Wednesday, February 15, 2012


"It is expensive to sit on cash."

"I gave you my money to invest in the markets, not to sit on it and do nothing with it."

Yes, investors dish out plenty of advice to 'professional' money managers. If the 'professional' does not oblige, the investor takes her money back and gives it to a 'professional' who will oblige and invest every last cent in stocks right away. If this is the case, we would advise the investor to keep her money and just buy an index fund, saving herself the fees and expenses associated with 'active' and 'professional' money management. This is because being fully invested makes sense only when Mr. Market is throwing fat pitches at us - we define a fat pitch as a company which is trading at a significant discount to its intrinsic value. This is when you want to go all out and swing confidently. Otherwise, you need to keep cash on hand to take advantage of the fat pitches when they are thrown sometime in the future. If you were planning to buy and own a private business, would you buy it when sellers are demanding a premium for their businesses or would you wait until you find a distressed seller who must sell his business at a price you perceive to be attractive?

If an investor trusts her risk capital to an asset manager, then presumably she has assessed the opportunity cost of parting with this capital for a reasonable period of time. There is no sense in coercing the manager into taking undue risk because you don't want the manager to 'just sit on cash'. The manager's task is to provide the investor with reasonable absolute returns over an entire business cycle. If the investor does not have the patience for this and has better uses for her cash, then by all means she should have never parted with it to begin with.

In the end, the asset manager's job is to own high quality businesses which will prosper over time, resulting in higher stock prices which will therefore increase the purchasing power of our hypothetical investor. The magic is to buy these businesses at attractive valuations and with plenty of margin of safety. This is possible only if the manager has had the foresight to hold onto cash, waiting for opportunities when volatile markets cause the valuation of securities to decline below their long-term intrinsic value. No cash, no possibility of taking advantage of Mr. Market's gyrations.

We recently watched an interview with Matthew McLennan, the portfolio manager of First Eagle Funds (of Jean-Marie Eveillard fame), who eloquently articulated the need to maintain cash on hand when constructing a portfolio of stocks. Mr. McLennan notes that markets are like stormy waters and investing is analogous to sailing a ship through the choppy waters without getting thrown overboard. It is the cash on hand which provides the ballast the ship needs to avoid disaster as Mr. Market's mood fluctuates from giddy to fearful. Without that ballast, the investor would never have the chance to take advantage of the fat pitches.

Do not be afraid to hold onto cash in your portfolio. But also do not be afraid to be greedy when others are fearful. These days investing in the bluest of blue chip global companies will enrich you with highly attractive dividend yields (much better than locking your capital in 10 Yr Treasuries for a meager 2%) while providing you with the opportunity to participate in the future growth of these wonderful enterprises. Intel (NASDAQ: INTC), General Electric (NYSE: GE) and Coca Cola (NYSE: KO) are a few names that come to mind. Happy sailing.


Thursday, January 19, 2012

Nucs Proliferate

Gilead's acquisition of Pharmasset (NASDAQ: VRUS) has been completed and PSI-7977 is now safely tucked into Gilead's pipeline drawer. As we discussed earlier this year, this was a relatively attractive merger arbitrage opportunity if you could stomach some downside risk.

Sure enough, the love affair with pre-approved HCV products and the companies developing them continues to proliferate. On January 8th, Bristol-Myers (NYSE: BMY) announced it will acquire Inhibitex (NASDAQ: INHX) for $26 or $2.5B. Inhibitex shares were trading at around $10 before the announcement. Inhibitex's crown jewel is INX-189, a nucleotide polymerase inhibitor or "Nuke" for short. For obvious reasons I prefer the acronym "Nuc". If you want to know what a Nuc looks like, here is a nice picture:

Inhibitex shares are trading at $24.61 today. By buying the shares and waiting for the acquisition to be completed, the return on investment would be 5.65%. The acquisition is expected to be closed by February 10th and would result in a spectacular annualized return.

It is important to note that this investment opportunity is somewhat riskier than the Gilead/Pharmasset merger arbitrage trade. INX-189 has not cleared the all important 12 week hurdle in its Phase II trials and therefore it is possible that an adverse event such as liver toxicity signals in patients enrolled in the trials will occur prior to close, scuttling the acquisition.

