficiency of the way the world works; it just is what it is. But I do know that I am relatively poor in the soft skills department. And I know I can get more reward for my effort by utilizing my skills a pure technical setting, like personal investing. To invest in one stock in one's personal portfolio requires the following mix. Note there is no use for soft skills.

However, this pie chart is hardly encouraging because it shows that a large component of success in picking one stock is still out of our control. It is luck. But if we buy a basket of relatively uncorrelated stocks and waiting long enough, say five years. Then the odds of success in the whole will have the following mix.

This is so because of the law of large numbers in probability theory. As the number of samples increases, the actual ratio of outcomes will converge on the theoretical, or expected, ratio of outcomes. Take a coin toss as an example. The theoretical number of heads and tails should be 50%. However, one toss, or sample, will result in either 100% heads or 0% heads. That is hardly the theoretical result. However, in the total of 100 tosses, the result will be something like 46 out of 100. The 46% result is very close to the theoretical 50% theoretical result. In simple terms, the more the samples taken, the less luck plays in the experiment.

But using one's technical skills to make investing decisions is not so simple. It requires constant vigilance. This is hard because it is very difficult to think objectively in our world. So much of what we perceive is based on subjective biases. Suppose an employee is given a point of view that he feels is wrong, but which is the view of his boss. Does the employee oppose his boss? Many times an employee doesn't because what he wants is not the success of the task or the company at hand, but it is his own personal success within the company. To do that requires being a "yes man". And when a person thinks like this often enough, I believe that person begins to believe that the expedient view is the truth. This kind of subjective mindset can corrupt our minds and has no place in personal investing. This is one of the reason's why the many people have trouble getting good returns picking his own stocks. Because they are not used to thinking this way.

I can think of many examples in the investing world where a lack of objectivity has been costly. Theranos is/was a thirteen year old private company claiming to be on the cusp of revolutionizing the blood testing world. The house of cards came tumbling down last year amidst revelations by the Wall Street Journals that the company did not do anything close to what they were claiming. Then came the soul searching. The medical and investment community were scratching their heads wondering how did they let such a scandal happen. In this video , Harvard Professor Bill George was asked if the "golden-girl" CEO Elizabeth Holmes got a pass on the scrutiny because she was a woman, and he said "..... I would like to see a lot more women successful women..... we all drank the kool-aid......". My opinion is yes, she definitely got a pass because she was a young attractive white woman in a world dominated by middle aged white men. You can see her photo below and judge for yourself.

Theranos CEO Elizabeth Holmes

As a result of this scandal reputations were destroyed, tens thousands of blood tests were recalled, and millions in investors money were flushed down the toilet. Theranos is a very poignant reminder to be very vigilant, skeptical and objective when it comes to one's own investment dollars!

Successful investing of course requires understanding of businesses, economic cycles and value/growth principles. These are technical skills described throughout this blog, in the media, in business schools and in books. But the knowledge I have pointed out here are those that I found extremely useful but which are not so well emphasized elsewhere. This knowledge is difficult to grasp, easy to forget, and can make a huge different in one's investment results.

Trump and Chess Are Helping My Returns

Happy 2017!

I know it is already February and a bit late for that but my first blog entry in a year always requires a new year's greeting.

For those that wondered why this blog is silent, it is mainly that my portfolio has been static. A long term investor typically doesn't change his portfolio and his views. So, if I give advice or opinions, it is just a repeat of what I already said. I have learned that long-term investing is always longer than what I initially. So, most of investing is simply waiting.And that is probably repeating what I already said before.

Trump is President???

The last year has been a truly unique year. In a year when I thought Trump becoming the president was absolutely improbable, the improbable happened. I was in Europe at election time, and I really wondered if I would be allowed back in the US. And even if I was allowed back, I wondered if I wanted to come back. My native Canada looked more and more enticing.

I was preparing to readjust my portfolio in reaction to the market fallout. Donald Trump won the election in the early hours of the morning local time. The Asian market dropped in reaction to it. So I thought the US market will be a bloodbath in the morning. However, I was pleasantly surprised that the market rose! Even stocks I thought would suffer under a Republican government went up, including my managed care stock Anthem. I didn't buy anything that day. And in the following three months hardly touched my portfolio. But what a blessing Trump has been to the market, especially value stocks which makes up my entire portfolio.

