Compounding Life

At CGI Las Vegas I listened to presentation by John Del Vecchio from Ranger Alternatives. John manages the Ranger short book and has a strong background in accounting forensics. Specifically finding companies with low earnings quality before the market does and building “short” positions based on that information.

In his presentation he referenced some stats from a Blackstar Funds paper on the Russell 3000 index between years 1983-2006.

Russell 3000 stats 1983-2006

39% of stocks were unprofitable investments

18.5% of stocks lost at least 75% of their value

64% of stocks underperformed the Russell 3000

25% of stocks were responsible for all of the market’s gains

Well obviously an enterprising investor after reading this would be diligently researching looking for the %25. If you only invest in those companies you are sure to outperform the market. Well not always…

What a difference a day makes

The paper also gives us a sampling of some of the best performing stocks during that time period and their performance after the peak:

Thoughts

It would be interesting to see of the %25 that made up %100 of the gain in 1983-2006, how many companies would still be worth owning today. Looking at that list there are a couple. Of course there are some that would have resulted in a permanent loss of capital and some that are not permanent losses yet but for which the immediate future is not bright. Lets take a quick look at a couple…

GE

If you had bought GE on 01/03/83 at its closing price of 91.75, split adjusted (48:1) each share would be worth around $670 today. I figure thats about %8.3 compounded annual gain. If you had sold that share before the market drop you would have approximately 3x that amount somewhere around %12.5 compounded annually. Not including dividend payments. While GE is a mess today, its fair to say you could of done worse things than buying a share of GE in 1983.

MSFT

If you had bought MSFT when they went public on 03/13/86 at $28, split adjusted (288:1) each share would be worth around $8000 today. Around %29.3 compounded annually. Not including dividend payments.

Conclusion

This data reinforces a couple of points that I sometimes temporarily forget.

1. If you own a sub par company because it was undervalued when you bought it, sell it when it reaches intrinsic value and take your profit. There is no reason to hold it afterwards because it is likely to fall into the %64 that under perform the market. If you sell it and move on to the next value you will be on your way to out performing the market.

2. Paying a little bit of a premium for a a great business with a great moat and great management can pay off big time.

3. I think people should really call “buy and hold” “due diligence, buy and due diligence hold, rinse repeat”.

Heading to Vegas today for Complete Growth Investor. If you are going to be there send me an email or DM on twitter so we can meet up.

The past year has been an interesting one thats for sure. I started seriously investing in August of 2008, meaning I started managing my own investments in stocks and bonds where as previously I had only invested in employer retirement accounts with some choices limited to a few funds.

It has been exciting times since then and while I really wish I had started earlier, to be honest I feel very lucky to have started in a time when stocks are cheap and Mr. Market is manic.

I figured I would disclose a few of the positions I have which have done pretty well. Of course I also have some positions which have been flat or lost value to date, but the gains out pace the losses and I think in the long run most of the losers will be winners.

Value Vision (VVTV): Multiple entries with an average price of $0.563
Current gain of 428.27%

I initially discovered VVTV by reading OldSchoolValue, there was some concern about the off balance sheet commitments they had which no longer made it a net-net, but the stock was so beaten down that I actually increased my position even after that news. So far that has paid off but Value Vision is far from out of the woods. I have been seriously considering exiting this position lately.

Ford Preferred Series S (F.PR.S or F-S): Purchase price of $6.17 current gain of 353.91%

These are shares of a trust that holds Ford bonds. While they are preferred shares, the shares are of the trust not Ford. So in the event of liquidation you are essentially a bond holder. The coupon is 6.5% on $50 face value. The coupon payment is in arrears, meaning they are currently not paying it and previous coupon payments are owed with interest. Who ever holds the shares when they pay the owed coupons will get all payments regardless of how long you have owned it. Upon maturity (2032) the holder would get face value $50. When I first found these they were trading at $4 a share but I had already invested all my excess cash. By the time I was ready they were up to about $6.
I decided I would stop buying if the price went over $10 which it did very quickly after it was obvious Ford was not going bankrupt in the near future. Today they are trading at $29 which is little over 0.50 cents on the dollar.