The bidding for Inhibitex was a competitive process as Bristol-Myers had to raise its offer several times to fend off other companies which rumors suggest included Johnson & Johnson and Merck. I highly recommend that you read the Tender Offer filing by Bristol-Myers, which lays out the bidding process in detail, prior to making an investment in Inhibitex shares. You will note that Bristol-Myers was able to review non-public material information prior to making its bid. Somewhat comforting.


Thursday, January 05, 2012


It has been a while since I made any changes to the Model Portfolio. That may be an understatement since the last trade in the portfolio was completed in October of 2009. Cadbury Schweppes did get gobbled up by Kraft (NYSE: KFT) which itself is spinning in to two companies. Two companies we have discussed in the past and held for some time in the portfolio.

I have decided to stop maintaining this portfolio going forward as I simply do not have the time to manage it. Having said that, I will continue to track the performance of the portfolio as is (including the cash position). It will be an interesting 'buy-and-hold' experiment to look back on years from now.

Since inception on September 1, 2006 the Model Portfolio's NAV increased by 16% versus the S&P 500's total return of 8.09% through the end of 2011. This does not include any dividends received since September 2010. Below is a snapshot of the portfolio as at the end of December 2011.

Monday, January 02, 2012

Start 2012 with a VRUS

It's been over year since I last posted on Margin of Safety. Let's just say life has been super busy. But for 2012 the plan is to post once a month at a minimum. Let's see how that resolution plays out.

A lot has happened since my post on October 2010 and I won't rehash the events of 2011 here in too much detail. Needless to say it was one of the most volatile years for the markets in recent memory. Retail investors abandoned equities in droves and prominent hedge fund managers were clobbered as high correlations apparently offset their superior stock picking skills. Meanwhile in Europe the situation went from bad to worse as leaders struggled to come up with a solution to appease the bond vigilantes. And then there is our favorite Mr. Buffett who was going about his business as usual and was putting his cash to work even as investors were fearing a total world collapse instigated by the affairs in Europe. In 2011 Mr. Buffett became a 5.5% shareholder of IBM (NYSE: IBM) at an average price of $170. IBM ended the year at $183.88. Yup, it seems stock picking does work after all and Mr. Buffett doesn't charge 2/20 to do the picking for you.

So here we are the day before the markets re-open for 2012 and many of the overhangs present in 2011 remain. Certainly the situation in Europe will continue to be on everyone's radar as will the U.S. Presidential race and D.C. politics in general. There are also worries about a Chinese hard landing and a double-dip recession in the U.S. 'Macro' will be the topic of discussion yet again. Investors remain cautious and are sitting on a substantial amount of cash - or they are taking their money out of equities and piling into fixed income securities and specifically U.S. Treasuries. Nevermind that some of the largest blue chip companies in the world will pay you a higher dividend yield than the U.S. 10 Yr. Intel (NASDAQ: INTC), Johnson & Johnson (NYSE: JNJ) and Coca-Cola (NYSE: KO) come to mind.

But there are plenty of other opportunities to take advanatge of which will somewhat insulate your portfolio from Mr. Market's volatility. The key is to focus on investments which are uncorrelated to the markets. Consider a risk arbitrage investment opportunity in shares of Pharmasset (NASDAQ: VRUS) which I profiled on Canada's Business New Network (BNN) on December 19th.

Pharmasset is being acquired by Gilead (NASDAQ: GILD) for $11B or $137 per share. When the announcement was made in late November, Pharmasset shares soared from around $72 to $134. Then the shares began to drift lower and traded as low as $123 before rebounding last Friday to close at $128.20. The deadline to tender shares is midnight January 12, 2012 with the acquisition expected to close shortly after.

The potential reasons for the decline are numerous. What is apparently spooking merger arbitrageurs is the potentially large downside (see below) and the fact that the purchase and sale agreement provides Gilead with a broad Material Adverse Clause (MAC) provision allowing the company to walk away from the deal if there is a Material Adverse Event associated with Pharmasset's Hepatitis C Virus (HCV) drug under development. There are also other conditions which could trigger the MAC but this is the main one. The drug under development is a paradigm changing oral product for treatment of HCV code-named PSI-7977. This is what Gilead is after.