I make politics off limits on this blog except as it pertains to the market. And the recent US election is one such case. The last US election taught me a lot as does much of politics. I am not talking about Trump the person. What I learned from the election is about Americans. The US population is not a cut above all other countries. They are prone to the same hysteria, xenophobism and gullibility as people of all other countries. Its institutions are exceptional, I admit that. But in think in the next four years, we will see it put to the test like no other time in recent history. I wonder if a single man can do as he wishes despite the constitution and laws that forbid what he wants to do. The recent Federal court decision to block his immigration ban from seven Muslim countries is one such example. And there will be more I am sure.

The makeup of the US population has made me even more eager to diversify away from the US. I am thinking more of countries like Europe and Japan. I already have investments in those places but maybe I should look again for more.

The recent election has also taught me that strange things often happen. In fact people are so caught up on avoiding past mistakes that one should not focus on that. Instead one should focus
on exactly the not-so-obvious. For example, last 8 years has seen extreme scrutiny of banks. So extreme that probably it has unnecessarily hobbled the banks. Banks are doing fine now. Maybe dismantling Dodd-Frank is the best thing to do. In that, maybe I do agree with Trump!

And I found it even more bizarre that the market rallied in the months after Trump got elected. It just reinforces the common wisdom that you cannot time the market.

And this leads to my main idea. My portfolio picks in this blog have almost all fundamentally not disappointed. But my portfolio hasn't done as well as I expect because I often sold too early because I was impatient. Sometimes I would wait 1-2 years for something to happen to a new investment. If nothing happens I'd sell. And the following year it doubles. This was the case for ITIC and ADW:TSX.

Play Chess to Enhance Returns

Investing needs skill and temperament. Many discuss the skill aspect, but it really isn't that technically hard as Buffett and Munger say. And I have found solutions for the skill aspect. Others may not find it suitable for them but it works for me. But I need a better solution for the patience issue. I looked at the habits of other great investors. They all seem to be comfortable under their own skin and they have good balance in their life. Warren Buffett's wife once remarked that Warren doesn't care much for money as one can see from the way he lives. But he is competitive and his net worth is a way of keeping score against the competition. It is very satisfying to know you have some innate superior skill that others cannot deny. You read the same stuff as everyone else, but you are able to perform so much better financially.

Some may see him as a big philanthropist or a humanitarian who makes money for the good of others. But I think his wife's description is the main reason that has motivated him throughout his life.

I also think many successful investors are very competitive. But one has to be very careful in channeling that energy. Millions of people have tried the short term investing game and have lost dearly. Some may be successful at it, kudos to them. But I believe in long-term investing. And it is very unsatisfying for the competitive spirit to do nothing but wait everyday. So in that way being competitive is detrimental to long-term investing success because it can spur the investor to be more active and less patient. And that is the case with me as I described earlier.

So looking at the habits of big investors like Buffett, I noticed that a lot of them channel their competitive and mental energy. Buffett, David Einhorn, James Cayne, Alan Greenberg, are just some of the people in the investing and financial world who play bridge. Einhorn is also a very successful Texas Hold'em poker player.

Less well known are several hedge fund managers who are excellent chess players. Boaz Weinstein is a master and also a fund manager. And Patrick Wolff is a 2-time US Champion who ran a fund aptly named Grandmaster Fund. Chess was my youth passion and I quit just short of expert level.

I started reading and watching videos on chess last few years and thought about the pattern of investors who have mental stimulation outside of finance. And I thought it would be fun to get back into it, as well as helping me channel my mind and competitiveness away from frequent trading. So about 5 months ago I got back into playing. First it was online and then over-the-board (OTB). And I am as passionate as ever as a child. I have so far played two OTB tournaments and I have achieved a 1996 rating. The two tournaments were the first face-to-face competitive chess I played in 28 years! The diagram above is from one of my games, which unfortunately I lost. But my performance so far is better than when I left the game so long ago. My goal is to be a master, which is a person with a rating above 2200. I don't want to put undue pressure on myself but I am making a serious effort to get there. I have even hired a grandmaster to coach me!

In the future I may even post some of my games with annotations! Would any of you be interested in that? Let me know your thoughts in the comment section.

My 5th Annual Schedule of Investments

So four years on, I am still posting. On each anniversary of my blog I list my dozen or so largest holdings. This year I am posting three months late but the following are my holdings at the anniversary. See this link for my past year holdings.

