Sunday, November 26, 2006

Nancy's House

What is a blog if we never talk about politics?

Let me be clear. Whether the government is run by Democrats or Republicans does not change much when I am deciding to buy Berkshire Hathaway (NYSE: BRKB) shares for my son’s college savings account. Neither will the actions of the soon to be Speaker of the House, Ms. Nancy Pelosi. But it sure will be fun to watch what she will do next when it comes to US policy towards China.

Source: The Wall Street Journal

An article in the Wall Street Journal about her stance towards China caught my recently. She has protested in Tiananmen Square, she has held protests outside of White House on China matters and she is expected to allow tough China legislation to come to full vote in the House. Don’t get me wrong, I am all for protection of human rights and religious freedom. To be sure, labor conditions at many factories supplying American multinationals still need to be improved. However, taking a tough stance towards China won’t be the most constructive way to deal with things.

She should be reminded that the US economy is more than ever linked to the global economy and is a direct beneficiary of the ascendance of these two countries. After all if foreigners weren’t lending the US so much money, Americans would not be able to consume as much as they do today. In fact they would not be able to buy the fancy wine she makes at her vineyard in California (Ms. Pelosi is quite well off indeed - she is worth up to $55 million with a $25 million stake in a couple of Californian vineyards and a $10 million stake in a golf course).

Suggestion for Ms. Pelosi – have a nice dinner with Treasury Secretary Henry Paulson to learn about what it takes to have a cordial and constructive relationship with the Chinese. Whether Ms. Pelosi likes it or not, China (and India for that matter) will influence the world more than she may realize for the rest of this century. I will never forget when David Conklin, a professor at Ivey School of Business, reminded me and my classmates how lucky we are to be able to witness India and China change the world. Meanwhile, my brother and I are happy participating in the growth of these markets through investments such as ICICI Bank Limited (NYSE: IBN) in India and US multinationals which will undoubtedly benefit from the rise of the consumer class in China.

Thursday, November 23, 2006


"We remain agnostic about the market. We light a candle and hope it goes down. Only during periods of stress can you find good companies at reasonable prices."

Bruce Berkowitz, Fairholme Fund – Barron’s August 14 2006

The Dow continues to break records. Google (Nasdaq: GOOG) continues to defy and hit a high of $513 today - not far from where I thought the stock would be in 5 years when I first wrote about it last November (the rapid rise is partly the risen I sold Google in our Model Portfolio). Incidentally, I find it interesting that an air of skepticism remains in the air. People don’t seem to want to believe the market rally has taken place and that it may indeed continue. Many continue to hold onto to their cash. Perhaps a good contrarian sign that the bull may still have some legs. But I digress. Amid the market’s recent torrid advance and the private-equity orgy, one sector remains unloved and untouched: homebuilders.

Don’t hold your breath though. Recent articles are beginning to mention the beaten down homebuilder stocks as possible targets for private-equity folks. We shall see. Regardless, my position on this sector has not changed. So I won’t rehash what I have said before except that I see opportunity in this sector. In the ten years since I started investing, I don’t recall any other industry getting so much negative news day after day, week after week. Company earnings are coming in below estimates, existing home sales are declining, potential new home owners are canceling contracts, inventories of new homes are piling up and homebuilders themselves are the most pessimistic they have been in years. Yikes. Amid all this the shares are holding up well, a possible signal that we are at or near a bottom.

So if you knew all this and someone gave you a few million dollars tomorrow to buy a business and make a living running it, what would you do? Where would you look? I bet homebuilding would be one sector you would shy away from, let alone a business which provides homebuilding materials to builders, unless, you are Warren Buffett. This brings me to USG Corporation (NYSE: USG) which recently emerged from bankruptcy. Mr. Buffett has managed to snap up shares and increase his holding in the company to nearly 20%, most of it recently at around $46. You may not know USG but I bet you know what SHEETROCK® is. Indeed, that is a USG brand. Apart from being cheap (the stock is trading at 4 times trailing EBITDA), what is unique about USG is that the management sought bankruptcy protection not because the business was performing badly, but because they wanted to shelter shareholders from asbestos litigation related to products sold decades earlier. The company emerged from bankruptcy with its equity intact - a rare occurrence.

If Buffett’s foray into a housing related stock doesn’t give you comfort, here is another data point to consider. Bill & Melinda Gates Foundation’s recent SEC filing shows the addition of seven homebuilders to its stock portfolio. The Foundation’s endowment is managed by an under the radar fellow named Michael Larson. However, I wouldn’t be surprised if Mr. Gates is getting a few ideas from his good pal in Omaha. Mr. Gates is a Buffett apprentice and they are extremely good friends – they do play online bridge on weekends after all.

Who knows, perhaps it is premature to jump in. But calling a bottom is never easy, if not impossible. But at these levels, the shares of the various companies in this sector offer a decent Margin of Safety and an above average upside potential for the long-term investor. One more thing to consider – during a couple of recent speeches, the brain of them all, Alan Greenspan, has been quoted as saying, “the worst may well be over,” and that he is seeing “early signs of stabilization” in the housing market.

Timmy and Wendy Part Ways

Late Septmeber was the big date. Wendy’s (NYSE: WEN) finally let go of Tim Hortons (NYSE: THI). The call earlier this year to buy Wendy’s shares before the spin-off was completed has turned out well with a return of about 30%. Tim Hortons shares languished after the partial spin-off and launch of its IPO but are trading near an all-time high now that the spin-ff has been completed. The stock may not be cheap but you are holding on to a valuable brand and a franchise which should be able to provide shareholders with sustainable growth for some time.

