The Third Pig

"The Third Pig" On Reuters, Yahoo Finance and Others

2009-01-05T22:28:38Z

Articles that appear on The Third Pig occasionally appear on the Seeking Alpha website and are regularly picked up by the general financial media outlets including Yahoo Finance, Reuters and other financial blogs. I have listed some of the latest entries and other locations they can be found:

Asset Allocation in 2009: Best to Go with the Devil You Know at:
Yahoo Finance: http://finance.yahoo.com/q/h?s=SBUX and http://finance.yahoo.com/q/b?s=BRK-A
Fav.or.it: http://fav.or.it/post/953406/asset-allocation-in-2009-best-to-go-with-the-devil-you-know

Coach: Luxury on the Cheap at:
Guru Focus: http://www.gurufocus.com/forum/read.php?2,42620
Fav.or.it: http://fav.or.it/post/929527/coach-luxury-on-the-cheap

Five Things to Be Thankful for in This Market at:
Reuters: http://www.reuters.com/finance/stocks/marketViews?symbol=COH.N
Yahoo Finance: http://finance.yahoo.com/q/b?s=COH&t=2008-12-15T03:55:28-05:00

GM Bailout Would Be Agony For Taxpayers at:
Yahoo Finance: http://biz.yahoo.com/ic/news/330.html?time=1226885400

Obamanomics and the Stock Market at:
Stock Shoot: http://stockshoot.com/content/view/6602

Buffett and Cramer Agree: It’s Time to Buy Stocks at:
AOL Finance in the Headlines area: http://finance.aol.com/related/berkshire-hathaway-inc-cl-b/brk.b/NYS?topic=144012971&tab=3

Greed, When Others Are Fearful, Is Good at:
Wall Street Oasis: http://www.wallstreetoasis.com/newswire/greed-when-others-are-fearful-is-good

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Disclosure: none

Best To Go With The Devil You Know

2009-01-02T23:10:17Z

The stock market ended the year of 2008 posting one of its worst annual price performances ever. The Standard & Poor's 500 index dropped 38.5% for the year marking its worst performance since 1937’s 39% drop in the index. In fact it was the first time the index saw a 30% or more drop in price in those 71 years. So if you survived this year, give yourself a pat on the back.

Investors over the past year made many wrong moves, paralyzed by fear, they drove down stock market prices to unreasonable levels. One bright spot is patient investors could invest in stocks very cheaply. Valuation levels had not been at those levels since the early 1980’s. Although the S&P 500 has advanced more than 20% from its low of November 20^th, there remain bargains to be had.

With so many bargains to choose from, some investors may experience paralysis because of greed. Which stock does one pick? In such an instance, it is best to invoke the spirit of Charles Munger, co-chairman of Berkshire Hathaway. In an Outstanding Investor Digest article some years back Munger was quoted as saying:

“For an ordinary individual, the best thing you already have should be your measuring stick. If the new thing isn’t better than what you already know is available then it hasn’t met your threshold. This screens out 99 percent of what you see.”

Although I picked up a few new positions for myself and my clients’ portfolios, in following Munger’s advice I found that the positions already in the portfolios were of solid companies that were similarly beat down as the market. Every nook and crannie of the market was hurt this year. It couldn't be avoided. And the potential of being hurt further is still present. However, when choosing where to allocate funds, sometimes it is best to go with "the devil you know".

Instead of scouring the investment universe for the new thing, I simply averaged down. The following chart marks the return of a few positions from the beginning of the year to the S&P 500’s low on November 20^th and then the return to the end of the year from that November date compared to the market’s return.

Although as a group the stock of these companies declined to a similar degree as the market, their rebound so far as been nearly 50% greater. Although it is too soon to say, I believe superior companies will bounce back to a greater degree than the average stock. I think this is what we are seeing in the chart above.

Disclosure: I and the clients of Brick Financial Management, LLC owned shares in all the companies mentioned in this post at the time of this writing. But positions may change at any time.

Coach’s Bags Are Expensive, But the Stock Is Cheap

2008-12-24T19:08:40Z

Source: Flickr by danperry.com

When the holiday shopping season is done for 2008 the results for retailers will show disappointing numbers. Consumers continue to pinch their pennies in this tough economic environment. The International Council of Shopping Centers expects November and December sales at stores open at least a year to fall as much as 1 percent, the largest drop since at least 1969, when the trade group began tracking such data [video].

However, there’s beauty in those numbers for stock investors. While the industry as a whole has performed poorly operationally, some have weathered the storm quite well. But panicked investors have thrown the baby out with the bathwater, pricing the stock of strong companies below reasonable levels.

Take for instance luxury bag and apparel designer, Coach, Inc (COH). Year-to-date, Coach is down 34% right along with the Apparel, Accessory and Luxury Goods sector which is down 37% as of December 19^th. But the company has been around for nearly 70 years, a period which has seen at least 10 recessions. Certainly it has seen and weathered some bad times before. Since going public in 2000 they’ve done nothing but continue to strengthen the company.

