Fifty Percent Losses

The Not So "Perfect" Storm

2007-08-09T07:30:00.000-07:00

In finance there is a group of people who tend to think they are just too smart and too well educated for everyone else. A lot of these guys run "quant" funds, investment funds that essentially trade using fancy formulas. There is a certain arrogance in thinking that a computer can understand markets in ways that humans cannot. Unfortunately for our quantitatively minded friends, sometimes humans do things their models don't anticipate.

This week Goldman Sachs is defending their Global Alpha fund. Global Alpha is one of the biggest, and probably the most famous quant fund in the world. While its track record is impressive, in recent years returns have been tepid as the models the fund uses have lost some of their horse power.

This year Global Alpha is down 16% after losing 8% in July. According to the Journal, the humans who run Global Alpha have stepped in and begun selling the riskiest positions in the fund, positions the model still likes. One has to wonder what the future holds for Global Alpha when the humans begin over ruling the computers. Officially Goldman is denying rumors that they are liquidating the fund, but if they admitted liquidating the fund, other traders would immediately take the opposite positions and crush the fund.

The Journal also quotes Keith Campbell, head of his own eponymous quant fund (which is down 10-12%). Cambell falls back on the "perfect storm" excuse. It is amazing how many "perfect storms" there are today, in fact the "perfect storm" seems to be so routine that I think we should just start calling them "storms".

Today it seems that any time two bad things happen at close to the same time we have a "perfect storm". The real situation may just be that Mr. Campbell's trading model isn't very good or very well designed. It would be difficult for anyone to admit that you aren't as smart as you think you are, and not as good at computer programming as you told your clients you were.
It seems like a lot of these models incorporate sunny days 365 days a year, which makes even a small shower look like "the perfect storm".

Greedy When Others are Fearful...

2007-08-01T12:32:00.000-07:00

I'm certainly not an expert on finding the bottom, but I think i can see value when it is presented to me. So, on a day with the S&P down a percent and in a week where it just seems like everyone is ready to crack, let me throw out a few names that I think you buy an forget for a while.

PCAR - I love this company. Some of the best brands in heavy trucks. The EPA put new emissions requirements in effect this January, which prompted a huge pre-buy during 2006. there is another cycle coming in 2009 and Paccar will benefit. The stock has fallen back into a range where you can feel good buying it. At 16.5 times trough earnings, a nice dividend yield and a ton of cash on the balance sheet, this is a stock you could own through some price volatility.

USG -- First off, I know, I have liked this stock for along time and for the past couple of months it has gone in one direction, down. The company is tied closely to residential housing and that makes it toxic waste in today's market. However it is also cheap and very well run. USG recently bought a building product distributor in California, is improving the quality and efficiency of its plants, and has cash on the balance sheet to make timely acquisitions.

The stock is tipping towards $40 per share, which means that today you can buy it for less than I did, and less than Warren Buffett did.

BAC - Everyone is worried about "liquidity" and thus has sold off the financials. Bank of America has a undersized mortgage division and continues to grind out growth by attracting new customers every day, every week, every month. At less than 10 times earnings and a dividend yield of 5.4% (44 bps above the 10 year treasury) you can sleep at night knowing that every quarter a check is in the mail.

(Correction: in the time it took to type this the S&P went from down 1% to up 1%, welcome back price volatility)

Q: When is a Buyback not Really a Buyback?

2007-07-24T13:40:00.000-07:00

A: When you cancel 80% of it because you don't have the cash and don't have a prayer of borrowing it.

"Expedia Inc. said Monday it is slashing the number of shares in its planned buyback by 80% due to a lack of acceptable funding, sending shares down 8.3% to $26.90 in early trading. On June 19, Expedia said it intends to repurchase up to 116.7 million shares (approximately 42% of common stock) at a price range of $27.50-$30.00, giving shares their biggest boost since the company went public in July 2005. Under the amended offer, Expedia now says it only willing to purchase up to 25 million shares (about 9% of the total outstanding) at the same price range, to expire August 8. "While we remain confident in Expedia's long-term prospects and will continue to be net buyers of our shares, the terms available to us in the current debt market environment were simply unacceptable," said chairman Barry Diller."

2 To Watch Today

2007-07-18T12:06:00.000-07:00

PFE -- down 4% today on a quarterly report that contained bad news about their biggest drug, Lipitor. The stock sports a P/E under 12 and a dividend yield of 4.65%. The patent on Lipitor will expire in 2010, the main fear that overhangs the stock. Assuming reasonable growth of the rest of the business and loss of 40% of EPS due to Lipitor in 2010, if you believe that post Lipitor the stock can trade for a P/E of 20, the stock is a screaming buy at $22 and looks pretty good at $25 today.

UNP -- Railroad CSX reported strong pricing this morning and the stock is up considerably today. UNP is cheaper and has more old contracts left to reprice, it report tomorrow and I wouldn't be surprised if the stock jumped tomorrow.

Blackstone Shares Fall

2007-06-28T06:53:00.001-07:00

Blackstone Group's share price is now below its IPO price of $31. The shares, which shot up to $38 following the company's IPO can now be bought for $30, 3% lower than price the shares were sold to the public at.

While four trading days isn't really that significant, if I had just taken the other side of a trade with some of the shrewdest investors in the world, I would be very uncomfortable when the price of those shares falls, I might begin to think someone had outsmarted me.

Lunch With Buffett -- $265,000

2007-06-26T13:34:00.000-07:00

Every year Warren Buffett auctions off the opportunity to join him for lunch. The proceeds from the auction benefit Glide, a San Francisco charity that Buffett supports.

This afternoon, the lunch is going for $265,100.

2007-06-26T07:58:00.000-07:00

John Mauldin previews Paul McCulley's new book in his letter this week. Overall, I think it sounds like a great book, but this excerpt really stood out:

"There is nothing investors can do about the potential deficit problem now. It is often true in investing that even when you anticipate a problem correctly, there is not much you can do about it in advance, if most investors have decided not to worry about it for now. In fact, acting too early can be a big mistake. So, in the case of budget deficits, it will have to be wait and see, and be ready to act."

While the specific example of budget deficits (and bond yields) is true, I think this applies to a lot of issues. While many people argue that markets fully discount all future events, I don't think that is really true. Life is really a long curved road, and I think markets often only discount around the first turn, they aren't very good at thinking two turns ahead, meaning that prices can easily go up or down more than someone with perfect knowledge (or even a reasonably good guess) about the long term would expect.

Calling All Lawyers

2007-06-25T09:27:00.000-07:00

Davita's (the country's number two kidney dialysis company) CIO was interviewed in today's Journal about his time working on the front lines at one of the company's dialysis centers. The company is one of many that is trying to get top execs some experience working in front line positions to learn more about their employees and customers.

While this generally seems like a good idea, it may not work so well in the medical field, and regardless of what field you are in you don't want management saying anything like this (emphasis added):

"The immersion experience prompts changes far from the clinic floor. Harlan Cleaver, DaVita's chief information officer, felt terrified when dialysis-machine alarms sounded during his clinic work -- even though a technician was nearby. "I didn't have a clue what I was doing but I had [the patient's] life in my hands," Mr. Cleaver recollects.

