Diamond in the Rough

Whitney Tilson mentioned a really interesting article in his latest e-mail. I wanted to make sure you took a look at it.

The Washington Post had Joshua Bell, one of the best violinists in the world, play in a Washington Metro station at rush hour and then discussed the results with various experts. The reaction from people passing by in very interesting,

I thought the thought of one of the curators of the national gallery of art was the most interesting. Essentially he says that if he put most masterpieces in a restaurant instead of a gallery people wouldn't pay attention to them, people need a frame to understand beauty, people have difficulty evaluating things outside of the context they expect to find them in.

For people who work in an industry where people don't think the "five dollar bill on the street" exists, it is interesting to note that only only five or six people out of over a thousand noticed a master playing in their midst, and one of them was a child whose mother moved him on.

http://www.washingtonpost.com/wp-dyn/content/article/2007/04/04/AR2007040401721.html

The Taste of Crow in the Morning

For the past couple of days I have been on Steve Jobs for ripping off his shareholders by backdating options.

Yesterday Apple announced blow out quarterly numbers (which I have never doubted) and the stock jumped almost 10% after hours. The guy may be kind of a crook, but apparently people like the stuff his company makes.

Long term the high P/E (30 times forward) and the loss of Jobs may crush the stock, but for today, AAPL is a big money maker and I get to eat some fine Spring Crow.

Whoops

Looks like Steve Jobs might not be so innocent after all:

"Apple Inc.'s former chief financial officer, in a striking public statement, asserted that Chief Executive Steve Jobs misled him about board actions on stock-options awards, and that he told Mr. Jobs the company might have to take a charge against earnings if it backdated stock-options grants -- a charge it didn't take."

What, Me Worry

According to the Journal the SEC has determined that two Apple employees decided to backdate Steve Jobs' stock options all on their own.

"Apple Inc.'s former chief financial officer Fred Anderson has settled with the Securities and Exchange Commission on his alleged participation in the backdating of stock options at the computer maker and the agency is expected to pursue a civil lawsuit against the company's ex-general counsel Nancy Heinen on similar charges, according to people familiar with the matter.

Ms. Heinen, who will be accused of helping to manipulate one of her own option awards as well as a grant to Steve Jobs, the company's chief executive, plans to contest the charges, these people say."

In fact Jobs didn't notice, although he did "suggest favorable dates"

"In December, after the completion of its internal probe, Apple cleared Mr. Jobs of any misconduct, saying he was unaware of the accounting implications of backdated grants and didn't financially benefit from them because he never exercised his options. The company did say, however, that Mr. Jobs recommended "favorable" dates for some stock-option awards."

Right.

How Correlated Are Global Markets

A key tenant of modern portfolio theory is that the ownership of a portfolio assets, even risky assets, with low correlations between them can reduce portfolio risk. The basic idea is that you want Asset B to go up when Asset A goes down and vice versa so your overall return profile is smooth. One of the key asset classes US investors use to diversify portfolios is International Equities.

By some measures the correlation between US markets and Non-US Equity markets are declining:

"During the two-year period that ended in February, correlation between U.S. and other developed markets was 0.63, according to ING Asset Management. That is a big decline from 2003 to 2005, when they practically moved in lockstep, at 0.93. (The figures are based on monthly movements in the Standard & Poor's 500-stock index and the Morgan Stanley Capital International EAFE indexes.)

So far this year U.S. markets have held up well. But foreign markets are doing even better. The Dow Jones World Index, excluding the U.S., is up 8.5% this year in dollar terms, compared with 3.9% for the S&P 500."

However, there is also anecdotal evidence that the economies of the US and other nations may be even more linked than official measures indicate:

"That's because home construction is the principal gateway industry for immigrants entering the U.S. labor market. Those immigrants contribute the lion's share of the estimated $50 billion in cash sent annually from the U.S. to family members and others in countries south of the border. That tide of cash appears to be ebbing.

"Monthly remittances from the U.S. to Mexico have dropped every month since their peak of $2.6 billion in May 2006 -- shortly before new-home construction in the U.S. plunged. In February 2007, the latest month for which data are available, remittances to Mexico had slowed to $1.7 billion.

"Mexico, Latin America's remittance leader, may be a leading indicator of a trend unfolding across the continent. In a recent study of 15 Latin American economies tracked by BCP Securities of Greenwich, Conn., all but three showed better than a 90% correlation between the ebb and flow of U.S. housing starts and the swelling and shrinkage of remittances as recorded by the nations' central banks.

"The contraction in remittances will dampen domestic consumption and hamper [economic] growth rates" in countries ranging from Mexico to Colombia to those in Central America, said the study's author, BCP Securities economist Walter Molano."