Position	Category	Business
Senvest Capital (TSX:SEC)	Canadian Smallcap	Investment Company
Seaboard Corp (SEB)	US Mid cap	Food Conglomerate
Installux SA	French microcap	Manufacturing
IEH Corp (IEHC)	US Microcap	Manufacturing
McRea Industries (MCRAA)	US Microcap	Footwear
Kansas City Life (KCLI)	US Small cap	Life insurance
Anthem (ANTM)	US Large cap	Health insurance
Tachibana Eletech (TSE:8159)	Japanese Smallcap	Electronic Distributor
New Century Hong Kong (HK:0234)	Hong Kong Small cap	Hotel, cruise line
European Reliance (ATH:EUPIC)	Greek smallcap	Insurance
Riken Keiki (TSE:7754)	Japanese smallcap	Manufacturing
Bruce Fund (BRUFX)	Mutual fund	Mid-cap value
Lewis Group (JSE:LEW)	S Africa large cap	Retail

I am posting less now because I have been busy with other things and because I have less new things to say. I think I will have a lot more to say once my thesis for many of these stocks have played out. That said, I have written this blog for four years and, to me so far, I see that my investment strategy is working out. By this I mean that my active investing is worth the time. I am beating the market and I should continue to beat the market. The edge is not big. I think I am beating and can continue to beat the market by 1-2%. But as we all know from the principle of compounding, such an edge will become a fortune over long periods.

Lessons of the Last Four Years

Wow, it has been a long time - four months - since I last posted. Well, no, I haven't stopped blogging but I have definitely slowed down. I have been busy with work while my investment activity has virtually halted until recently. Besides, I probably needed a break as I have been blogging for four years.


During the last few months, I have reflected on what I've learned in the last four years. For one thing, I am still learning new aspects of value investing. The value investing concepts seem to be straightforward, but different people can interpret the same thing differently and even the same person can interpret the same thing differently at different times.


I have heard from Peter Lynch and Walter Schloss, among others, that an investment needs about 3-5 years to play out. That is a long time to get the feedback on whether you are right. But it's the easiest way I know of to get outsized results. By now or soon from now I can see whether my investment ideas were sound.  One example is Installux. I bought it originally 3 1/2 years ago and it has more than doubled in addition to a nice dividend. Which is as good as I can expect. But I didn't believe this concept as much as I should have.  Take the case of Andrew Peller (ADW:TSX), which I bought 3 years ago at CDN$14. Today it is CDN$32.  But unfortunately, I got impatient and sold and barely eked out a gain.  This is a hard lesson learned. I will redouble my efforts to see my investments through the 3-5 year period.

A second investing concept I've genuinely learned is that buy and hold can mean forever. I read this from in Fisher's book Common Stocks and Uncommon Profits. What it means is that if a company's prospects grow with the price at any given time, then one should hold the stock until that changes. And if that doesn't change then one should hold on indefinitely. This is more of a growth investing approach but one can argue that growth is part of value. Stocks that used to undershoot can now overshoot beyond my wildest expectations. I've learned this lesson the hard way when I sold Phillip Morris (MO) after 12 years. By then this cigarette company had a PE in the low teens.  Who would have thought that cigarette companies now have PE above 20 and MO would triple in the last 4 years!


Thirdly, I often wonder what drives the market of months or years when it doesn't behave quite rationally. And from watching the market for almost 20 years, I have concluded that often there simply is no rhyme or reason for its behavior. Nobel Laureate Robert Shiller drove this point home to me in his book Irrational Exuberance. He points out example after example of long periods of mispricing in different times and different countries because it is human nature. For example, I've owned MSFT off and on for years while its PE was in the teens. Then, over the last 2 years, it expanded to over 20. This hasn't consistently happened since around 2000.  And I cannot see any significant change to the company's growth prospects.  And I cannot even see any good reason why the market changed its sentiment, other than the fact that investors feel bullish about the market.  The market is quite overpriced but I don't feel more money chasing yield is a good reason for a stock to go up. Or at the very least I don't think I can count on excessive multiple expansion for my gains.

The same anomaly can occur in the negative direction. Entire markets can be depressed for as long as a decade. I am not referring to Japan, which one can argue is depressed for good reason. But the Hong Kong market should be much higher because it's price to book ratios are extremely low. And Hong Kong does not have the demographic problems that plague Japan. That gives the Hong Kong investor like me a huge margin of safety.  And I hope this margin of safety will give an edge over other investors who may not be inclined to invest in such markets.  I am also buying and waiting for multiples to revert to more normal values in other markets like Russia.