By investing in Pharmasset shares at $128.20 you woud lock in a 6.86% return on your investment. Assuming he deal closes by the end of Q1 (I think it will close in January), the anualized return (a metric used by merger arbitrageurs) would be about 27.44% which is incredibly high. If you really want to juice up your returns, you can also consider selling one January 21, 2012 $125 put option for about $7 for each 100 shares of Pharmasset you purchase. This of course doubles your exposure and magnifies your losses if Gilead walks away from the transaction. But if the transaction goes through, your return on investment including the option premium you collect would be 12.32%.

Of course no investment is without risk hence the term 'risk arbitrage'. Usually such situations offer a lower upside as the target stock trades closer to the acquisition price. At the same time the downside is usually on the order of 20%-30% if the deal is scrapped. This is what merger arbitrageurs are used to. In Pharmasset's case, if something does happen to PSI-7977 between now and closing of the deal, the stock would be decimated by 50%-80%. So you get more juice on the upside but you also have to stomach a potentially very large downside.

In my opinion what the folks in the merger arbitrage camp are missing is that Gilead is an expert in the anti-viral therapeutic space and they would not be putting $11B on the line for a product which is not yet approved by the FDA. The acquisition will almost certainly close before any additional clinical trial results will be announced and most certainly before PSI-7977 is approved. The key is that PSI-7977 has passed some key hurdles which almost guarantee its success including 12 weeks of treatment without any adverse liver signals being detected. By contrast, on December 16th, Pharmasset announced the discontinuation of another pipeline drug PSI-938 due to abnormalities detected in liver function during a Phase IIb trial. This news by the way further spooked the markets and was the reason for the decline in the shares to the $123 level. Nevermind that this news had no bearing on Gilead's offer to acquire Pharmasset. We have talked about Efficient Market Theory before, right?!

Before you invest in Pharmasset I highly urge you to do your own research as well as read the SC-14D9 filing by Pharmasset on for details of the transaction and the negotiations between Gilead and Pharmasset. It's a good read.

All the best for 2012.


Tuesday, October 12, 2010

Bond in Drag

I am not a strategist or an oracle. But I know something smells funny when Johnson & Johnson’s (NYSE: JNJ) stock yields more than the bonds it recently issued to yield hungry investors. With U.S. Treasury yields in a free fall, investors looking to earn some sort of a return on their cash are willing to accept what appear to be insanely low coupons on corporate debt. The spread over risk-free rates may seem appropriate but the absolute yield is not enough to persuade us to forgo JNJ’s stock for its bonds.

Granted, the bond market may be signaling a faltering recovery with deflationary forces setting in and the stock market may get caught wrong footed. It is unlikely they can be both right. But we would rather collect a handsome dividend with potential for upside than earn a paltry return in bonds while locking up our capital for a lengthy period of time Even if the market does falter and JNJ’s stock declines, it is highly unlikely the company would cut its dividend. Plus, we would gladly hold the stock for the long run and buy more of it.

This is not meant to be a recommendation to buy JNJ’s stock but merely an illustration of the vagaries of Mr. Market. Investors of all types appear to be dumping equities in favor of the ‘safety’ of bonds and gold. What about all the money that is being printed by central banks all around the world? Could inflation be on its way sooner than people think one that money finds its way into the hands of borrowers? Higher rates would follow thereby decimating bondholders in its wake. Gold appears to be in agreement with this outcome as its price zooms ever higher if you agree with the characterization that it is a classic inflation hedge. The bond bulls on the other hand contend that the world is on the brink of collapse and we are in a deflationary spiral which will only lead to lower Treasury yields. Even if this is so, the bulk of the gains have probably already materialized and in any case the risk/reward profile just doesn’t seem to be there when compared with equities.