After the program, Mr. Cleaver accelerated plans to extend the training period for new analysts on the company's computer help desk, and lowered his expectations of productivity from such new hires. Before Reality 101, he notes, "I never really realized how incompetent entry-level people are when they start their jobs."

Who is On the Other Side

2007-06-22T11:03:00.000-07:00

This morning the Blackstone Group, a well known and respected private equity firm, went public. The shares are currently trading up 16% from the IPO price. I don't think I can improve on what the Daily Reckoning has to say about it, so here it is:

"On the surface, it makes no sense. Why would the smartest investors on the planet want to share their gains with the unwashed multitudes? If they can make so much money in private equity why would they want to go public? The only reasonable answer is the obvious one: The Masters of the Universe believe their own shares are overpriced.

Even more remarkable, here are the same schleps whom Blackstone commonly outsmarts lining up to be suckered again. Today's FT tells us that the IPO is already six times oversubscribed, despite Senate action that threatens to double the firm's tax bill beginning in 2012. The poor boobs think they are going to put one over on Blackstone. For isn't that the real nature of this transaction? The world's most successful insiders are on one side of the table; the world's most naïve public market investors are on the other. Who's going to get the better end of the bargain?"

$10 DSL = ???

2007-06-19T09:17:00.000-07:00

From Seeking Alpha:

"AT&T is now offering DSL internet service for $10/month, something it is apparently trying to keep secret. The cheap broadband, which offers download speeds of 768 kbps and upload speeds of 128 kbps, was part of AT&T's deal with the FCC when it acquired BellSouth in December for $86 billion."

Not too long ago DSL was the telecom answer to price competition. AT&T and Verizon spent a ton of money to build the capacity to offer DSL, now I can't imagine the ROI they are earning on that investment at $10 per month.

China Reduces Holdings of US Treasuries

2007-06-18T09:25:00.000-07:00

From Merrill:

"That’s right. Friday’s TIC data showed China selling on net $5.8 billion of its Treasury holdings, the largest outside of a $10 billion decline in June 1997 and the first outright sale since Oct 2005. This will further add to concerns that the Chinese, and in particular the PBOC, will noticeably diversify their reserve holdings."

Be careful what you ask for, if you don't want the Chinese to manage their currency, then they don't need to buy as many Treasury Bonds, and that means rates go up in the US.

"Meltdown"

2007-06-15T07:29:00.000-07:00

From the WSJ:

"The situation got worse last week when Treasury bond yields, on which the loans are based, shot up.

"It's going to bring the price of real estate down," says Gary Mozer, principal with George Smith Partners, a Los Angeles-based commercial real-estate finance firm. The "meltdown" in the CMBS market, as Mr. Mozer calls it, has caused a "sea change" in the amount that real-estate investors can borrow. "People can't pay as much for property because they can't get as much positive leverage," he says.

Mr. Mozer estimates borrowers can get 20% to 30% less than they could have eight weeks ago.

"I've had lenders walk away from the table," he says. "I have an institutional client, one of the largest REITs, that was at the table with a lender for a $230 million deal. The lender walked away and gave back the deposit, saying if they closed, they would lose $20 million. Keep in mind, this client borrows $6 billion a year overall. So that says a lot. The whole market is in upheaval," he says."

“Fixing Our Reputation Daily.”

2007-06-07T20:59:00.000-07:00

Wow.

Ford took the top honors in JD Powers annual initial quality survey. Ford, Lincoln, Mercury and Jaguar all made the top 10 for initial quality. This is a big deal for an American car maker whose products have a reputation for, well, let's just say they don't have a reputation for being Toyota. Based on the results of the survey, that might be a good thing for once.

For all of the recent news about who is buying what part of what auto maker and who owns shares of whom, this is the best sign for a turn around for a US auto maker. Ford has been running ads highlighting how the Focus sedan does better in consumer surveys than the Accord of Camry, now Ford comes in at number one for initial quality.

Could Detroit be on a new run?

Now on Sale: Risk

2007-06-07T08:11:00.000-07:00

Yesterday US 10 year treasury bond yields fell back below 5%, ending the day at 4.97%. The recent rise in bond yields, coupled with the recent rise in the S&P 500 has brought the earnings yield on the S&P to within 58 basis points of the 10 year treasury.

At the start of the day, the S&P 500 was trading at a P/E of 18.01, in other words a 5.55% earnings yield. The "Fed." model holds that the earnings yield on stocks should equal the 10 year treasury, and thus the earnings yield falling below the 10-year would indicate that the stock market is (on average) overvalued.

AAA corporate bonds are trading at a yield of 5.65%, and Baa (lower quality) bonds are yielding 6.59%, spreads of 68 and 162 basis points over the 10-year.

I think it is safe to say that investors aren't asking for much of a premium to take on substantially more risk than the 10-year.

"Investors Yawned"

2007-06-03T20:02:00.000-07:00

Fortune's Adam Lashinsky has a great article about how Rich Kinder made a boat load of money taking his company, Kinder Morgan, Inc., private.

One of the hottest questions in investing circles is the role of private equity. In my mind one of the biggest things private equity has in its favor is that ownership by a single entity, or small group of entities, removes a big part of the "agency" issue. Most public companies are run by management teams answering to weak boards with little interest in the company and primarily owned by institutional investors who manage money for the actual owners of the company. Most funds take little interest in the actual management of the company and typically outsource most voting decisions, primarily to a company called ISS. In other words, there are typically three layers of "agent" in between the investor and the company, private equity only deals with one level of "agent."

On excerpt from Lashshinsky's article that highlights this problem:

"In February, Kinder had personally informed investors that a planned megaproject, the $4.4 billion Rockies Express pipeline under construction in Colorado and Wyoming, was fully booked for customers. That meant the Kinder Morgan empire was virtually assured of fat profits from the project. Still, investors yawned, and the weak response was all an aggressive investment banker needed to set the buyout wheels in motion."

It is probably accurate to substitute "Wall Street Analysts and Big Mutual Funds" every time "investor" shows up in that sentence. Also, you could add "Private Equity (and Rich Kinder) ate the lunch of the index hugging funds that couldn't or wouldn't buy Kinder Morgan stock." at the end.

Fewer Specialists = Problems for ETFs

2007-06-01T07:57:00.000-07:00

Seeking Alpha (following up on a Journal article) reports having fewer specialists at the NYSE is creating problems for new ETFs:

"Over the past year, specialists on the NYSE have declined by over 30% as floor traders are phased out in deference to electronically cleared trading. Exchange traded funds [ETFs], which resemble mutual funds but trade on the open market like stocks, use seed capital to create shares (usually between 100,000 and 500,000) so that the ETF can begin trading with a big enough float to keep flow liquid. As recently as two years ago, specialists were offering ETF firms $50 million to seed promising ETFs.

"Now, many ETFs are launching with as little as $3 million, making them unattractive to institutional investors who need the ability to move in and out of large share blocks with minimal slippage.