There is some discussion going on about diversification at Oldschoolvalue a site that I read regularly. Like most things investment related you can find opinions telling you to do almost anything. Buffett is known historically as a non diversified investor, meaning a generous amount of his capital are tied up in small number of investments. Does that mean you should have a concentrated portfolio? Here are Buffet’s thoughts he delivered to an MBA class.

If you are not a professional investor, if your goal is not to manage money in such a way to get signifigantly better return than the rest of the world, then I believe in extreme diversification. I believe that maybe 98, 99 or maybe more than 99 percent of people who invest should extensively diversifiy and not trade. So that leads them to an index fund type of decision with very low cost. Because all they are going to do is own a part of America and they have made a decision that owning part of America is worth while. I don’t quarel with that at all and that is the way they should approach it… Unless they want to bring an intensity to the game and make a decision to start evaluating businesses. Once your in the business of evaluating businesses and you decide that you are going to bring the effort and intensity… and time involved to get that job done, Then I think that diversification is a terrible mistake…

If you really know businesses you probably shouldn’t own more than six of them, if you can identify six wonderfull businesses , that is all the diversification you need. You are going to make alot of money and I guarantee you that going into a 7th one instead of putting more money into your first one has got to be a terrible mistake. Very few people have gotten rich on their 7th best idea, but alot of people have gotten rich on their best idea.

But to quote Buffett again…

A public-opinion poll is no substitute for thought.

Regardless of what experts or friends say. Ultimately you have to decide whats best for you. You are the one that has to sleep at night with your investment decisions.

Paul Graham is well known in the start up world, probably not as much in the value investor world. Paul has a bunch of great essays on his site. One that I really enjoy is “How to do what you love” .

While they are all good this post was inspired by reading “How to Fund a Startup”. I think this essay is very informative on a couple of different levels.

Value investors are generally not interested in Initial Public Offerings of startups, for good reasons. I still think its important though to understand the process that most startups go through in their quest to get acquired or go public. Not to say that either of those two are the goal of all startups but in a lot of cases that is the exit plan. Its also interesting to note just how early on the differences between company managers and investors start to manifest. Of course in these early stages the founders usually do have a major stake so they are of course shareholders as well but not always “investors” meaning they do not have as much capital in play.

A great quote from the essay:

I don’t mean to suggest that our investors were nothing but a drag on us. They were helpful in negotiating deals, for example. I mean more that conflicts with investors are particularly nasty. Competitors punch you in the jaw, but investors have you by the balls.

I find this comical because in a lot of cases after the company has gone public and the original investors have cashed out the tables can be turned rather quickly to a situation where people running the company can have the investors “by the balls”.

Burlington Northern Santa Fe has been getting some attention because Buffet has been steadily increasing his position. This past week another  purchase of approximately 4 million shares was reported:

NATIONAL INDEMNITY CO  10% owner 1,800,000 $62.19 $1.11946E8 7.1889E7

NATIONAL INDEMNITY CO  10% owner 681,000        $63.43 $4.31969E7 7.257E7

NATIONAL INDEMNITY CO  10% owner 1,882,000 $61.65 $1.16031E8 7.4452E7

It should be noted that National Indemnity is a Berkshire Hathaway company.  It’s an Omaha based insurance company that Buffet purchased on behalf of Berkshire. If memory serves correct I believe this was one of first insurance companies he purchased and hence the beginning of his “float”  investing career.  The story of Buffett and National Indemnity is covered in some detail in “The Snowball” which I would highly reccomend reading.

The only reason I bring this up is because when reading information about insider purchases and sales you have to keep in mind that it might not always be clear who is purchasing the stock. In this case someone not familiar with Berkshire and it’s history of  buying BNI stock might not realize who is actually making the purchase.  As far as insider information goes InsiderCrow is the best site I have found so far for that info but please let me know if you have any others you use. Insider filings are available from the SEC site, but the search functionality on InsiderCrow is far better.

Back to BNI. Well I think there are two major things to consider:

1. Rail is the cheapest way to move goods across the country. When people start spending money again and gas prices work their way back up (both of which will happen eventually, nay sayers be damned) railroads will be in high demand.