In any case, shouldn’t one be investing in equities when all others are reluctant to do so?! Apparently not if you ask David Rosenberg who is the high profile Economist and Strategist at the wealth management firm Gluskin Sheff in Toronto. In a recent note he thought it more prudent to lock one's capital up for 10 years in U.S. Treasuries collecting a paltry 2.4% yield (Mr. Rosenberg argues that bonds will mature at par reducing the risk of owning them. But what good is a bond which pays us 2.4% and locks up our capital with no optionality for 10 years!), described Pfizer (NYSE: PFE) as a “bond in drag” (Question for Mr. Rosenberg – wouldn’t your clients have benefited if you had actually bought shares of Pfizer when they were trading below $15? Why only point out the decline from $19 to $14 since the beginning of the year?), conjured up memories of Nortel (I am not kidding) when alluding to risk of owning equities and, finally, disagreed with Warren Buffett’s recent assessment of equity valuations:

“They’re making a mistake, the ones that are buying the bonds ... It’s quite clear that stocks are cheaper than bonds. I can’t imagine anybody having bonds in their portfolio when they can own equities, a diversified group of equities. But people do because they lack confidence. But that’s what makes for the attractive prices. If they had their confidence back, they wouldn’t be selling at these prices. And believe me, it will come back over time.”

The last time Mr. Buffett made such a proclamation was back in November 2008 when he wrote an Op-Ed piece for the New York Times and was ridiculed for his views. Well, we all know how the markets have performed since then.

Mr. Rosenberg and the bond/gold bulls could be right. We may end up with a double-dip recession and/or a decade of no growth à al Japan which would severely dent current equity valuations. To be fair, Mr. Rosenberg concedes that gold prices may have gone too far too fast. Still he conveniently touts the virtues of holding bonds in a deflationary world while at the same time advocating gold for its ability to preserve value as currencies get debased. But couldn't higher gold prices possibly be a prelude to dangerous inflationary forces eventually rearing their ugly head and destroying bond prices? Something doesn't add up here. To be sure highly successful investors such as John Paulson have also made huge bets on gold viewing it as a means of preserving their wealth (a currency substitute). But at least they don't deny the possibility of higher inflation/rates down the road.

As massive inflows into bond funds continue (Mr. Rosenberg rationalizes this by describing it as sensible asset allocation by oh so rational investors), the allure of owning rock solid businesses at today’s prices which offer attractive dividend yields is too much to pass on. At least we know Charlie Munger would rather own JNJ or Coca Cola (NYSE: KO) or Kraft (NYSE: KFT) rather than gold. Here is a classic quote from a recent speech by Charlie:

“I don't have the slightest interest in gold. I like understanding what works and what doesn't in human systems. To me that's not optional; that's a moral obligation. If you're capable of understanding the world, you have a moral obligation to become rational. And I don't see how you become rational hoarding gold. Even if it works, you're a jerk.”

Wednesday, October 14, 2009

The Old Abnormal

Earlier this decade we were graced with the catchphrase the ‘new economy’ to explain why price to earnings ratios of 100 made sense. Today’s catchphrase, the ‘new normal’, has been coined by the folks at PIMCO to explain why we should get used to much lower growth rates for a while. Mohamed El-Erian and his boss Bill Gross have been on a bit of a mission touting the virtue of weighing security portfolios in favor of bonds and reducing allocation to equities. The logic is that the Great Recession has embarked us on a new era of slow growth characterized by high employment, capital starvation, more regulation and the rising power of China and other emerging markets at the expense of the United States. According to PIMCO equity exposure should now be in the 30% to 54% range as opposed to 60% with no more than half in U.S. equities. Needless to say this advice will benefit PIMCO as one of the biggest bond shops in the world with over $800 billion under management, $120 billion of that coming in since the beginning of 2008.