"Case in point: In late 2006, Claymore MacroShares Oil Up and Down Tradeable Shares, which track crude oil prices, were hit with an unusually large order, causing share prices to fluctuate to over 10% premiums and discounts to its net asset value."

Les Schwab Passes Away

2007-05-28T11:59:00.001-07:00

I'm about ten days late on this one:

"When Les Schwab died May 18 at 89, the company he founded from scratch in 1952 had annual sales topping $1.6 billion and 7,700 employees."

"Chief Executive Dick Borgman reaffirmed the company's commitment to running the business the way its namesake did.

"Les had very clear principles about how he wanted the business to operate," he said in an e-mail exchange with The Oregonian. "The best way to ensure continuation of those principles is for the family to retain ownership of the company."

It could be a tricky transition, since both of Schwab's children have died.

His wife of more than 70 years, Dorothy, and four adult grandchildren survive him. All are on Schwab Tire's board. Borgman said they, and he, will rely on the traditions that built the business to carry it forward.

"I plan to continue Les's unrelenting focus on providing world class customer service through extensive employee training and continued employee profit-sharing programs," said Borgman, a longtime Schwab Tire executive named CEO in December.

Schwab shared yearly profits from each store with its managers and staff. That helped produce employees who worked like race car pit crews, rushing out to greet customers on arrival.

Schwab Tire promoted exclusively from within, creating a consistent corporate culture across 410 tire stores in eight states, from Alaska to Utah.

2007-05-24T06:31:00.000-07:00

John Dugan, the Comptroller of the Currency (who is responsible for regulating multi-state banks) has made some tough statements about the need to restrict "stated income" mortgages, also know as "liar loans"

"But, what may be suitable in limited circumstances has now become acceptable as
general practice. For subprime loans, stated income has become the rule rather than the
exception, and in a very brief span of time. While this practice was relatively rare just a few
years ago, last year nearly 50 percent of all subprime loans relied on stated income."

"Art"

2007-05-22T06:16:00.000-07:00

The Daily Reckoning continues to tie it all together, people with too much money doing silly things with it:

"Of course, Blackstone couldn't do this unless there were plenty of people
with plenty of money to throw around on this sort of stuff. We have not
only more evidence of that in today's news...we also have an explanation.

For the evidence, we have a report from last week's art sales - that hit
new records of absurdity. Can you imagine paying $70 million for one of
Andy Warhol's slick inventions? Well, someone did. And others spent
millions more on other works of art. How did they know they were valuable
works of art...and not just silly pieces of pop trash? Ah...ah...ah...how
did they know these objects had VALUE...and not merely prices?
Ah...ah...ah..."

Time for a Diet

2007-05-21T08:34:00.000-07:00

John Mauldin shows us where inflation lives:

"Few people I know slice and dice the details in the data better than good friend Greg Weldon (www.weldononline.com). Let's look at some of the tidbits he found buried in the CPI data.

Food at home prices (different than restaurants) are rising at a three-month rate of over 8.6%, up from only 0.8% in January. Alcoholic beverages (!) are up 7.1% on a three-month basis versus 2% in January (bad news for bud Art Cashin and the Friends of Fermentation at the NYSE). Ditto for meat, poultry, fish, and eggs at 10.1%! Overall, the three-month rate for CPI food has spiked to 6.4% since being at 2.1% in January.

For most of the country, food and energy are at the core of our expenses. When we spend more on food and energy, we have less to spend on other goods and services."

USG in Barron's

2007-05-21T06:40:00.000-07:00

Barron's has a good article about USG this week:

"Building for the Future by Dimitra Defotis

Summary: Wallboard maker USG Corp. (USG) emerged from asbestos litigation-induced bankruptcy last year just as the housing market peaked. From $11.05 in 2005, USG hopes to make $2/share in 2007-8. While USG's share price halved commensurately to $48, other builder suppliers like American Standard (ASD), Masco (MAS) and Owens-Corning (OC) have weathered the housing slump better because USG is so strongly identified with wallboard. Gypsum market demand should fall 10% this year, and y/y prices were down 9%; USG controls 30% of the industry. Yet diversification efforts have made just 45% of USG's $5.8 billion revenues derive from new homes; the rest comes from sturdier residential remodeling (15%) and commercial construction (40%) markets. USG invested $900 million+ in faster production facilities, expanded product lines, and reduced wallboard output 20% to stem price declines -- but also used the drop in prices to acquire businesses like a lower-cost Mexican manufacturer and L&W Supply distributors. Warren Buffett's Berkshire Hathaway believes in USG's value; it owns 17% and counting. Barron's Bottom Line: Bulls say when the housing market turns EPS could triple, doubling shares back up to $90."

Everyone Feels Invincible

2007-05-18T08:14:00.000-07:00

According to Merrill:

" In a speech in Europe last week Bank of America CEO Lewis, after celebrating his firm's ability to arrange large, complex financial transactions added in response to a question later: "We are close to a time when we'll look back and say we did some stupid things…We need a little more sanity in a period in which everyone feels invincible and thinks this is different."

"Zaitech"

2007-05-15T09:07:00.000-07:00

Economist Ed Yardini adds an important new risk to his risk list:

"(3--new item) “Zaitech” (Financial Engineering): The concern is that abundant and cheap credit is fueling the private equity bonfire. More than five years into the current economic expansion, company balance sheets are becoming increasingly leveraged with debt. This is bound to exacerbate the next recession, which will eventually occur.

Larry Fink, BlackRock’s chief, told the FT (4/26) that “[l]enders to highly indebted companies are making the same mistakes that undermined the US subprime mortgage market.” So the leveraged loan market is likely to become “tomorrow’s problem.” According to the WSJ (3/31), “covenant-lite” loans--with few provisions that protect debtholders--are increasing rapidly. High-yield loan lending rose 65% to a record $216 billion in Q1, as leveraged buyouts fueled the demand for such financing. Reuters reported that loans without any “maintenance financial covenants,” which restrict the amount of additional debt that is permitted, reached a record $29 billion in the last quarter. This is a relatively small amount, but may be a harbinger of much more Zaitech ahead. This is more likely to keep the economic boom and equity bull market going for now than to lead to an imminent bust. More than $4 trillion in M&A deals occurred in 2006. By early May of this year, there were already over $2 trillion. April was the busiest month in history for such deals.

KU APM Wins RISE Award

2007-05-14T09:14:00.000-07:00

KU's Applied Portfolio Management class recently took first place in the Hybrid portfolio class at New York's RISE completion.

APM allows KU students to manage a portfolio of real investments. The students in the class research, write up and make buy and sell decisions for the portfolio, which over time, has produced outstanding returns.

Diamond in the Rough

2007-04-29T15:34:00.000-07:00

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

2007-04-26T14:25:00.000-07:00

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

2007-04-25T08:42:00.000-07:00

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

2007-04-24T07:17:00.000-07:00

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

2007-04-23T12:33:00.000-07:00

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

2007-04-20T09:13:00.000-07:00

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?