Fourthly, while concentration is needed to maximize gains, don't overdo it! The concentration argument is that one should bet big when one has conviction. Extreme concentration is warranted only in a few types of situations. For example when Charlie Munger levered to buy BCP, or when Warren Buffett bought the Washington Post.  In the first example, Munger was waiting for the outcome of an impending court decision which would either determine if he breaks even or makes a profit. In the second, the Washinging Post was a diversified media company with many assets which are spread out in different media and different locations. And he knew he could get an offer on those properties if they were for sale. And the Washington Post was selling for a fraction of book.

However, very often people have more conviction than they should. When a person concentrates like this investing becomes gambling because a few events can make or break a portfolio.  The purpose of diversification is to prevent catastrophic loss of the entire portfolio. And often even successful investors make this mistake. And when that happens it isn't just bad luck, it is because they've been playing Russian roulette one too many times.  They may have been lucky for many years but eventually the odds catch up to them.  Earlier I said value investing gives feedback in 3-5 years, so a few feedback cycles can take over a decade, and maybe over that time they may have been lucky.

Recently, the internet chatter has been buzzing with two big disasters: Valeant and Horsehead Holdings. Both were companies with big stories of potential gains. But Horsehead was betting on one plant coming online as the low-cost producer. If that did not happen, well it's complete equity wipeout. And that's exactly what happened.  Valeant was a company with a suspicious business model and it also came crumbling down with a 90% loss of shareholder value.  Those two situations wouldn't have been so bad except that some big fund managers put 20% or more into these stocks! And they threw in new money after the companies started to stink! I think putting in new money was an obvious case of denial.  This was a timely reminder to me that no matter how long I can have success, I should stay diversified.  Bad things happen at the most inopportune times.


I don't know whether my investing strategy will ultimately succeed. However, I will keep learning and relearning value investing concepts. I will also learn the mistakes of others and stay vigilant

2015 Year End Results

By March every year all companies with fiscal year end on Dec 31 should have announced their annual results. Six of my holdings are summarized below. Overall all results are reasonable and make all six stocks overvalued. But I don't know why the market trades these stocks so cheap. I am not one to think too much of catalysts so I have no clue when will it end.

	EUPIC	PFHO	SEC	KCLI	Soundwill	KARE
Price (April 1)	€ 1.49	10.15	CAD$ 125.70	9.20	HK$ 9.20	€ 240.00
Marketcap M	€ 40.98 ($ 46.71)	8.12	CAD$ 354.47 ($ 270.59)	384	HK$ 2616.20 ($ 337.57)	€ 662.40 ($755.14)
PE	3.66	4.84	loss	13.15	loss	12.40
ROE	0.14	0.33	-	0.04	-	0.15
PTBV	0.51	1.58	0.53	0.58	0.16	1.89
Div Yield %	0.00	12.32 (one time)	0.00	2.70	2.17	3.54
Vol (basis)	0.51	6.89	1.06	5.52	2.41	4.13

The table summarizes the key metrics. I mostly focus on PE and PTBV. And for each company, one or the other shows the company is cheap. The last row gives the average daily volume divided by the total shares. The fraction is showed in basis points units. So PFHO daily volume, which is 6.89 basis points, is actually 0.0689% of total volume. I have found most companies with healthy volumes should trade at about 20 to 30 basis points (0.2% to 0.3%). The table shows that all the six companies trade at extremely low volumes. None are at 20 or 30 basis points. This may explain why the stocks trade so cheap, they have extremely small interest.

European Reliance Insurance (ATH:EUPIC) continued its growth streak by increasing pre-tax profits by 6.6%. Even better is equity growth at 13.3%. The stock is still super cheap. I presume the reason is the ongoing crisis situation in Greece. Warren Buffett used to say he could find stocks that trade at 2 or 3 or 4 times earnings. They exist now and you just have to look. Well, I found one here trading at less than 4x earnings! On top of that it is trading at half of book. Now if only the market can cooperate.

Pacific Health Care Organization (PFHO) had a rough third and fourth quarter. The stock went from the high twenties to as low as $6.50 after announcing that they will lose their biggest customer Amtrust in Q4. But after their official annual report, the stock managed to recover to $10.15. Q4 results show that subtracting Amtrust's waning revenues in the quarter, the company still did $1.2M in business. So at that conservative trend, the company can do $4.8M for 2016. At their current profit margin of 20%, that is still more than $1 a share. The company said in the report that they employed 36 people in mid-March. That is still more employees than they've ever had except for their record year in 2014. And the company is continuing its IT expansion. I am cautiously bullish on PFHO.