Perhaps not surprisingly the masses are blindly following the advice of the 'experts' and succumbing to Mr. Market’s mood swings. There is a lot of talk about slow growth, the importance of asset allocation and the nasty repercussions of a depreciating U.S. Dollar. I recently posed a question to Stephen Yacktman of Yacktman Funds during a Q&A facilitated by the Wall Street Journal’s Journal Community and here is what he had to say about the new normal:

So one can try to figure out how to play the asset allocation game or one can concentrate on buying good businesses at reasonable prices. As I have discussed before, many of the largest U.S. corporations offer a natural hedge against a declining U.S. Dollar not to mention the fact that by virtue of being multinationals they will also let you participate in the growth of non-U.S. economies. This is the time to invest in equities for the long run not when growth resumes and the ‘new normal’ morphs into the ‘old abnormal’. To be sure Mr. Market has been on a bit of a tear since April and equities are more fairly valued than cheap. But companies such as Johnson & Johnson (NYSE: JNJ), Coca Cola (NYSE: KO), Procter and Gamble (NYSE: PG), Pfizer (NYSE: PFE), Microsoft (NYSE: MSFT), Intel (Nasdaq: INTC) and Ebay (Nasdaq: EBAY) are worth considering despite the recent rally.

Wednesday, August 19, 2009

The Golden Wall

The Black Box algorithms and catchy names served their purpose while the good times rolled along through the early part of 2007. Fees and market beating returns for the likes of Pequot Capital and Atticus Capital were all too easy to come by. But the recent turmoil in the markets is turning out to be a tad too much for these folks. Pequot is all but shut down and Atticus announced a few weeks ago that it is returning 95 percent of its investors' money by October. It turns out, according to one source close to Atticus' Mr. Barakett, that “there is no fundamental analysis in the market today” and that the "golden era of equity investment is over”. I am not making this up. This was printed loud and clear on the front section of Financial Times' Market section. Yup, Mr. Barakett even attributed a portion of his performance over the past ten years to luck. So much for the secret Black Box algorithms and hanging in there for your loyal investors when the times get tough. Unfortunately he has no incentive to do so. Why work hard to make up for losses when he won't get paid for his efforts (hedge funds can't collect a performance fee until they get back over the previously set high water mark)? This pervasive psychology along with the rise of the Black Swan theory and Dr. Doom and headlines such as “There will be Blood” in our own Globe and Mail newspaper are what typify market bottoms. We may not be out of the woods yet but this is exactly when you want to be putting your money to work. The golden age may have ended for the fancy hedge fund folks, but Mr. Market will happily continue climbing that shiny Golden Wall of Worry for a long time to come.

Tuesday, November 25, 2008

Certifiably Crazy

The recent sell-off in Berkshire Hathaway's (NYSE: BRKB) stock has been nothing short of astonishing. But it is perhaps another sign of fear creeping into investors' psychology. Hand in hand with that decline has been a dramatic rise in the value of the company's credit default swaps implying the AAA-rated conglomerate's credit should be considered junk. Whitney Tilson's article published by Seeking Alpha is a great read on this subject. He calls the stock's dramatic decline "certifiably crazy".

Mr. Buffett himself warned of the derivative time-bomb in his 2002 letter to shareholders. Who in their right mind would think that one of the best investors of our lifetime would ignore his own words of wisdom and enter into such perilous contracts? The equity index put options written against 4 indexes appear to be causing the most angst for Mr. Market. Never mind that the contracts do not require him to post barely ANY collateral even in the event these indexes decline dramatically and that any losses recorded on the books are merely paper losses and nothing more. Never mind that the first contract won't expire until 2019 and that they have an average life of 13.5 years. Never mind that according to a just released email from Mr. Buffett, the value of the indexes would have to decline to ZERO for Berkshire to incur a loss equal to its maximum exposure of $35.5 billion. And never mind that he has gotten paid $4.85 billion in premiums for those contracts which he may invest as he wishes.

Mr. Buffett has indicated that he will provide much greater detail about these contracts in his 2008 shareholder letter and that he will provide "all aspects of valuation" and "deficiencies in formula" for pricing the derivatives. He goes on to say that he uses the formula despite the deficiencies. Classic Buffett to point out the shortcomings of the formula. This should make for some fascinating reading.

In a sign of the times we live in, Berkshire's stock has already rallied 28% from the lows they hit last week. They closed today at just over $3,200. Something is not right when you witness this kind of volatility in Berkshire. But it is precisely in the midst of this confusion that you should be taking advantage of the buying opportunities being presented by Mr. Market. Mr. Tilson has. He has doubled his holding in Berkshire by committing 20% of his fund to the stock.