2007-04-20T07:33:00.000-07:00

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

2007-04-11T11:56:00.000-07:00

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

2007-04-10T12:54:00.000-07:00

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"

2007-04-01T21:18:00.000-07:00

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."

Back in the Game

2007-03-23T07:37:00.000-07:00

Yesterday the Shanghai "A" share market hit a new high, taking it above the previous peak, hit before the market dropped 8% in late February igniting a world wide equity sell off.

Apparently, after taking a few weeks to re-evaluate their positions, investors are back in the game in China.

"Never Get Into and Argument With a Fool..."

2007-03-18T11:44:00.000-07:00

"Never get into an argument with a fool, people from a distance may have trouble deciding who is who"

In today's Daily Reckoning Bill Bonner explains the fallout of sub-prime defaults:

"Until only a few months ago, the constant welling up of house prices gave
them some traction. When a sad-sack subprime buyer gave up and defaulted,
the lenders, and the lenders to the lenders, and the lenders to the
lenders to the lenders, could still tread confidently, secure in the
knowledge that they could sell the shacks and get their money back - and
more.

"What they didn’t seem to realize was what seemed most obvious - that house
prices wouldn’t go up forever. Indeed, some day they might even go down.
And when they went down, lenders would have neither a strong borrower to
make payments, nor decent collateral to sell, nor even a buyer with any
money to sell it to."

The problem is that originators allowed fools to buy houses they couldn't afford at prices that no reasonable man would pay by borrowing money from banks at interest rates that didn't compensate for risk. The banks would only loan at those rates because they knew they could repackage the loans and sell them at even LOWER rates to investors.

The release valve was the fact that they could resell the house to some greater fool at an even more ridiculous price if the first fool defaulted on the note. The problem is that when a lot of the original fools start to default investors start getting worried and ask for higher rates and more documentation. Well at higher rates, and if you actually make the borrower disclose their true financial status (things sensible people have demanded all along) then suddenly it gets very difficult to put all the pieces in place for a fool to buy a house he can't afford and an insane price. If fools can't buy at high prices, suddenly you can't resell a highly priced home that really doesn't have the features or location that would cause a sensible person to pay a high price.

So with the fools out of the equation all you have left are serious investors who will only buy homes and bonds at reasonable prices. This breaks the virtuous circle of higher prices and lower standards, in fact it breaks it twice.

Back to the fundamentals, a reasonable decision making process based on the facts and not on unreasonable hope that the future will be totally different from the past. Nobody wants to buy a shack for $500,000 and nobody wants to lend hundreds of thousands of dollars to a deadbeat who won't show you his pay stub or credit card balance, imagine that.

USG to Sell Additional Stock

2007-03-14T10:26:00.000-07:00

According to Forbes, USG is planning to sell an additional 7.9 million shares, increasing the share count by almost 9%.

The majority of the proceeds will be used to fund the $280 million acquisition of California Wholesale Material Supply, Inc. by USG subsidiary L&W supply.

At first look, I don't like this decision at all. USG stock is significantly undervalued, the company reported significant cash on the balance sheet at the end of the quarter, and by my estimation the company appears able to take on additional debt.

However I haven't read the covenants on USG's existing debt very closely, so perhaps they are more limited in their ability to sell debt than I thought. Hopefully USG management believes they are getting such a good deal for CALPLY that they are justified in selling the company's undervalued shares to raise the cash they need.

USG remains a core holding.

Bad News on ARM Mortgages

2007-03-14T10:10:00.000-07:00

While much of the mortgage news over the last few days has focused on the sub-prime and "low doc" loans, rumors are beginning to circulate about rising default rates on adjustable rate mortgages (ARMs).

While much of this talk may be just be the type of rumour that spreads when an investment starts to get the type of news flow sub primes have earned over the past few days, that won't keep investors from selling the product.

Apparently big banks have cut or are in the process of cutting, the lines of credit originators use to fund loans before they sell them to investors. At the same time many of these banks are trying to force originators to buy back many of the mortgages issued over the past few months that have any kind of late pay. The result is a liquidity squeeze that is killing mortgage originators.

"Poor people have a lot of ingenuity."

2007-03-14T08:54:00.000-07:00

Apparently this is how slum lords are justifying their business:

"Mr. Barnes says he's giving such buyers what may be their only shots at home ownership. Low-income people, he says, generally know how to recognize and fix flaws. "Poor people know how to install a hot-water heater and they know how to paint" and even how to fix a foundation, he says. "Poor people have a lot of ingenuity."

Last September, Ola Gorby, a 35-year-old mother of four who works evenings cleaning offices, put $500 down and agreed to pay $400 a month for 15 years -- about $34,000, before interest -- for a home in Martins Ferry, Ohio. Public records show the house previously sold, in October 2003, for $44,000, then went into foreclosure in 2006 before being acquired by one of Mr. Barnes's investors for $7,875.

Ms. Gorby says she used to pay $470 a month for a three-bedroom apartment, and that banks had told her she didn't have a strong enough credit record to qualify for a home loan.

Her new place needs work. Duct tape covers a hole where a front-door lock was removed. Ms. Gorby had to replace some water pipes that had been stolen, and a bedroom wall needs patching. But she says she's happy with the home, which she figures is generally in good shape."

Flaw #135

2007-03-11T20:23:00.000-07:00

Niall Ferguson identifies yet another flaw in the system of relative performance measurement in this week's Barron's:

"Ferguson acknowledges this. "If we all get caught in a 1914-style crisis, we all go down together and nobody will underperform the benchmark," he says. "But if I become pessimistic too early and I'm wrong, I definitely will underperform. Therefore it's better to consign a major geopolitical crisis to the realm of uncertainty, and treat it like the risk of an asteroid hitting the earth. Common sense tells us that a major war is much more likely than an asteroid, or indeed the melting of the polar ice caps. But there are incentives for investors and financial professionals to ignore the risk of crises.""

If You Are Looking for Opportunity...

2007-03-09T08:57:00.000-08:00

Many investors, notably proponents of fundamentally weighted indexing, contend that index funds that follow capitalization weighted indexes systematically put more money into over valued stocks and systematically under invest in undervalued stocks.

Additionally many investors believe that small cap stocks are inherently not as efficiently priced due to the fact that they garner less sell side research coverage and less investor interest in general

With that in mind:

"According to research from Prudential Equity Group LLC, three ETFs that track small-company stock indexes now account for 20% to 40% of the trading of certain smaller stocks in the popular Russell 2000 small-cap index. The three ETFs are Barclays Global Investors' iShares Russell 2000 Index Fund, iShares Russell 2000 Value Index Fund and iShares Russell 2000 Growth Index Fund." (Source WSJ)

USG Write Up

2007-03-08T08:12:00.001-08:00

I recently completed a discount cash flow analysis of USG. Many of you may know that Berkshire Hathaway owns 19% of USG, which was the catalyst that triggered by initial interest (and purchase of USG last year).

At the time I did a quick DCF and determined that USG was almost 20% undervalued. The recent release of USG's 10K provided a good opportunity to review my DCF and revise my write up.