Meanwhile, it didn’t take Mr. Market too long to realize that it was valuing Wendy’s portion of the business too pessimistically pre spin-off. Wendy’s shares began inching up almost immediately after the split. The script is playing out almost to perfection. The Baja chain has been jettisoned and Wendy’s has announced a $1 billion share buyback program including a recently completed Durtch auction to vacuum up 19% of outstanding shares. Thank you very much. If management can execute its turnaround strategy from here, shares should have another 30% upside from here.

Sears Capital LP

OK, so that entity doesn’t really exist. At least I don’t think it does. But Sears Holdings (Nasdaq: SHLD) does. I first wrote about Sears and Eddie Lampert in October 2005. The stock is up about 50% since then and may not be the bargain it was back then. But it’s too early to bail.

Mr. Lampert has kept his word and emphasized profitability over top-line growth (sales are declining) while adding to his cash pile. As predicted, Mr. Lampert is also beginning to take advantage of the freedom he has been given by the Board to use the cash for acquisitions and investments as he sees fit. Last week’s earnings announcement showed a handsome profit from Mr. Lampert’s investment activities using fancy, albeit risky, derivates known as total-return swaps. It is still early in the game and I would venture to bet that Mr. Lampert is looking to make a more substantial move. I am not sure if I believe rumors that he has been sniffing for an acquisition with potential targets being companies like Anheuser-Busch (NYSE: BUD) and Home Depot (NYSE: HD). No matter. Over the past 18 years he has proven to be a worthy investor, perhaps, dare I say, as good as Mr. Buffett. This ride may be bumpy but I think patience will be richly rewarded in the long-term.

Wednesday, November 01, 2006

3 and 30

Mr. Buffett: "Why do you charge 2 and 20?"
Hedge fund manager: "Because I can't get 3 and 30."

Warren Buffett, recounting a conversation with a hedge fund manager

The Dow surpassed 12,000 a few weeks back without the fanfare one may have expected. The hoopla surrounding Dow 10,000 was curiously absent this time around. The recent advance seems orderly and justified.

Still, some are partying hard, maybe too hard, on Wall Street these days. The $1.2 trillion hedge fund industry and the $1 trillion private equity folks are going bananas. The Hedgies are making fancy trades and the Barbarians are accepting lower returns while loading on the debt. Where this will all end is anybody’s guess.

To be sure there are signs that the system is beginning to cleanse itself. The recent implosion of various high profile hedge funds may be the beginning. Amaranth went down in flames playing around with natural gas and others are closing shop, taking a break or getting hammered by placing wrong bets on bonds and direction of interest rates. How people expect to consistently return 20% or 30% or 50% to their investors in beyond me when some of the best investors of our time have been happy beating the market by a handful of percentage points over time. It amazes me when people tell me such and such hedge fund is up 50% year to date. At that rate, the fund manager should displace Mr. Gates on the Forbes richest people in the world in no time. Brace yourselves.

I recently finished reading Adam Smith’s (George J.W. Goodman) Supermoney. I wish I had read this book before the .com bubble burst. The environment of the late 60s was eerily similar to the late 90s. Companies with negligible or nonexistent earnings were going public and trading at crazy multiples. Money managers were promising outsized returns. The accumulation of supercurrency – stocks and options – was the name of the Game. It all ended badly with the 1973 – 1974 bear market. In a July 1999 Book Review article in the New York Times Mr. Smith wrote:

Within living memory, a billion dollars was real money. We can see why - if not when - our own trillion-dollar bubble will pop: even though the Internet itself will grow as a mighty force, if the market will give a billion-dollar value to a two-year-old company losing money, then the efforts of a diligent populace will be put to creating such companies, until the supply of those companies overwhelms the demand for them. The seasons turn and all the rivers flow into the sea. We read these histories and we know the ending. Yet such is the intensity and excitement of manias that they never lack for participants.

Good call indeed. Incidentally, Supermoney has the distinction of being the first book to introduce Mr. Buffett to the world. At the time, Benjamin Graham had approached Mr. Smith to work on a new edition of The Intelligent Investor which led Mr. Smith to visit a so-called Warren Buffett in Omaha, Nebraska. Isolated from the frenzy of Wall Street, we get a first glimpse into Mr. Buffett’s disposition. Smith writes:

A leading investment manager of a billion dollar fund had delivered himself of a statement that money management was a full-time job, not only week by week and day by day; “Securities must be studied on a minute by minute program.”

“Wow!” Warren wrote. “This sort of stuff makes me feel guilty when I go out for a Pepsi.”

It gets better. Perhaps not surprisingly, the teachings of Benjamin Graham were in question by the hotshot money managers of the time. Mr. Buffett’s response in a letter to Smith:

“Graham’s teachings,” he wrote, “have made a number of people rich, and it is difficult to find any cases where those teachings have made anyone poor. There are not many men you can say that about.”

We all know who has had the last laugh some 25 years later!

All of which brings us back to the Hedgies and the Barbarians. I don’t know how all this will end. To be sure, the markets seem to be absorbing the shocks quite well. The Amaranth news barely put a dent in the market and other hedge funds are undeterred. And word is that the private equity players really know what they are doing this time around. But it all makes me uneasy. The Game we play in pursuit of supercurrency is taking place in a continuously evolving arena and is all about accumulation of wealth. To play the Game right, you must take advantage of the follies of Mr. Market and you must have a long-term contrarian perspective on things without getting caught up in the emotional roller coaster of the moment. In the meantime, in the words of Adam Smith, “If you are still for the Game, why, may you prosper; I wish you the joys of it.”