Saturday, November 15, 2008

Burnt Hedges

Fancy suits, designer glasses and a personality that perhaps stood out a bit from the crowd. Back in 2007 as the Dow was marching its way to a record 14,000, these were apparently some of the prerequisites for launching a fund according to some folks. Oh yes, there was one more prerequisite: a secret sauce or ‘black box’ strategy to go along with the fanciness. The Hedgies could do no wrong with returns exceeding 25% a year over the past 5 years or so, justifying their exorbitant fees. Bland looking, boring value investors were out of style.

Well, a
Black Swan has swooped in and ripped the Armani suits and the black boxes to pieces. Hedge funds are closing up shop at a rapid pace and more carnage probably lies ahead as redemptions pour in at a furious pace and losses mount. Our own Globe and Mail newspaper has had recent articles about ‘high-profile’ Lawrence Asset Management and Salida Capital which have suffered heavy losses.

To be sure there are those who will come out of this stronger and bigger than before. Steven Cohen’s SAC Capital has managed to raise capital in this environment, a testament to his staying power and superior performance relative to peers. John Paulson’s Paulson & Co. has posted impressive gains amid the turmoil. But the ranks of the Hedgies will be thinner come 2009. Here is a sampling of Canadian hedge funds’ performance as reported by the Globe and Mail in October 2008.

Thursday, November 13, 2008

Time to Buy

It has been a while but life can get busy sometimes. I last posted on Margin of Safety in January 2008 and discussed the possibility of a recession and outright Armageddon. Well, both of those are upon us with a vengeance. I have been investing for a little over ten years and the tech bubble and ensuing recession pale in comparison to what is happening right now.

Meanwhile, I have been behind on updating you on the Model Portfolio but have been posting trades I would have executed during that time. I have just posted an update of the portfolio’s performance for the twelve months ending September 2008. Please visit that section of the blog for more color on the portfolio’s performance. Of course the carnage began in October and the Model Portfolio has not been spared. But I plan to add new positions and add to existing holdings as the market experiences these wild convulsions.

These are scary times for investors. I feel especially bad for those who have been saving to go to college or those who may have been contemplating a retirement. The joke is that 401(k)s are now 201(k)s. Predictions range from a short recession to a long and hard economic slowdown that may last through 2011. One article I read used the expression “contained depression” to describe the environment we will face over the next few years. Others are calling this a bottom while others think we may see Dow 7,000. Regardless, we have given up a decade of gains in the stock market. How this will end and when the markets will begin a turn around are anyone’s guess.

There is no question we have some hard times ahead of us. The number of people losing their jobs is mounting every day. The world’s consumption appears to be screeching to a halt. Oil has lost more than half its value and other commodities have been battered as well. Wall Street has been reshaped forever. Bear Stearns, Lehman Brothers and Merrill Lynch are gone. Goldman Sachs (NYSE: GS) is trading at levels not seen since its IPO in 1999 and is now a bank holding company. Even the most revered investors have not been spared. Buffett, Icahn, Kerkorian, Eddie Lampert and Bill Miller have all lost billions. Many prominent mutual funds that have been closed to investors for years are reopening heir doors. Meanwhile, many hedge funds are reeling from Mr. Market’s wrath and succumbing to the high volume of redemptions forcing them to sell assets at any cost. There is no doubt the recent volatility and severe decline in the valuation of various companies are in part due to investors demanding their capital forcing funds to liquidate in anticipation of upcoming redemptions.

Franchises such as Goldman Sachs and General Electric have been left for dead by Mr. Market. I have been buying both in recent weeks. For all I can tell Mr. Market is assuming that companies such as Intel (Nasdaq: INTC), Cisco (Nasdaq: CSCO), Ebay (Nasdaq: EBAY) and Starbucks (Nasdaq: SBUX) will never grow again. It seems our beloved analysts are overshooting on the downside just as they did on the upside. The bearish mentality is pervasive and even the venerable Warren Buffett is being questioned for his recent moves.