According to Standard & Poor’s, “For the five years through FY 08, COH exhibited a revenue compound annual growth rate (CAGR) of 27%, a gross profit CAGR of 29%, an EBIT CAGR of 37%, and a net income CAGR of 40%. Total assets grew at a five-year CAGR of 30%, and inventory at a modest 19% CAGR, attesting to a tight operating structure that reduces inventory risk.” The company also sports gross margins of 74%, the highest in the industry. Only Luis Vuitton (LVMHF.PK) comes close with gross margins of 64%.

Coach also holds a commanding lead in the luxury handbag market in the U.S. and is making strides in Japan with a market share 13% behind only Luis Vuitton’s 30% share of the market. Coach sees promise overseas, especially in China. It expects the overall market to more than double in size over the next 5 years to more than $2.5 billion in annual sales, up from of $1.2 billion now.

Even in this difficult environment, Coach has increased sales 18 percent year-over-year has essentially no debt to speak of. Louis Vuitton on the other hand has $4.5 billion in long-term debt and a total-debt-to-equity (TDE) ratio 52%. The industry’s average TDE is 27% (Source: Reuters).

The bags may be expensive at Coach but the stock is cheap. In my humble opinion, a company that is able to perform like this even in bad times is deserving of more than the 9x trailing earnings it now fetches.

Disclosure: I and the clients of Brick Financial Management, LLC owned share of Coach (COH) at the time of this writing. But positions may change at any time.

The Auto Bailout and Mental Accounting

2008-12-12T15:10:35Z

Source: Flickr by Cobalt

Last night the $14 billion bailout for the auto industry failed in the Senate primarily because the United Auto Workers union refused to accept a pay cut for its members. This likely spells big trouble for the Big 3 as collectively they are asking for funds in excess of $30 billion. General Motors (GM) alone, which employs a quarter of one million workers, needs $8 billion over the next two months to stay afloat according to its CEO Rick Wagoner.

Supporters of the bailout are now looking to the White House and the Treasury to step in. To date the Bush administration has resisted dipping into the remaining balance of the $700 billion TARP earmarked for the banking industry to help the Big 3. The Bush administration’s position in this regard is well understood. It wants to reserve the remaining TARP funds for the banking industry “just in case”. But there is also no denying reluctance to use the TARP funds to assist the auto industry is really grand scale mental accounting.

Mental accounting, as studied by Richard H. Thaler, is the way we attribute a monetary value or utility to an economic transaction, situation or expectation. It tends to separate those values in different accounts according to their origins and purposes. Mental accounting can also be seen as the failure to see the entire financial picture and how one decision affects another. To understand this concept on a personal level it is best to consider a couple of examples.

A divorced mother holds a grudge against her ex-husband and father to her children on whom she depends for child support. In an effort to exact revenge against the ex, the mother makes crank calls to the father’s place of employment causing him to loose his job. This in effect decreases the mother’s income in the form of child support. The mother failed to connect that her income was dependent upon his. In her mind they were separate.

A consultant on a temporary project wants a file cabinet to store just a few papers. The local office supply store has small, medium and large size cabinets which cost $200, $250 and $300 respectively. Being analytically minded the consultant buys the largest cabinet as he calculated it would allow him to get the most space per cubic inch for his money. However, he failed to consider he had only enough files to fill half of the smallest cabinet. In essence, he wasted $100 dollars. When something sells for below the mental price we have assigned it, the deal takes precedence over the actual utility of the item.

Whether the government uses the TARP money, some other funds or does nothing at all, we as Americans will collectively “pay” for the automakers woes. Perhaps it will be in funds going directly to the companies. Or perhaps it will be in increasing the welfare and unemployment rolls. It may come in increasing bankruptcies and foreclosures among former workers of the industry. At this point, we, Americans, the government, cannot avoid expending these dollars either directly or indirectly.

In the interest of full disclosure, I wrote an earlier post suggesting giving money to the automakers amounted to a very bad investment decision. I stick by that position. In 2007, GM lost $38 billion in 2007 and Ford (F) lost $2.7 billion. However, in no way was I suggesting nothing be done. As an investor, I am against the bailout. As an American, I can see the government giving the Big 3 the billions they are asking for – I will just close my eyes and hold my nose when and if they do.

Disclosure: I do not, nor do the clients of Brick Financial Management, LLC, own any securities mentioned in this article. But positions may change at any time.