Senvest Capital (SEC:TSX) reported FY15 EPS CAD$(35.39), which is pretty much expected. However, the book value per share increased because of a 19% rise in the Canadian dollar relative to the USD throughout the year. That would give per share book value of CAD$271 at year end. And also with estimated hedge fund losses from the company's 13F and its website, we can expect expect book value after Q1 to be about $237. Today it trades at $127. So the stock trades at 53% of book. That is too low even by Senvest standards. And one big reason for the huge discount is the market's view that the company charges excessive fees. This year has been kind of flat, and so there is little if any incentive bonus. The salary drawn should be all the employee expense on the books which is $12.5M. Other operating expenses, which may include costs for expanding their New York office is $16.8M. I am not thrilled about the expense. But for a company that manages about $1.4B in net money for common shareholders, minority interests and hedge fund holders. One can argue the cost is reasonable.

Kansas City Life Insurance (KCLI) reported for the first time after delisting from NASDAQ. The company revealed it bought back 1.1M shares for an average price of $51.13. The shares included normal buybacks and the odd-lot tender offer of 906,500 shares at $52.50. There are now 9.6M outstanding shares. The company earned $29.2M for the year, which is flat compared to the previous two years. However comprehensive income was $(9.0)M due to unrealized losses in fair value of securities. The comprehensive loss along with the 1.1M reduction in shares, minus the dividend, meant that the book value per share was flat from 2014 to 2015 at $68.55. I anticipate that unrealized gains will be much higher in 2016 because interest rates will be lower than expectations at late 2015. Lower interest rates mean a higher valuation on the company's stock portfolio, with the drawback that the company may receive less revenue as people avoid the company's products due to their low yield.

Soundwill Holdings (HK:878) is a real estate company that renovates and develops buildings as well as lease properties, primarily in Hong Kong. It is dirt cheap on a price to book basis. But last year it turned a small loss mainly due to fair value adjustments on its investment properties and almost no property sales.

Soundwill owns some of the best retail properties in Hong Kong. But rents were ridiculously high. I heard some of their properties were the highest retail properties in the world! But now that less tourists are coming from China, rent prices have fallen. Along with rents the fair value of Soundwill's properties have also fallen.

In 2014, the company sold HK$2.5B worth of properties for a $1B gross profit. But last year they had virtually none. But that could be a simply a quirk of timing. The following table shows the company's yearly property sales as well as the total money held as deposit on properties under development. The sales seem to oscillate every two years, with a high amount on year followed by a low. But the amount under deposit on the low years does seem to foreshadow good sales the following year. So, I expect 2016 to have significant property sales as in 2014.

	2015	2014	2013	2012	2011	2010
Property Sales (HK$ M)	10.40	2466.00	199.00	1310.60	483.20	591.20
Deposits	735.00	421.00	1277.00	482.00	529.00	422.00

Karelia Tobacco (ATH:KARE) reported year end earnings of € 19.35 versus € 22.44 a year earlier. Revenues were up 15% and gross margins, net of excise taxes, were up to 14% from 12.7% a year ago. The difference in the bottom line is from a previously mentioned € (14M) adverse tariff decision. The appeal is ongoing which, if successful, would return € 14M to income.

Playing Anthem-Cigna Merger Arbitrage

The managed care industry is under pressure by shareholders and regulators and the public to decrease costs while increasing coverage for the needy. It has done a lot to that end but the next step looks to be consolidation. Anthem (ANTM) last year announced plans to merge with Cigna (CI) last year. Similarly Aetna (AET) last announced plans to merge with Humana (HUM). These two mergers have the potential to change the managed care industry from five big providers to three big providers.

	Revenue	Members	Notes
United Health	$154 B	45.7 M	Big on Medicare and Medicaid OptumRx for perscription benefit
ANTM + CI	$117 B	53.8 M	ANTM: BCBS provider in 14 states and public exchanges CI: Medicare and international and national accounts
AET + HUM	$115 B	33.5 M	AET: strong in Medicare and public exchanges HUM: Big on Medicare

In this deal, Anthem would give $103 plus 0.5152 Anthem shares for each CI share. The potential value to CI shareholders is shown below. Anthem last year traded in the $125-170 range. The last ANTM and CI values are also shown in the chart. Note that CI is trading $35 below the merger price if the merger is consummated with ANTM trading at the most recent price. This huge discount reflects the high uncertainty of the merger passing regulatory scrutiny. However, in CEO's of both companies said in conference calls they were confident of success.