Mr. Buffett has been putting a lot of Berkshire Hathaway’s (NYSE: BRKB) cash to work in recent months. He has financed the acquisition of Wrigley’s by Mars as well as Dow Chemical’s (NYSE: DOW) acquisition of Rohm and Haas for a total of more than $7 billion. He has purchased preferred shares in Goldman and GE to the tune of $8 billion as well as warrants to buy common stock within a 5 year period at $115 and $22.5 respectively. Many pundits are questioning his timing for these transactions. A recent Op-Ed piece in the New York Time also drew fire from critics. In that article Buffett declared: “Buy American. I am.”, and concluded with this paragraph:

"I don’t like to opine on the stock market, and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I’ll follow the lead of a restaurant that opened in an empty bank building and then advertised: “Put your mouth where your money was.” Today my money and my mouth both say equities."

As we were going through the tech bubble, the experts declared: this time is different, companies with no earnings are worth infinity. As the Dow worked its way toward 14,000 in recent years they declared: this time is different, China and India will grow indefinitely. Now the Dow is hovering near 8,000 and they have declared: this time is different, Buffett is wrong and he is making his bets too early. Early he may be but wrong he is not. Calling a bottom is a futile exercise but buying companies at attractive valuations is a game winning strategy. Buffett is still the richest man in the world and I am betting he is still the one and only expert to listen to.

Monday, January 21, 2008


In 2005, while an MBA candidate at Ivey, I was enthralled by David Conklin’s Global Environment of Business class. David is a fantastic professor and was kind enough to warn us on numerous occasions to sell any and all of our US dollars because it had nowhere to go but down. I did not heed his warning.

Fast forward to 2007. I spoke with David in December asking him about his availability to give a presentation on the credit markets to our team at DRI Capital. I confessed to David that I had not taken his advice on the USD. He gave me a second chance. He said Armageddon is upon us and to brace myself. Here we are in January and 2008 has begun with a bang. The Dow has swooned more than 15% from its high (earlier today stock markets around the world were pummeled and the Dow Futures don’t look pretty for tomorrow).

The R word is being thrown around like there is no tomorrow and financial stocks are in a free fall. Even strong results from IBM (NYSE: IBM) and Intel (Nasdaq: INTC) were not enough to calm the jittery crowd. Meanwhile, Bank of America (NYSE: BAC) seemingly took advantage of the turmoil and snatched Countrywide Financial (NYSE: CFC) for pennies on the dollar. At least 30 BofA analysts spent 4 weeks on their due diligence. Time will tell how real the diligence was and if this move was brilliance or stupidity. Countrywide shareholders will get 0.1822 BofA shares for every share they own. Countrywide shares are trading at least 20% below that exchange value creating what could turn out to be a fantastic arbitrage opportunity. The market believes BofA could still walk away or reprice the deal.

Meanwhile, Mr. Buffett is bouncing up and down with joy snapping up more Burlington Northern Santa Fe (NYSE: BNI) on a daily basis. He also figured he may as well start a bond insurance business while he is at it. Look no further than Ambac (NYSE: ABK) and MBIA (NYSE: MBI) to see why he smells blood. I hope you weren’t one of those unloading your Berkshire Hathaway (NYSE: BRKB) stock because according to many Mr. Buffett is apparently past his prime. Well not quite. The shares have all but ignored the downdraft and have rocketed to all time highs as Mr. Buffett works his magic and puts his cash hoard to work. There are also the Sovereign Funds of Kuwait and Singapore and the famous Prince Al-Waleed. All are salivating at the chance to own a piece of America’s behemoth financial titans.

One positive out of all this is that stellar businesses such as Moody’s (NYSE: MCO) are trading at half their peak valuations. And one of our favorites, Mr. Lampert’s Sears Holdings (Nasdaq: SHLD) has been cut in half. Ok, so retail is in the dog house especially since a recession is all but inevitable, if the US isn’t only experiencing one. But I believe Mr. Lampert will squeeze value out of Sears. The real estate and the Sears brands should provide ample downside protection. In the meanwhile, both Mr. Lampert and I thank Mr. Market for giving us the opportunity to buy more stock. Starbucks (Nasdaq: SBUX), the purveyor of my daily morning coffee has also been the subject of numerous analyst downgrades and doomsday scenario press coverage by the media. That is one to keep an eye on. And how about Intel? Robust results and the crushing below we predicted they would deliver to Advance Micro Devices (NYSE: AMD) have not prevented a 30% decline from 2007 peak valuations.