The stock was also the subject of a presentation by Whitney Tilson at last fall's Value Investor Conference in New York. Tilson's enthusiasm surpasses mine, primarily due to the fact that my valuation model prices in a large decline in the gypsum wallboard market due to a decline in housing construction that Tilson's USG model does not.

That's right, USG's primary product is Sheetrock, the top wallboard brand in the world and the biggest use of that product (45% of revenue) goes into new home construction and yes, new home construction is going to be weak. However the fear this decline inspires in investors, coupled with USG's messy financial statements (due to a recent asbestos and bankruptcy settlement) have lead to a cheap price for the stock, so cheap that I am willing to tough out a housing decline.

Take a look at my write up and model and let me know your thoughts, USG is currently my largest stock holding and I'm interested in feedback.

USG Write Up

USG Valuation Model

Timothy Burger
timothyburger(at) gmail.com

What a Difference a Week Makes

2007-03-04T15:15:00.000-08:00

According to Barron's Up and Down Wall Street Column:

"Nothing better illustrates how vivid an impression Tuesday made on ordinary Janes and Joes than the marked change in their sentiment as registered by the American Association of Individual Investors: to 39.6% bearish and 36.6% bullish, from 53.9% bullish and 22.3% bearish the previous week."

Best Job Ever

2007-03-02T07:50:00.001-08:00

Warren Buffett has announced he will be hiring an understudy to learn from him and eventually take over as CIO of Berkshire:

From the recently released Berkshire Annual Letter to Shareholders:

"I have told you that Berkshire has three outstanding candidates to replace me as CEO and that the Board knows exactly who should take over if I should die tonight. Each of the three is much younger than I. The directors believe it’s important that my successor have the prospect of a long tenure. Frankly, we are not as well-prepared on the investment side of our business. There’s a history here: At one time, Charlie was my potential replacement for investing, and more recently Lou Simpson has filled that slot. Lou is a top-notch investor with an outstanding long-term record of managing GEICO’s equity portfolio. But he is only six years younger than I. If I were to die soon, he would fill in magnificently for a short period. For the long-term, though, we need a different answer.

At our October board meeting, we discussed that subject fully. And we emerged with a plan,which I will carry out with the help of Charlie and Lou. Under this plan, I intend to hire a younger man or woman with the potential to manage a very large portfolio, who we hope will succeed me as Berkshire’s chief investment officer when the need for someone to do that arises. As part of the selection process, we may in fact take on several candidates.

Picking the right person(s) will not be an easy task. It’s not hard, of course, to find smart people, among them individuals who have impressive investment records. But there is far more to successful long term investing than brains and performance that has recently been good.

Over time, markets will do extraordinary, even bizarre, things. A single, big mistake could wipe out a long string of successes. We therefore need someone genetically programmed to recognize and avoid serious risks, including those never before encountered. Certain perils that lurk in investment strategies cannot be spotted by use of the models commonly employed today by financial institutions.

Temperament is also important. Independent thinking, emotional stability, and a keen understanding of both human and institutional behavior is vital to long-term investment success. I’ve seen a lot of very smart people who have lacked these virtues.

Finally, we have a special problem to consider: our ability to keep the person we hire. Being able to list Berkshire on a resume would materially enhance the marketability of an investment manager. We will need, therefore, to be sure we can retain our choice, even though he or she could leave and make much more money elsewhere.

Washington Post Net Income Down

2007-03-01T06:51:00.000-08:00

Today the Washington Post announced a plunge in net income:

(From Seeking Alpha)

"Another quarter, another decline in revenue at the Washington Post's print media division. The Post reported a net income loss of 6.7% in its most recent quarter as continued weakness at its newspaper and magazine publishing divisions hurt strong results in other segments.

"Revenue at its educational division which includes the Kaplan Test Preparatory service rose 18% (43% of total revenue) while revenue from its affiliated cable television channels grew by 14%.

"On the other hand, revenue from newspaper (Washington Post) and magazine (Newsweek) publishing fell 2% and 3% respectively. Post shares fell $3.24, or 0.42%, to $766 on the earnings report. In other news, the company set its regular quarterly dividend at $2.05 a share."

As a current Kaplan customer and former Newsweek subscriber, I can attest that there is a big difference between the two. The difference is that Kaplan is focused on the core needs of its clients (passing tests) and does that well. A few years ago Newsweek decided that its customers (who subscribed to a news magazine) were probably more interested in having a smart ass celebrity infotainment magazine mailed to them every week rather than a magazine about news. I'm sure that a lot of other people like me canceled their subscription to "News"week.

Unfortunately now the infotainment trend is in full force, much of the space that isn't taken up by ads in the Journal is filled with silly cartoons, pictures and graphs a la USA Today. The typical reason given is that the papers are trying to "update" to compete with online news sources.

Ironically, if you look at most news, politics or finance sites on the Internet they have a smaller percent of their overall space filled with ads and probably have fewer silly graphics than most major papers.

Instead these sites have...text...news...analysis, you know, the things people used to read NEWS papers for.

The simple fact is that most people are kind of stupid and would rather look at a cartoon or a picture of Paris Hilton than read anything. It is a tough sell to convince those people to pay for a newspaper, because no matter how many graphs you have, you can't compete with US Weekly or TMZ.com of that is what people are looking for.

For many years the Journal's circulation numbers held strong because they didn't play the USA Today game. While people canceled Newsweek and their local Knight Ridder paper, they kept their Journal subscription because every day they could count on five columns of hard news text and one column of feature on the front page and a whole lot of news in the middle. Now the Journal has shrunk the paper, cut a column and made 75% of the paper colorful ads, not what they typical Journal reader is looking for.

The Post's number's today were bad, and the sad thing is that nobody in the media is going to learn anything from them.

"Margin of Safety" Summary

2007-02-28T08:32:00.000-08:00

A good summary of Seth Klarman's (now out of print) Margin of Safety is now available through the Motley Fool.

Close to the Top in Mining?

2007-02-22T09:30:00.000-08:00

From today's Journal:

"Now, after several years of hefty profits, shareholders are pressuring mining companies to show they have projects in the pipeline to sustain growth over the next decade.

At the same time, banks and other providers of capital are becoming more comfortable financing mining ventures, including higher-risk projects developed by lesser-known "junior" companies. These include outfits like Nautilus Minerals Inc., a Vancouver, British Columbia, company that said it has raised $300 million for a project to mine gold and copper from the ocean floor near Papua New Guinea, with backing from several major mining houses.

"It almost seems at the moment, if you have a piece of paper that has an outline for a project, you can" get money, said Mark Tyler, head of mining and resources at Nedbank Group Ltd., a South African bank.

Chrysler's Rounding Error

2007-02-21T08:17:00.000-08:00

According to Merill Lynch Chrysler's liabilities for pension and retiree health care is $52.5 billion.

The company's equity is estimated to be worth $6.5-9, if it were split off of DCX. Add on the traditional debt and you have some serious leverage.

