January 2005 Client Letter

February 14, 2005

Dear Clients and Friends,

The Relative Value portfolio held up amid downward pressure from the market in January. However, January proved a tough month for our Choice portfolio.

The Choice portfolio had a suboptimal return of -8.37%, substantially lagging the market’s return. The returns for both model portfolios versus relevant stock market indices (including reinvested dividends) as of January 31, 2005 follow³:

	January	YTD 2005	2004	2003	Total Return Since Inception^1,2
Relative Value¹	-0.46%	-0.46%	33.54%	44.09%	87.53%
Russell Midcap¹	-2.48%	-2.48%	20.22%	40.06%	62.41%
S&P 400¹	-2.55%	-2.55%	16.48%	35.62%	47.62%

Choice²	-8.37%	-8.37%	15.31%	22.31%	29.23%
S&P 500²	-2.44%	-2.44%	10.88%	32.87%	43.73%
Russell 1000²	-2.52%	-2.52%	11.40%	29.65%	40.79%

Russell 3000	-2.66%	-2.66%	11.95%	31.06%
Dow 30	-2.42%	-2.42%	5.31%	28.26%
Nasdaq	-5.18%	-5.18%	9.15%	50.77%

The inception date for the Relative Value model portfolio is 12/6/2002. For comparison purposes the S&P 400 is assumed to have an inception date of 12/1/2002 and the Russell Midcap is assumed to have an inception date of 12/6/2002.
The inception date for the Choice model portfolio is 4/4/2003. For comparison purposes the S&P 500 is assumed to have an inception date of 4/1/2003 and the Russell 1000 is assumed to have an inception date of 4/4/2003.
Notes: The returns of the Relative Value and Choice portfolios represent models each with an initial investment of $10,000. They do not represent actual trades of client portfolios although client portfolios are based on the model portfolios. The model portfolios are for informational purposes only. Although Brick Financial believes the information and data in this report were obtained from sources considered reliable and correct, we cannot guarantee their accuracy or completeness. Neither this commentary, nor any opinions expressed herein, should be construed as an offer to sell or a solicitation of an offer to acquire any securities or other investments mentioned herein. Persons associated with this firm may own or have an interest in securities or investments mentioned in this presentation. Their positions may change from time to time and they may buy or sell such securities or investments. Past returns are no guarantee of future performance. Model portfolios and charts are maintained at Foliofn.com. The index data comes from several sources including Standard & Poor’s, Russell, Barra and Bloomberg.

The fall in value in the Choice portfolio was primarily due to the fall in price of our eBay position, which happens to be the largest position in the portfolio. After reporting pro forma earnings of 33¢ per share, a penny below analyst estimates, eBay’s stock price fell 30% in January. Some may find this unusual, but I was extremely pleased by the occurrence. Now do not misunderstand, I do not like to loose money. But here is a case where the infamous Mr. Market[1] and his panicked behavior, should work for those whose approach is calm and rational. (In case you’re keeping notes, we’d be the calm and rational ones.)

With each change in a company’s circumstance, whether inventory changes, debt issuances, firings, hirings, new competitors, innovative products, or the occasional earnings miss, we try to assess how the business of the company is affected. So last month, when eBay announced its penny per share earnings miss, we set out to see if the business had deteriorated at all. Here is some of what we found:

All of eBay’s trading categories grew at double digit rates, even eBay Motors, the company’s largest trading category. So after looking ‘under the hood’ of the company, all appeared to be in order. The company seems to working on all cylinders and according CEO Meg Whitman the company is gearing up for more of the same in 2005 with heavy investment in China. (Ok, no more car analogies. Or is it car metaphors? Let’s move on.) Although the company missed analyst estimates for revenue and net profit, the company actually beat its own estimates (guidance) in 2004. The company has a history of underpromising and overdelivering. Way back in 2001, the management of the company projected revenues of $3.2 billion by 2005. Low and behold, they reached that exact goal in 2004, a year before they were due to make good on their ‘promise’. So, I’ll give management the benefit of the doubt.

After looking at the eBay’s financials we found no evidence of erosion in the business. In fact, the company’s permanence is becoming more evident with each quarter’s results. The three big reasons we like eBay still hold true:

By way of contrast, ‘newly’ public company Google has astonishingly similar financial results to eBay and is growing at a faster rate to boot. But it’s ‘moat’ is less evident in its main business - paid search. Yahoo and Microsoft are big players in this business and pose a consistent competitive threat. Google, though presently the leading search company and making consistent strides toward the being the ‘go-to’ company in their area, does not yet have the same competitive advantages as eBay.

All that said we still had to assess whether eBay was worth adding to, even after its precipitous price fall. By any traditional measure eBay seems expensive with a price-to-earnings ratio (P/E) at about 65x. Our belief however, is that the P/E is only an indicator of value, not a measure of it. Value is determined by calculating the present value of future free cash flow. And as we’ve seen, eBay is beginning to produce 'goo-gobs' of free cash. In eBay’s case, a company that is still in the hyper-growth stage of its business life, the P/E is especially misleading. Thus, in our estimation eBay is well under its intrinsic value[4] at its current price in the mid $70s. So we’ve added to our position.

Looking at the stellar performance of eBay over the past quarter and year, you might ask why did the price fall so far. Our answer to that question - we have no idea!

The actions of Mr. Market are often unpredictable especially over short periods of time and we have no ability to predict his next move. All we do is try and find good companies, assess what we think the intrinsic value of the company is and then wait for the market to give us an opportunity to buy the stock below that value. Managing investments in this way unfortunately will lead us to months like this one (re: Choice portfolio’s -8.37% return). We hope that this short term stumble in the Choice portfolio’s performance will lead to long term outperformance of the market. To quote Warren Buffett (Again!? Yes, again.), “we would much rather earn a lumpy 15% over time than a smooth 12%.”

Please look out for our article next week (we will post it on the website and you will receive it by email):

In Value Investing in Real Estate: A Rebuttal (part 1 of 4), we review Dr. Gary Eldred’s book and rebut many of his conclusions on the superiority of small property real estate investing vs. stock market investing.

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[1] Popularized by Benjamin Graham and later Warren Buffett, it is the idea of thinking of the stock market as a single individual (Mr. Market), who has some stock in every company and shows up every day willing to buy and sell any number of shares in any company, many times, without the benefit of rational thought.

[2] cash conversion (rate) cycle: The length of time between the purchase of raw materials and the collection of cash generated in the sale of the final product.

[3] GMV is the total value of all merchandise sold on eBay’s websites during the year.

[4] Intrinsic value is the perceived actual value of a security, as opposed to its market price or book value.