The magnitude of write-offs at the Citigroups (NYSE: C) and Merrills (NYSE: MER) of the world has been staggering. That may just be the tip of the iceberg. But don’t fret Mr. Market’s moodiness. To paraphrase Warren Buffett, be greedy when others are fearful. Yes, life will go on beyond Armageddon and will almost certainly be better than before.

Tuesday, September 18, 2007

Syntax Destruction

This past weekend Alan Greenspan was interviewed byLesley Stahl on 60 minutes. During the interview, what was known as "fedspeak" during his tenure as Fed Chairman was coined Syntax Destruction by the man himself. Here is what he told Lesley: "I would engage in some form of syntax destruction which sounded as though I were answering the question, but in fact, had not."

Lesley then went on to play a clip (you may be able to take a peak at it here on YouTube) of one of Mr. Greenspan's testimonies in Congress. I almost fell off my chair laughing. Here is what he said during that testimony:

"Modest preemptive action can obviate the need of more drastic actions at a later date and that could destabilize the economy."

Mr. Greenspan's reaction after he watched the clip, "Very profound." You could sense the sarcasm in his voice a mile away. Not that the Fed's actions matter much to us in the long run. But at least Mr. Greenspan's Fed provided us with some entertainment.

Alpha's Delta

S&P's total return for August: 1.5%

Goldman Sachs Group's (NYSE: GS) flagship Global Alpha fund performance for August: -22.7%

The Model Portfolio outperforming both: PRICELESS

Wednesday, September 12, 2007

Moody Brothers

Some of the most high profile value investors have been hit hard by the recent turmoil in the credit markets. Bill Miller and Wally Weitz have seen their holdings in homebuilders and mortgage originator Countrywide Financial (NYSE: CFC) suffer massive losses.

It doesn’t stop there. Great franchises suspected of being remotely exposed to the subprime fiasco in one way or another have seen their shares pummeled over the past few months. Citigroup (NYSE: C), Lehman Brothers (NYSE: LEH) and Moody’s (NYSE: MCO) are a few that come to mind.

What if Mr. Bernanke doesn’t cut rates? What if home prices plummet? What if the U.S. consumer is tapped out? People asking these questions are also throwing around the R word - you know, a Recession.

Against this backdrop, the Millers of the world are sticking to their guns. In a recent letter to shareholders, Miller contends that he would be a buyer of homebuilders and Countrywide if they were not already in his portfolio. To form, as two large shareholders in Countrywide were unloading shares in August, Legg Mason increased its position in the firm. Then there was Bank of America’s (NYSE: BAC) $2 billion injection into Countrywide which it can turn into an equity stake convertible at $18. And yes, amid this mayhem, our friend Mr. Buffett took a new position in Bank of America and continued to increase his exposure to banks. Mr. Lampert also jumped in and bought a stake in Citi.

A bear trap? Hardly. Is there more turmoil ahead? No doubt. But it is precisely this kind of uncertainty which creates long term opportunity. There is no question that Moody's business will be affected as appetite for fancy loan structures has all but disappeared. But the company's long term prospects will not diminish because of recent scrutiny of its role in the creation of CDOs - that would be a collaterlaized debt obligation. Meanwhile its stock has declined more than 35% from peak. Some of the financials I have mentioned above are trading at extremely attractive multiples and provide Treasury like yields close to 5% to boot. Lehman, as profiled in Barron's recently, could be a Goldman Sachs (NYSE: GS) in the making and trades at only 1.5 times book value. Even Countrywide is worth a look. The company has survived through down cycles before and has managed to diversify its business to include banking. Smaller rivals are exiting the mortgage business altogether. The company should emerge as a stronger player once the market stabilizes. It has ample resources at its disposal to navigate through the credit crunch and is trading below book value.

Moody’s is now predicting that housing’s woes will not subside anytime before 2009. That may seem light years away but if your time horizon is more like 5 to 10 years, this is the time to take advantage of Mr. Market’s generosity and start building a position in some fantastic businesses such as Moody’s and Lehman.