Inflation is Dead (Except for Food)

2007-02-19T10:30:00.000-08:00

Last week Chairman Bernanke testified that inflation generally appears contained, but that the Fed. remains vigilant.

This is good news, especially if you noticed Hormel's quarterly earnings call, Hormel expects higher grain costs:

"will continue to burden our turkey operation, and we are working hard to find ways to offset this extra expense, including through advances in pricing," said CEO Jeff Ettinger.

Corn costs driving up turkey costs, sounds a lot like the seed of inflation to me.

Oil at $30?

2007-02-15T07:49:00.000-08:00

From Bloomberg:

"Oil will drop more than 30 percent to $40 a barrel in March and may drop to $30 as rising prices for storing crude lead to a `breaking point' that forces speculators to sell, Sanford C. Bernstein & Co. said.

""As storage fills up, storage costs rise and the contango widens,'' the analysts said in a February report. ``At some point, investors will reallocate money away from the commodity funds, causing futures prices to fall.''

"The ``breaking point'' could come in March if Saudi Arabia, OPEC's largest producer, fails to cut production below 8 million barrels per day, the level needed to keep the market balanced, the Bernstein analysts said. Spare capacity would rise, widening the contango and driving investors out. "

Even Good Managers Have Bad Years

2007-02-12T09:50:00.000-08:00

With the end of Bill Miller's highly publicized streak of beating the S&P 500 coming to an end at the end of 2006 (as well as a bad year for Bill Gross and about 80% of active managers), this is a good time to think about when investors should consider selling a mutual fund.

Litman / Gregory recently did a study of mutual fund manager under performance during long term periods of superior performance, a study referenced in Nick Murray's most recent column in Financial Advisor. Their results are compelling if not totally surprising. Litman finds that at least 93% of large cap managers who beat the index by 1% or more over a 10 year period will out under perform the index by 2% or more over a three year period during their 10 year run of superior performance. Furthermore, 64% will have a three year period where they trail 5% on an average annualized basis, very bad numbers to say the least.

Let me make those figures easier to read: even the best managers will do poorly over significant periods of time on their way to great performance records.

The lesson is simple; investing is like all human endeavors and results can be lumpy and irregular more often than they are neat and consistent. According to the study's authors the three year periods of under performance are often created by one bad year that is not immediately corrected by great performance in the following year.

This study rebuts the idea that investors need to (or pay someone to) closely "watch" their funds for index under performance and sell funds that lag over short time periods. This is a common marketing point for advisors who believe that they can earn better performance by selling funds after short periods of under performance.

The reality is that, like most things in life, good manager selection probably has more to do with understanding the people and philosophy of a firm than on what they have produced in the last day, month, or quarter. If investors spent more time getting to know the people who manage their money they would probably own fewer funds and have less anxiety when they trail some random benchmark, longer holding periods would be the result which would mean less in taxes and better overall performance.

What Qualifies as a "Win"

2007-02-09T07:41:00.000-08:00

The FT erroneously reported yesterday that Blackstone had won the bidding for Equity Office Properties, a large REIT.

In reality Vornado won the bidding by dropping out, now Blackstone will have to pay the $39 billion it bid for EOP. Equity Office owns office buildings and profits from people renting those offices. Currently EOP has just over $26 billion of real estate on its books, less depreciation $22 billion. While these buildings could be on the books for substantially less than what they are really worth, the deal prices them as if they were worth 50% more than their book value.

The company trades at a 66 P/e ratio and at a dividend yield of only 2.38%, that means that at the price of $39 billion, these properties are going to provide less income than Blackstone could have earned by investing in Treasuries. That means that in a tough real estate market with rising interest rates, Blackstone has a huge bet on the price appreciation of these buildings, quite a win indeed.

Defense Spending Strong, Will Remain Strong

2007-02-05T14:43:00.000-08:00

According to General David Baker (Ret.)

“The Chief of Staff of the United States Army, General Schoomaker, has said that his biggest costs don’t start until the last bullet is fired in Iraq. That drops a few jaws when I get into conversations with people about this subject, but resetting the forces and giving the Marines back all the equipment they loaned the Army is indeed very expensive, and that’s going to continue”

General Dynamics is the Army’s top supplier for armored vehicles and should benefit from increased equipment spending. While GD certainly isn't the cheapest stock in the defense sector, it is uniquely positioned from the needs of the US military

E-T-F'd

2007-02-04T11:19:00.000-08:00

This weekend's Journal reports on the rational and well thought out way individual investors are using Exchange traded Funds (ETFs) to add a lot of juice to their portfolio. Now I love ETFs, they are a great way to get easy, transparent access to defined market segments, unfortunately they also allow poorly informed speculators to make silly bets on parts of the market they know little about.

Media consultant Steve Sox shares that since his mutual funds weren't "doing anything" he built a portfolio of EFTs all by himself now he "easily" outperforms market indexes. Since most ETFs track a market index, I have a feeling Steve may be taking on a little more risk than the indexes he is so easily outperforming.

Retired consultant Stan Zawrontny shares that he has committed nearly one third of his assets to a set of ETFs that focus on emerging market countries like Brazil. He tells us that "I didn't like the returns that mutual funds were getting." so he chose to carefully and rationally evaluate the geopolitical environment, inflation and economic growth scenarios and buy an ETF that tracks the market in Singapore.

While I think it is amazing that people like these guys who appear to have no related education or experience can make such complex decisions, it is good to see that the individual investor has once again found a way to beat out all of those stupid fund managers who you know, study investments all day.

In an unrelated note, Barron's also reports that margin debt hit an all time high last week, passing its previous high set in March 2000.

Looking at history and common sense, I recommend investors rush into the market immediately, preferably by buying into a sector of the stock market that they know little about but that seems like it will yield high returns.

Spend, Spend, Spend

2007-02-02T09:01:00.000-08:00

From Seeking Alpha:

"The Commerce Department reported yesterday that Americans had a 2006 savings rate of -1% -- not only did they on average spend everything they earned, but also dipped into their savings or borrowed money to finance their spending.

2005 savings were -0.4%; this year's figure is the worst since the -1.5% figure of 1933, in the midst of the Great Depression. The rate has now been in negative territory for 21 straight months; 2005-06 is the only the second time it's ever been negative, the other being 1932-33.

Economists have various theories to explain the current lack of savings, from over-reliance on a strong economy/home equity to a consumerist mentality that drives people to spend even when they can't afford. In other figures released yesterday, consumer spending rose 0.7% and incomes rose 0.5%, both in line with forecasts. The Institute for Supply Management said its benchmark index came in at 49.3 last month, down from December's 51.4; anything below 50 is considered contracting. From the Department of Labor, initial unemployment claims were down 20k to 307,000, pushing them to their lowest level in a year.

Not So Fast on the Housing Recovery

2007-02-01T09:13:00.000-08:00

According to Merrill Lynch:

"Housing market affordability is not only still more than 20% below the norm, but is actually deteriorating again: the NAR's affordability index receded to 109.2 in December from 110.7 in November, ending a string of four monthly improvements in a row. This, even with continued income growth and lower home prices -- the culprit was the backup in mortgage rates."