2. Moat. This is a no brainer. When it come to moats railroads have it locked down. The threat to their competitive advantage (Moat) is that a cheaper way to move goods comes along.  

Riding on Coattails

Warren Buffett has talked about “riding on coattails”. Well here is a situation where it may be possible to ride on his.  We know what Berkshire has paid for all of its BNI stock.  So we can come up with an idea of what he considers to be a “fair” price. One thing to keep in mind is that in some cases he bought the stock on “puts” which means he collected a premium for taking on the obligation to buy the stock at a certain price.  In these cases he technically paid less than the price reported because that does not reflect the discount for the premium. 

With recent purchases its obvious he thinks its a good deal in the low 60’s and coincidentally it has also recently hit its 52 week low. But am I saying mimic what he does blindly? No.

 The thing I like about this situation is that I can research BNI on my own, come up with my own valuation for the stock, my own opinion and then compare it to someone elses. This someone else just happens to be far more knowledgable then I am. I am not saying buy a stock just because Buffet buys it.

In alot of cases Buffet gets deals that we can’t. With GE and GS he got high interest perferred shares with lots of consequences in his favor. Those are unique and should not be read as “Buffet is buying GE stock!”. While he is technically buying GE stock he is getting alot more reward and protection than anyone buying their common stock. In this case he is buying BNI common stock without any special deals.  

Risks and other thoughts

There are some things to take in consideration when looking at BNI from the perspective of a personal investor:

1. Buffett has to make large investments. There are great companies selling for great prices right now, alot that will probably make you more money than BNI but they are too small for large investors. This is where you have an advantage over Buffet. BNI is a good long term play but for someone who is not managing billions of dollars there are probably better oportunities. 

2. Buyout. It is possible that Buffett is working his way to a complete purchase of BNI for Berkshire Hathaway. If this happens sooner rather than later you will not get the same return and if it were to happen within a year of your purchase date you could pay higher taxes on your gains. Keep in mind there has been no talk of a buyout, but I think its something to consider. 

Personal thoughts

As I mentioned in a previous post, I look at investing as far more than a vehicle for income. I personally like BNI because I live in South Seattle close to alot of rail activity so I constantly get a personal real life view of my holdings and I derive much joy from that.

Alot of people look at investing primarily as a vehicle for making money.  I on the other hand enjoy researching companies and finding stocks to buy its an interesting activity that also has the potential for financial reward. Having a passionate interest in stocks and companies is key to investing in my opinion. If you don’t posses that then you are probably better off buying an index fund or sticking your money in a safe interest earning account.  Buying something on a tip from a friend or based on market trends to make some easy money is like walking into a casino. You have no knowledge about where your money is really going, you are just interested in turning a profit.  Furthermore without this passionate interest I feel that you will be less likely to learn anything from investing mistakes and hence you will be condemed to repeat them.

My interest in companies and the market is the key motivator behind my investments. The financial pay off is almost secondary but I won’t lie making money is part of the game.  I don’t invest to lose money  However there are some investments I make purely because I want to own a small piece of certain companies . I like being somewhere and seeing there products or signs and thinking “I own a little chunk of that”.  So the point of this post is to describe how I currently buy little pieces of companies just for the sake of having a position and not nessecarily for financial reward.

Currently I use a Sharebuilder account for that.  I mention them not as a promotion but to describe how I use them because their service is somewhat unique.  Primarily with scheduled investments they only charge a $4 commision, you can invest an even dollar amount once a week and you can get fractional shares. 

Let’s take MVL (Marvel Entertainment) as an example. When I first saw that Marvel was publicly traded I thought that it would be really cool to own a piece of the comic book and movie industry. It spoke to the little kid in me. However I know little about those industries. I know very little about Marvel as a company and even after doing some research I might find it does not meet my criteria for buying stocks. But it is still a good company and the fact remains that I want to own it

That is where sharebuilder comes in.  A basic sharebuilder account is free and with the right promo code they will give you $50 4-6 weeks after your first transaction. So you open a free account make one purchase and you get $50, sweet. On top of that for the first month you can try their premium subscription free of charge which gives you 6 free scheduled investments, even better. To top it off you can schedule the premium trial to end at the end of the month so you don’t have to worry about forgetting to end the trial and then getting charged the re-occuring monthly fee. 