HRB to Sell Option One

Last year I wrote up H&R Block with the basic thesis that the company's tax business alone is worth about $21 per share and that while the other business lines (investment services, corporate tax, mortgage) are difficult to value, they are worth something.

Today, Cerebus Capital validated my thesis by agreeing to buy HRB's Option One Mortgage for about $900 million, or $2.79 per share, meaning that the value is approximately $900 million more than last night's stock price implied.

Today the stock is up about $.80 per share, implying that there is still more upside to today's price of $22.61. I sold my HRB shares towards the end of 2006, but if I owned them today I think I would be willing to sell at about $24 and walk away.

Miracle?

Guy Sorman has a great article about the edge of the China miracle in today's Wall Street Journal:

"Will China's surging economic growth end the rumbling discontent? Not according to the esteemed economist Mao Yushi, under house arrest for asking the government to apologize for the 1989 Tiananmen Square massacre. He doesn't trust the Party's claims of a 10% annual growth rate -- and why believe the official statistics when the Party lies so consistently about everything? Doing his own calculations, he arrives at a rate of about 8% per year, vigorous but no "miracle," as some in the West describe it.

"Moreover, he believes that the current growth rate isn't sustainable: natural bottlenecks -- scarcity of energy, raw materials, and especially water -- will get in the way. Also, Mr. Mao says, the fact that investment decisions frequently obey political considerations instead of the market has helped generate an unemployment rate that is likely closer to 20% than to the officially acknowledged 3.5%."

"Because China's economy desperately needs Western consumers and investors, China's propagandists do all they can to woo foreign critics. "Do you dare deny China's success story, her social stability, economic growth, cultural renaissance and international restraint?" one Party-sponsored scholar asks me in Paris. I respond that political and religious oppression, censorship, entrenched rural poverty, family-planning excesses and rampant corruption are just as real as economic growth in today's China. "What you are saying is true, but affects only a minority yet to benefit from reforms," he asserts.

Yet nothing guarantees that this so-called minority -- one billion people! -- will integrate with modern China. It is just as possible that it will remain poor, since it has no say in determining its fate, even as Party members get richer. The scholar underscores my fundamental assumption: "You don't have any confidence in the Party's ability to resolve the pertinent issues you have raised.""

Housing in Decline

From today's Journal, new evidence that the housing market may be weaker than believed:

"D.R. Horton Inc., the nation's largest home builder by number of units, said its second-quarter orders fell 37%, an indication that the crucial spring home-selling season is proving to be weaker than many builders had hoped.

"The company said it had orders for 9,983 homes in the quarter ended March 31, compared with 15,771 homes a year earlier. The dollar value of those orders was $2.6 billion, down from $4.4 billion a year earlier...

"Orders in all geographic regions declined in the fiscal second quarter. California posted the sharpest drop, declining 59% to 1,107 homes. Orders in the Southeast fell 30%, in the South Central region orders dropped 34% and in the Southwest slid 39%. The West was down 28%. The Northeast had the smallest decline, down 21%.

Horton, based in Fort Worth, Texas, is the latest builder to report that the usually strong spring-selling season has gotten off to a slow start. Its deteriorating orders come amid a tightening of mortgage-lending standards and a softening of home prices in many markets.

Last week, Dominion Homes Inc. reported a 54% drop in homes sold during the first quarter. The Dublin, Ohio, company sold 218 homes in the first quarter, for a total sales value of $43.5 million, down from 475 homes, or $89.3 million, a year earlier."

Buffett Buys 10% of BNI

A lot of commentators have focused on the fact that Buffett's Burlington Northern purchase is at a market P/E instead of at a discount.

The second half of the story are the tremendous economics of BNI's business. Burlington Northern and Union Pacific are the two major rails west of the Mississippi and form a pricing duopoly that insures little price competition. Additionally, Burlington Northern's biggest product is inter modal freight, with much of that coming from West Coast ports.

BNI has done a good job of improving the speed and efficiency of its network over the past few years and is now probably the best run railroad.

Based on the quality of the business, it is worth more, and thus Buffett's purchase doesn't look so pricey after all.

Technically, that's not "Analysis"

Charles Ellis has a nice review of the new edition of "A Random Wall Down Wall Street" in this week's Barron's.

The highlight (and possibly best part of the book):

"Devastating to technicians, Malkiel patiently exposes all the main concepts and techniques of the chartists to sunlight. None survive. Ever the pragmatic realist, he reminds us that while technicians don't make money for investors, they do make money for the stockbrokers who employ them and advertise their "skill" to us."