Food vs. Fuel Round 1

2007-01-28T10:36:00.000-08:00

As Americans turn to corn based ethanol to supplement their need to consume oil the corn demand created by ethanol distillers is beginning to drive up the price of corn. This may not seem like a big deal today, but in the near future it is reasonable to expect rising corn prices (which literally feeds into beef, pork and chicken prices) to force us to make a choice: food or fuel.

In rich societies like the U.S. and Western Europe it is easy to write off the higher cost of food in the name of the environment (or more accurately in the name of high discretionary resource consumption). This is not as easy in the rest of the world where the price of food is an important factor in regards to your ability to feed yourself.

This trend is a positive for fertilizer manufacturers and farm equipment manufactures like Deere, but a major negative for the people who will have trouble providing food for their families due to ethanol consumption.

From the Washington Post:

"Poor Mexicans get more than 40 percent of their protein from tortillas, according to Amanda Gálvez, a nutrition expert at the National Autonomous University of Mexico.

"The tortilla-making process, Gálvez said, releases antioxidants and niacin, which allows them to be absorbed by the body, and the membranes on each corn kernel provide important dietary fiber. As a result of eating tortillas, Mexican children have a very low incidence of rickets, a bone disease caused by calcium deficiency that is common in developing countries.

"It is absolutely crucial for our population to keep eating tortillas," Gálvez said.

Gálvez said she believes the price increase is already steering Mexicans toward less nutritious foods. The typical Mexican family of four consumes about one kilo -- 2.2 pounds -- of tortillas each day. In some areas of Mexico, the price per kilo has risen from 63 cents a year ago to between $1.36 and $1.81 earlier this month.

With a minimum wage of $4.60 a day, Mexican families with one wage earner have been faced in recent months with the choice of having to spend as much as a third of their income on tortillas -- or eating less or switching to cheaper alternatives.

Many poor Mexicans, Gálvez said, have been substituting cheap instant noodles, which often sell for as little as 27 cents a cup and are loaded with less nutritious starch and sodium.

"In the short term, the people who can buy food are going to get fatter," she said. "For the poor, the effect is going to be hunger."

There is almost universal consensus in Mexico that higher demand for ethanol is at the root of price increases for corn and tortillas.

Many poor Mexicans, Gálvez said, have been substituting cheap instant noodles, which often sell for as little as 27 cents a cup and are loaded with less nutritious starch and sodium.

"In the short term, the people who can buy food are going to get fatter," she said. "For the poor, the effect is going to be hunger."

There is almost universal consensus in Mexico that higher demand for ethanol is at the root of price increases for corn and tortillas."

Higher Food Prices On the Way

2007-01-17T07:21:00.000-08:00

The USDA recently announced that corn reserves stood at 750 million bushels at the end of 2006 and are expected to decline to 519 million by the 2007. At this level the US has less than one month of corn in reserve.

The primary culprit is surging corn consumption by ethanol producers. During 2007 ethanol is expected to consume almost 23% of US corn consumption. The tight supply of corn is expected to drive up corn prices, bad for ethanol producers, and really bad for people who use corn for other things, like food.

Unfortunately corn yields are declining at the same time corn consumption is rising. yield per acre dropped from 151.2 bushels per acre to 149 bu/acre.

The one upside to rising corn prices is increased farm incomes, which should eventually lead to better machinery sales for companies like Deere and better fertilizer sales as farmers try to raise falling yields in the face of rising corn prices.

ROIC Rick, ROIC

2007-01-14T11:55:00.000-08:00

If you are thinking about buying GM read this first:

"General Motors CEO Rick Wagoner was upbeat on a conference call with investors yesterday outlining his plan for further recovery at the world's largest automaker in 2007 and beyond. While maintaining GM's policy of not providing specific financial guidance, the company plans to address the 8% decline in U.S. vehicle sales last year by increasing capital spending to between $8.5 and $9 billion in 2007 and 2008 after spending less than $8 billion in 2005 and 2006."

So the idea is put more money into a company that seems to be burning through cash like no other. So you would expect something good to come of that right?

"Still, with all the hype being created by Wagoner about how successful 2006 was for the company, GM does not expect to begin generating more cash than it spends in the coming year."

In my opinion Wagoner's record at GM is mixed. He has instituted a slew of turn around plans, but as far as I can tell, has failed to turn the company around.

(original article can be found at Seeking Alpha)

The Virtue of a Mess

2007-01-09T10:01:00.000-08:00

Jerry Marks at AutoRetailStocks.com has such a great post today that I decided to share (steal) it (via Seeking Alpha).

“If a cluttered desk is a sign of a cluttered mind, of what then, is an empty desk?”

-Albert Einstein quoted in the book “A Perfect Mess” by Eric Abrahamson and David Freedman

Beginning with the right frame of mind (remembering there is a cost to every return) when you think about all of the news coming out of the Detroit Auto Show

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

It was really interesting watching CNBC’s reporter Phil LeBeau interview a lot of the heads of the major automakers yesterday. But before I get into what the industry leaders said, I wanted to begin with a question. Why do we spend the bulk of our time (as investors) analyzing the return, and very little time focused on the investment?

Go back and read the question again. Because the point that I am making is perhaps one of the most overlooked aspects of investing. And it filters into every facet of our lives. Remember investing is merely the allocation of resources, most noteworthy being people’s time and abilities.

For example, this morning, I began with a quote from a book called “A Perfect Mess.” The book basically talks about how people fail to measure the cost of not being messy. You heard me right, some dudes wrote a book about why it is advantageous to be messy (and I bought the book.) Now I’m not ready to completely buy into the premise that things are better messy and unorganized (although I’m pretty good at making a mess.)

But the authors make a good point. Life is messy and unorganized, so why should we try to put order to said disorder? I’d add, instead, people can thrive by developing the best ways to adapt to this mess and disorder versus trying to put order to it (different from chaos theory.) But maybe this is a little deep for a Tuesday morning at the beginning of the year.

The bottom line is that with any (and everything) in this world, there is a cost. Most of us simply look at the return. The result, that is. Being organized, having a clean desk at work, getting tons of sales, etc., are all simply examples of returns that are a result of some investment. And this is what I am trying to point out. We often forget the costs involved in generating this return (like a clean desk.) Here’s an excerpt from the book that I think is pretty revealing:

“Izsak (President of the National Association of Professional Organizers) says he can prove organizing pays off with a little demonstration he likes to throw into his presentations. In this demonstration he takes two decks of cards, one shuffled and one ordered by suit and rank, and gives each to a different person. He then calls out the names of four cards and the two deck-holders race to find the cards. Naturally, the person with the ordered deck always wins handily.

But who puts the neat deck in order? A little experimenting with people of modest card dexterity shows that on average it takes 140 seconds to order a deck, plus another 16 seconds to find four cards in the ordered deck for a total of 156 seconds; it takes about 35 seconds to find four cards in an unsorted deck.