5 Things To Be Thankful For In This Market (Part 4)

2008-11-27T18:25:07Z

Over the last week or so I have been listing things to be thankful for in this market. So far I have covered three things. They are:

1. The Teachings of Benjamin Graham

2. Low P/E Ratios

3. The Inevitable Market Rebound

And now I am listing numbers 4 and 5:

4. Black Eyed Peas, and
5. Collard Greens

Seriously, do I really need to say more? There are few things in life that beat mom’s collard greens and pop’s black eyed peas thrown in with a little Jamaican corn bread. And with today's economy and the burden it is putting on the pocket book, a cheap meal is hard to come by. In fact, with Americans on food stamps reaching an all-time high, a cheap nutritious meal is just what the doctor ordered.

Southern folklore suggests, that a meal of black eyed peas and collard greens will bring with it good luck and financial prosperity. The peas represent coins and the greens represent folding money. Both foods are dependable sources of nutrients and antioxidants that protect your heart and maybe prevent cancer and both are great sources of folic acid.

So in the spirit of Thanksgiving and my hope we can all get a little more luck and wealth in our lives, I have decided to share a recipe from the Homesick Texan for black eyed peas:

http://homesicktexan.blogspot.com/2006/12/black-eyed-peas-for-new-years-day.html

And another for collard greens from Ms. Financial Savvy:

http://www.msfinancialsavvy.com/article.php?aId=141

Good eats and Happy Thanksgiving!

Disclosure: I do not, nor do the clients of Brick Financial Management, LLC, own any securities mentioned in this article. But positions may change at any time.

5 Things To Be Thankful For In This Market (Part 3)

2008-11-24T22:10:57Z

The last couple of posts (here and here), I have been listing some things to be thankful for in this market. Here's # 3.

3. The Inevitable Market Rebound

This bear market has been the most severe we have seen since the decline of 1929. The good news is that we are not likely to see precipitous declines from here. So, although it is impossible to pick the exact bottom, it would be my guess that we are in the “bottom range”. I feel strongly that over the next 3 to 5 years, the market will be much much higher. And according to the data below, most of that recovery will come in the first few days and months.

On average, using the last nine bear/bull markets as a proxy, 87% of the S&P 500’s high has been recovered in the first year of the market bottom. On average, all of the prior high, and then some [122%], has been recovered by the second year. This is represented in the following chart [click image for larger view]:

For example, on August 25, 1987 (light blue highlight) the S&P 500 reached a high of 336.77. Then it began a drop over the next three months, which included the infamous Black Monday when the market dropped more than 20% in one day, and by December 4, 1987 the market had fallen to 223.92, representing a 34% drop over that period and a loss of 112.85 points off the index. However, within one year of the bottom, the market had returned to 277.59, rebounding 53.67 points, a 24% return, from the bottom and recovering 48% of the loss of the previous high. By the second year, the market had stood at 348.55, recovering a full 110% of the previous high of 336.77.

In fact, in most instances, you will recover a full third of what you’ve lost in the first 40 days into a new bull market. Buy and hold is not dead. No one can time the market so it pays to stay fully invested even in times of uncertainty.

Disclosure: I and the clients of Brick Financial Managment, LLC hold positions in iShares S&P 500 Index ETF (IVV) and ProShares Short S&P 500 Index ETF (SH) but positions may change at any time.

5 Things To Be Thankful For In This Market (Part 2)

2008-11-21T17:56:31Z

Many of us may find it hard to be thankful for much in this economy, especially when it comes to our portfolios. From its October 9, 2007 peak of 1565.1, the S&P 500 has been down as much as 52% hitting 752.44 on November 20, 2008. But every cloud has a silver lining. The other day I decided to list a few things to list a few things to be thankful for in this, and most bear markets. Here's #2.

2. Low P/E Ratios

Last month, I pointed to a Wall Street Journal article by Jason Zweig where he points to a Benjamin Graham measure of valuing the stock market adopted by Yale professor, Robert Shiller. Dubbed the “Graham P/E”, it divides the price of major U.S. stocks by their net earnings averaged over the past 10 years, adjusted for inflation.

At October 24, 2008, when the S&P 500 stood at 876.77 the Graham P/E was 15 (I have included November 20^th’s low of 752.44, a Graham P/E of 12.5, represented by the red line), the lowest it had been for nearly 20 years the suggestion being the market was greatly undervalued and investors were acting irrational. However, Chris Carroll a Johns Hopkins Professor of Economics, takes a slightly different position in a recent white paper. He points out the numbers predict a 6% or so rate of return over (grey dot, 8% at the red dot) the next 12 years net of inflation, about the historical average. Hardly the panic many market pundits have talked about.

Whether the current market provides for the buying opportunity of a lifetime or simply a return to normalcy as Carroll suggests is of little concern to me. I am finding quality companies at P/E multiples never available before. One company that fits the bill is Coach (COH), the leader in the handbag and accessory market.

Since being spun off from Sara Lee almost a decade ago, Coach has grown its tangible book value by 49% per year and has not seen its return on equity dip below 40% in seven years. The company has raised its earnings per share by 47% per year and year-over-year EPS has increased every quarter for the at least the last five years including its most recent. Coach also has nearly $410 million in cash with only $2.2 million in debt.

