Monday, August 28, 2006

Miller Time

“The call is much harder from here, with only scattered Stone Age tribes in the Amazon, the comatose, or newly arrived aliens from Alpha Centauri, unaware that energy stocks are a one way ticket to outperformancedue to demand from China and India, the location of reserves in unstable areas, thelack of investment in new refining capacity, the rate of depletion, the dwindling ability to locate giant new fields, and so on.”
Bill Miller on Value Trust’s lack of exposure to energy stocks, July 2006

Bill Miller is well known for his outstanding record of beating the S&P 500 for 15 years in a row. He manages the Legg Mason Value Trust and is considered a value investor, although you may not agree with that designation given 20% of his portfolio is invested in internet companies including Yahoo (Nasdaq: YHOO), eBay (Nasdaq: EBAY), Amazon (Nasdaq: AMZN) and Google (Nasdaq: GOOG). He thinks the first three are trading at 50% of fair value – my brother and I agree and have added to our eBay position and considering adding to our Amazon holdings.

The press is having a ball these days speculating if the run is finally coming to an end as Miller’s portfolio has been decimated so far this year. Miller has admitted as much and in July wrote a letter to his investors reminding them to think long-term and that his portfolio looks different from the index, and may therefore underperform significantly at times, for a good reason: to beat the index you have to look different from the index. In his letter he admitted he was too early to get into homebuilder stocks such as Centex (NYSE: CTX) and Pulte (NYSE: PHM) and that he missed out on energy stocks. Another possible reason to speculate an end to his spectacular run may be that his fund has gotten too big. After all, Buffett has said that “a fat wallet is the enemy of superior investment results.”

In any case, it seems Miller is not alone. Other value managers are singing the same tune. In late June, Bill Nygren of the Oakmark Fund gave a speech at a Morningstar Conference in which he laments the short-term focus of financial media, echoed by Miller in his letter noting the “market’s myopic, obsessive focus on what is going on for the next three to six months.” Oakmark’s recent absolute returns have been nothing to balk at, but Nygren has been underperforming the market. One culprit has been his lack of exposure to energy stocks. The other is his decision to begin buying what he classifies as superior businesses at reasonable prices beginning in 2003.

He provided some interesting data in his slides and focused on 10 stocks Oakmark finds interesting. Stocks we have talked about and included on the list are Wal-Mart (NYSE: WMT), Citigroup (NYSE: C), Home Depot (NYSE: HD), and Tyco (NYSE: TYC). Consider this. These ten stocks have declined 42% vs. S&P 500’s 19% decline from its peak in 2000. Meanwhile, S&P earnings have increased 67% since 1999 vs. 161% for the ten companies. Moreover, on a P/E basis, they are trading at about par with the market. In other words, they are priced as if they are average businesses. If the market is right, well, then they are priced accordingly and Nygren views this as his margin of safety. Otherwise, higher earnings growth and a P/E expansion should reward him (and us) handsomely.

Nygren for one was vindicated after the bubble burst in 2000 as investors who had bailed on him to buy tech-havy funds wished they had stuck with him. Perhaps most importantly, both Miller and Nygren have skin in the game and are invested in their funds. During his speech, Nygren reminds us that it is practically impossible to avoid mistakes when investing. The secret to success is to consistently apply your investment philosophy and discipline over the long run and to stay patient.

Lou Simpson

“You live by the sword, you die by the sword. If you are right, you are going to add value. If you are going to add value, you are going to have to look different than the market. That means either being concentrated, or, if you are not concentrated in a number of issues, you are concentrated in types of businesses or industries.”
Lou Simpson, GEICO Insurance

In The Warren Buffett CEO, Robert P. Miles introduces Lou Simpson as Berkshire Hathaway’s (NYSE: BRKB) back-up capital allocator. Simpson operates very much under the radar and is in charge of equity investments at GEICO, one of Berkshire’s insurance businesses. He has an impeccable record. Indeed, it is all but a forgone conclusion that in Buffett’s absence, Simpson will be responsible for capital allocation at Berkshire.