For the cost of eating out one night I can buy a share or two of Marvel paying a very low or in the case of a new account free comission and relish in the thought that I own part of a comic book company.

For my normal larger more researched investments I use a full featured online broker with standard comissions and real time trades. I use Sharebuilder to satisfy my desire to own little pieces of America that don’t always satsify my standard investing criteria. 

This is by no means a recomendation to follow my lead.  I am sure some people might think that buying a stock just for the sake of owning that company even in tiny positions is a bad idea. These are all personal preferences and you should always think for yourself when looking at any investment option regardless of the dollar amount.

A few other things worth noting about Sharebuilder:

1. You can setup dividend re-investment (I believe its turned on by default).

2. Scheduled investments happen every Tuesday morning and must be scheduled by the Monday before at 5pm. So you the price you pay for share is not known when you schedule the purchase.

3. Sharebuilder sells fractional shares. So if a stock you want to own is a little out of your price range, for example a Berkshire Hathaway (BRK.B) B share you can purchase a fraction of this share and add to your position over time eventually getting an entire share.

I am not going to go into detail about the Puget Sound Energy deal, it has been covered in depth in many other places which I will list at the end of this post. 

But I wanted to bring it up because it was my first taste of risk arbitrage. I started my initial position in PSD (PSE’s ticker symbol is PSD, confusing) around a month ago.  The deal gives all share holders $30 a share cash in exchange for their shares. So the idea is quite simple buy it for less than $30, the deal goes through you get your cash and profit. The reason merger deals are called “risk” arbitrage is well… because there is risk. In true arbitrage you have two simultaneous markets with different prices and you have essentially a risk free profit. 

The risk is that the deal had to be approved by the Washington UTC and this had not happened a month ago. In fact it just happened this week. In addition some of the communities in WA are not in favor of the merger hence there was risk that this could prevent the UTC from approving it.

On the downside if the deal did not get approved I was quite content with holding the stock and collecting dividends in the event that I could not sell it for a profit in the short term. For someone who might not want their money tied up in the long term, the downside is different. 

Interestingly enough with news of the approval the stock traded Wednesday below the sale price so there was still an option to make a quick very low risk profit.  It will be interesting to see if it continiues to trade at this price tomorrow on Friday. 

Mucho thanks to the Old School Value Blog for consistently posting updates on this deal.

PSD Merger at OldSchoolValue

Puget Sound Energy Website

I am unabashed fan of Warren Buffett and I really enjoyed watching this video of him speaking to a MBA class at University of Florida.  Its a little over an hour but its time well spent.  

The video is from 2000, but like all of his advice its timeless. One the things mentioned in the talk that really stuck out in my mind is the following in reference to the failure of Long Term Capital:

 

 

To make money they didnt have and didnt need they risked what they did have and what they did need.

 

He goes on to make an example with someone who has 100 million dollars. If this person can earn 10% a year on his 100 million dollars without leverage at almost no risk, or take some risk and leverage his 100 million dollars to make a 20% return this person would be crazy to risk losing their 100 million for an additional 10%. Especially because they already have 100 million bucks, how is the additional 10% going to make their life that much better? It isn’t it. But the downside if they loose is obvious, they no longer have any money.

The google video link above is for the whole 1 hour talk, its also on youtube broken up in smaller chunks.

Other Warren Buffett videos:

Warren Buffett talks Business

Charlie Rose Interview 

Dry shipping is the industry in which dry comodity goods are moved around the world in large boats.  There are quite a few publicly traded companys that operate and lease  boats for this purpose.  The company that I follow the closest is Paragon Shipping (PRGN). 

There a quite few people on the PRGN google finance discussion boards. The majority are quite polite and provide each other with great information on the company and also the industry in general. However stock discussion boards are littered with trolls that post just to get a rise out of people or some cases post in an attempt to scare people into selling their positions or pumping up penny stocks. 

So a couple of us on the board have setup a google group that we hope will be a great place to carry on our discussion and have better tools to deal with unfriendly posters. You have to request an invitation to join if you are interested. We are doing this just as a small barrier to entry and have no plans to make the group exclusive in any way shape or form.