The deal also has a lucrative $1.85 B breakup fee payable by Anthem to Cigna if the deal cannot consummate by next year due to regulatory snags. That is about $6 to each CI share! In the event that the merger fails due to regulatory snags, I conservatively estimate the CI price to be 13x the expected $8.50 year-end earnings guidance, plus the $6 breakup fee minus taxes. That works out to about $115 per CI share. That is the bottom limit of the chart.

I used a 13x multiple for CI because CI has a better than average profit margin (6%) than other managed care companies such as ANTM. While managed care companies now typically have multiples in the mid to high teens. Based simply on the CEO's comments, I give the deal a 60% chance of success. So to me, CI looks like a easy way to get a good one year return. In addition, I had a large ANTM position coming in. So it was most logical to do a merger arbitrage. Merger arbitrage typically calls for shorting the acquirer and buying the acquiree. So, I sold part of my ANTM position and bought CI. If the deal does happen I grow back part of my ANTM position. If the deal does not happen I own CI which is a sound company in an industry I like, albeit I paid a higher price than I liked.

Buying the Correction: KCLI

I first bought Kansas City Life Insurance (KCLI) almost three years ago simply based on cheap price to book ratio. The stock has yoyo'ed between 38-50 for about 2.5yrs that I owned it. I bought and sold it twice but in July last year they did a odd-lot tender so anyone with less than 250 shares will be bought out for $52.50. It was selling at $44 around the time of announcement. Management did the tender to reduce the number of investors so that they could delist from the NASDAQ. The company began trading OTC on January 1. The company generated a lot of buzz on the blogsphere because it was an easy way for a trader to make up to an $8 spread on 249 shares in short time. That is up to $2000 on each open account. I failed to do so because I was out of my KCLI position and failed to notice it until it was too late!

I am sure many who took advantage of the tender thought it was a really neat trick they pulled on a big corporation. But I bet KCLI management thought they got the last laugh. They were consistently buying their shares back last several years and getting a whole bunch at $52.50 was a steal.

The management hasn't revealed how many share were tendered but their estimate was for about 600,000 shares. That would bring down the outstanding shares down to 10M shares, and raise equity per share to about $70.50. This is an 3.5% annualized growth over the last five years. In addition the company pays 1.5% of equity as dividend. Which brings a total 5% return on equity. And Berkshire Hathaway grew equity by only 4% last year. Still that is pretty sub par for a business but then again, life insurance is like that. KCLI operates with a 6.5% after tax margin. I think KCLI is an average performer. But the stock recently traded in the $36-38 range, which is just 52% of equity. That was the catalyst for me to jump back into KCLI for the third time. If feel the current price is just too cheap. Clearly the management feels the stock is worth more than $50. And there is no reason for it to fall so much lower than before the tender. The company is basically still the same. It now trades on OTC and in its first month there, the trading volume is actually higher than before on NASDAQ. So liquidity is not an issue. The company no longer files with the SEC, which was to save about $1M a year, or about $0.10 per share. But I am sure the quarterly reports and shareholder communication will be the same quality as before.

The half price share discount means the 5% per share equity return is 10% shareholder return. Admittedly this is helped greatly by stock buybacks. The company has reduced share count by 13% in the last 5 years, so it isn't shy about using cash for buybacks. But at 50% of book, buying back shares is getting even more effective.

Deciphering the risk of the company's insurance policies is difficult for me. But I sense the company is extremely conservative. The company is run by the fourth generation of Bixby's. The company separates their policies into two types. The first is premiums on traditional life insurance and immediate annuities, plus a small portion of disability and dental. These have guaranteed payout. The immediate annuity, which has longevity risk, is historically less than 10% of yearly premiums. The second is deposits type insurance such as universal life, variable life, variable annuities which have a surrender value and depend on market conditions. These have guaranteed interest rates which may cause KCLI losses if interest rates change violently. But that is a very unlikely scenario.

The company's investment portfolio is also very conservative with 77% in fixed-income.

Overall, this is a very conservative company that is at the virtual bottom of any reasonable valuation. So, I think of this as a very safe investment with upside, almost like cash with benefits. Such an alternative for cash is very useful in this down market where I want liquidity handy to buy really depressed stocks in case the markets drop further.

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.

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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.