It took a while to get through this book. There is a lot of repetition with praise for each of the CEO’s of the various subsidiaries and their admiration for their boss. But in my opinion, the real message to take away from this book is that Berkshire is an assembly of many wonderful businesses run by dedicated manager owners who love their job and their businesses. Of course there are some subsidiaries which may be in for tough times such as the various shoe manufacturers. But GEICO, Gen Re, Flight Safety, Executive Jet Aviation (NetJets), Washington Post (NYSE: WPO) and See’s Candies along with a few furniture retailers are top notch businesses. The book also gives you a good feel for the kinds of people and businesses Buffett looks for as well as a culture which he has created to last even once he is no longer at the helm. That is the power of Berkshire.

The chapter on Lou Simpson alone makes this a worthwhile read. His business tenets are listed by Miles as follows:

  1. Read company reports and financial press voraciously. He reads 5 to 8 hours a day. His favorites are the Wall Street Journal, BusinessWeek, Fortune, Forbes and Barron’s. All must reads.
  2. Research any company extensively before making an investment.
  3. Don’t overpay.
  4. Think independently.
  5. Invest for the long-term.
  6. Hold only a few stocks. He thinks individual investors should hold no more than 10 to 20 stocks. We have talked about this before.

Remember our discussion about value vs. growth last October? It seems Mr. Simpson agrees with us: “When you ask if someone is a value or growth investor – they are really joined at the hip. A value investor can be a growth investor because you are buying something that has above-average growth prospects and you are buying it at a discount to the economic value of the business.”

Since we are talking about equity investments at Berkshire, here is a quick update. During Q2, its positions in Gap, Lexmark and Outback Steakhouse appear to have been completely eliminated. The company also disclosed that during Q1, it accumulated a $117 million position in Johnson & Johnson (NYSE: JNJ) – a wonderful company which was trading at a reasonable price.

Sunday, August 06, 2006


"In the short run, the market is a voting machine but in the long run, it is a weighing machine".
Benjamin Graham, The intelligent Investor

A recent study by the CFA Centre for Financial Market Integrity and the Business Roundtable Institute for Corporate Ethics recommended companies stop giving quarterly guidance to encourage long-term thinking among managers, analysts to stop demanding short-term results and for asset managers to have their own wealth tied up in funds they manage.

It’s about time people start to pay attention. Indeed, a few companies are starting to back away from providing guidance. All this mumbo jumbo about missing analyst consensus by a penny or not meeting the whisper number is ludicrous. Meanwhile, ‘investors’ have punished shares of 3M (NYSE: MMM) and United Parcel Service (NYSE: UPS) in recent weeks even though the long-term prospects for those businesses are more than just average.

For long-tem investors, this behavior simply creates opportunity. The key is to be patient and have the discipline to believe in your investment thesis and not be swayed by short-term fluctuations in prices. Speaking of fluctuations, the market has provided a fun ride since March. After reaching its highest level in years in May, the S&P 500 fell by more than 7% at some point in June before recovering some of the lost ground and has been practically flat on a monthly basis from May to July. Our ‘value fund’ was also whipsawed during this period but recovered sharply in June thanks to a spectacular run in the shares of the NYSE Group (NYSE: NYX) which seem to have been battered for no apparent reason.

We are weighted heavily in these shares and still believe the shares are undervalued at these prices. Meanwhile, Atticus Capital LP, disclosed on Friday that it has almost doubled its holding in the NYSE Group and now owns just over 7% of the company with options to buy more shares. The firm also has stakes in Deutsche Boerse and Euronext, which has agreed to a $10 billion merger with NYSE. The deal is not done by any means as Deutsche Boerse remains a dark horse and could still derail the agreement. Stay tuned.

Charlie and Warren

I am a bit late with this one. But for you die hard value investors and Buffet fans, you have to check Charlie Rose’s three part series on Buffett. The Man, the Company and The Gift are well worth watching, especially the first two. You can find them on Google Video. I have ordered the DVD’s and will add them to the curriculum my son will surely have to complete before he makes his first ever investment. For now, as a 10 month old, he will have to trust his father. Tomorrow, he will be the proud owner of one share of Berkshire Hathaway (NYSE: BRKB) Class B share in his newly opened college savings account.