One could argue that you only have to order the deck once, and then you can find the cards more quickly many times. But in that case, you also need to account for the time it takes to replace the four cards in an ordered deck, about 16 seconds – with cards, as with most things in life, it requires repeated effort to maintain order – compared to the fraction of a second it takes to stick four cards anywhere in an unordered deck.

Thus with a pre-ordered deck, it takes 32 seconds to find and replace four cards, versus 36 seconds with a shuffled deck, giving the pre-ordered deck a 4-second advantage. But since it requires 140 seconds to order the deck, taking that trouble wouldn’t pay off unless you need to repeat the task at least 35 times, and you’re meticulous about maintaining the deck’s order between each attempt. In real life, decks tend to get shuffled sooner or later, requiring 140 seconds each time to restore order.”

And so it is with our investments as well. Whether it is getting organized, investing in a new point of sale system, new technologies (like the Ford Sync,) or even new vehicles/vehicle lines (like the GM Volt,) there is an investment (cost) required at the outset. Oh yeah, and those pesky maintenance costs need to be kept in mind also.

Don’t get me wrong, I am a big fan of better systems and processes, new product development, and just in general investing in making things better. But there is a cost to every return, and this is what I want you to keep in mind as you see new concepts, technologies, products, and strategies, being introduced this week at the auto show.

And to kick off the auto show, CNBC’s reporter Phil LeBeau interviewed many of the heads of the major automakers yesterday. So below is my quick take from Toyota, Ford, GM, and Chrysler automaker heads comments in the CNBC interviews

Toyota’s Jim Press: “We want to be #1 with the customer"

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Toyota’s President of the North America’s (Jim Press) most aptly (just a cooler way to say appropriately) addressed the concept of recognizing there is a cost to every investment when he was being interview by CNBC reporter Phil LeBeau. During the interview he said sales are merely the result of investments into things like quality. And this is why they don’t benchmark themselves against the competition, or becoming #1 in the market (share.) Mr. Press said it best: “We want to be #1 with the customer.”

I actually don’t care if they benchmark themselves against the competition or not (and I have a feeling they do keep a close eye on those stats,) it was his answer about wanting to be #1 with the customer, not #1 in the market that impressed me most. Sound familiar to one of my emails from last year? I said sales are not 1%, 10% or whatever figure of a marketing campaign you put in place, a sale is either 100% or 0%. What matters is the product or service is relevant and important to the customer you sold the product or service to.

Ford’s Alan Mullaly: Delivering what customers want with minimum resources (does Mercury remain?)

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One industry leader that seems keenly attune to the competition (particularly Toyota) is Ford’s new CEO Alan Mullaly. Apparently he has been getting some “heat” for his rather public admiration of Toyota Motor Company. In the interview, CNBC reporter Phil LeBeau asked Mr. Mullaly about this and Mr. Mullaly said: “Ford can learn a lot from Toyota’s focus on delivering what customers want with minimum resources.”

It is not that I am necessarily encouraged that Mr. Mulally feels he needs to look outside his own company to become a better player in the market (I don’t care where it comes from,) but I like his reason being resource maximization. Remember, it is not just the return you are getting, it is the investment (or resource) you are putting in to get said return.

So I was particularly encouraged to hear Mr. Mulally say they will “continue to evaluate portfolio of brands and product development within brand,” when asked about whether they may jettison the Mercury brand or some other brand that is not generating attractive returns. His reasoning? “Because clearly a focus and consistency of purpose and to be able to invest more in each one of products you believe in, so we will continue to look at that.” Is the quote I copied down after clicking replay some 15 times on CNBC.com.

GM’s Rick Wagoner: “We can do both” (profits and #1 market share) I give his answer a D minus

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The CEO that didn’t seem to get it? Quite frankly was Rick Wagoner (GM’s CEO.) I have to give him a “D minus.” Don’t get me wrong, I think Mr. Wagoner has done some tremendous things in pushing the company to right size its cost structure. I am simply saying that given the emphasis and premise I encouraged above, Mr. Wagoner did a poor job in answering Mr. Lebeau’s questions. And I am specifically referring to when he was asked if Mr. Wagoner could trade being #1 for being profitable, would he take it? Mr. Wagoner’s answer: “think we can do both. . . We’re not ready to give up anything.”

The correct answer (in my opinion,) is like Mr. Press said that you want to be #1 with the customer (share doesn’t matter,) and that you want to allocate your resources most efficiently (maximizing your shareholders returns.)

Chrysler’s Tom LaSorda: “I am on the hotseat” Most candor in an interview award

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Finally, the industry leader that gets the award for the best candor was Tom LaSorda (head of the Chrysler Group.) Most of the interview was pretty straightforward as he discussed things like Chrysler’s goal to maintain its leadership position in the Minivan segment (with something like 34% to 35% of the market.)

But things got interesting toward the end of the interview. CNBC’s reporter Phil LeBeau really doesn’t seem afraid to ask the tough questions (as I would expect from a fellow WLTL alum.) So he wasn’t about to let Mr. LaSorda away without asking a really important: “are you still going to be CEO in 2007/2008?” What impressed me was Mr. LaSorda’s answer. He said “I am very confident I will still be CEO. . .But I am on the hotseat. Any CEO that did not deliver on the numbers is in the hot seat.” He went on to say that the company had some issues in 2006, like dealer relations, but that they are working to fix those issues.

You can say all you want about Tom LaSorda (and I have heard and read some of the comments.) In a world where management teams cry about gas prices and just about everything else under the sun when things go wrong, I think Mr. LaSorda deserves some props for bringing a new concept in industry leadership: accepting responsibility for missing the mark.

Value Destruction and Financial Reporting

2007-01-08T12:20:00.000-08:00

John Graham and Harvey Campbell recently published a paper titled "Value Destruction and Financial Reporting Decisions" the highlight:

"Our results show that the destruction of shareholder value through legal means is pervasive, if not a routine way of doing business. Indeed, we assert that the amount of value destroyed by firms striving to hit earnings targets exceeds the value lost in these high profile fraud cases."

The Superstar Economy

2006-02-08T21:17:00.000-08:00

Timothy Burger has a good series started about the changing structure of compensation in the economy. Check out the Superstar Economy.

Welcome to Fifty Percent Losses

2005-12-28T10:47:00.000-08:00

Welcome to Fifty Percent Losses, a blog dedicated to compliance departments and financial marketers.

The impetus for creating this site is the founder's impending employment with a great company whose compliance department will surely not allow him to continue writing under his own name, thus he is starting a new webpage under anonymous authorship to satisfy the requirements he knows are coming.

The name comes out of contempt for financial advertising and naming traditions. It is customary to name your fund or company something grand (The Stable Return Fund), something relating to finance (Pure Alpha) something in your backyard (The Iron Rock Creek Fund) or something grand from mythology (The New Romulus Fund). All of the good names have been taken, leaving silly names that are really a stretch, so I picked one that nobody else would: Fifty Percent Losses. The name insures that only people interested in reading what I have to say will be reading, thinking people who will gladly get past the ridiculous title.