In any other environment Coach would be selling for 25-30x earnings and has since it went public years ago. But today an investor can have Coach for a cool 8x earnings. I must agree with Warren Buffett when he says,

“…fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.”

Disclosure: I do not, nor the clients of Brick Financial Mangement, LLC, hold any positions in the companies mentioned but positions may change at any time.

5 Things To Be Thankful For In This Market (Part 1)

2008-11-19T21:38:20Z

With the Thanksgiving holiday coming up and people somewhat depressed about the market and the economy, I tried to find some things to be thankful for in a tough environment like this. I thought I’d list a few, at least five, leading up to the holiday. The following is #1:

1. The Teachings of Benjamin Graham:

Benjamin Graham is perhaps best known today from frequent references made to him by billionaire investor Warren Buffett. Besides giving us Security Analysis in 1934 and his 1949 classic, The Intelligent Investor, he gave us short but meaningful quips about keeping our collective heads as investors in any market, let alone a bear market where we have seen a 52% drop. Some of my favorites are:

“Confronted with a challenge to distill the secret of sound investment into three words, we venture the motto, Margin of Safety.”
“Price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to…the operating results of his companies.”
“…in the short run, the market is a voting machine but in the long run it is a weighing machine.”

I wonder where Buffett would be without Graham.

Disclosure: none

A GM Bailout Would Be Agony For Investors

2008-11-14T17:37:36Z

Talk in the marketplace, Detroit and Washington has been percolating about giving General Motors (GM) and the auto industry in general a bailout ala the TARP for the banking industry. GM is on the verge of running out of money. Cash received from auto sales, down dramatically from last year, will not cover the cost of running its business. GM has a monthly cash burn rate of $2 billion or more per month and only $16 billion in cash left on its latest quarterly balance some of which needs to be held in reserve.

GM blames the current economic environment on their woes. Year-over-year sales at month end October saw a 45% decrease, worse than almost all of their competitors. Toyota (TM) for instance, which will soon overtake GM’s market share in the space, saw sales decline a significant but less severe 23% over the same period. But GM’s execs are not being genuine. GM has never been a great business.

Warren Buffett in a 1991 gave a speech to Notre Dame students and faculty. In it he compared two businesses - Company Agony and Company Ecstacy. Company Agony lost its investors more money than virtually any business in the world while the other, Company Ecstasy did nothing but make money.

The difference in the two businesses was Company Agony, which in Buffett’s story was American Telephone and Telegraph had all kinds of employee benefit programs, stock options, pensions, the works. The business operated under heavy regulation, was heavily unionized and extremely capital-intensive. In fact, shareholders had to continually reinvest in the company simply to keep it going.

Company Ecstasy on the other hand, Thompson Newspapers, didn’t have elaborate compensation programs and never needed to reinvest in the company. They simply wrote a story and produced it by putting ink to paper. Thompson was able to raise prices which raised earnings and there was nothing to do with the money except to return it to shareholders or purchase more profitable businesses.

In advising his audience about which kind of businesses to work for, an Ecstacy non-capital intensive business or an Agony capital-intensive business, Buffett said,

“One is a marvelous, absolutely sensational business, the other one is a terrible business. If you have a choice between going to work for a wonderful business (Ecstasy) that is not capital intensive, and one that is capital intensive (Agony), I suggest that you look at the one that is not capital intensive.”

The same can be said for investing in capital intensive businesses. Investment in a capital intensive, Agony business like GM where market share [chart below] is eroding which began well before an economic recession, labor costs are the highest in the industry at $73 per hour [$30 higher per hour than Toyota’s], the workforce is heavily unionized and it makes products consumers don’t want (i.e. gas-guzzling SUVs), doesn’t seem like a smart move to me.

The government is our investment manager now. It must make prudent investments and should make sure we see some return. GM has not returned any money to investors for years and years. In fact, an investment in a simple index fund like the Vanguard S&P 500 Index Fund (VFINX) would have been a much better investment over the long haul. [See chart below].

If an investment in GM never made money in the past, what would be different now? I venture to say, nothing.

Disclosure: none

Obamanomics and The Stock Market: Part II

2008-11-07T22:34:08Z

We Can All Relax… Maybe Not

Today President-Elect Barack Obama held his first press conference since the election on November 4^th. This followed a meeting with his economic advisors the purpose of which was to solidify a strategy to right the U.S. economic ship.

Ah! Now that Obama is on the job we can all relax. Well, not quite. In Obama’s opening statement he said, “We are facing the greatest economic challenge of our lifetime.” Although Obama’s statements were strong, his speech seemed mainly aimed to temper expectations of what he can do as the incoming President. In answering a reporter’s question, Obama said as President his chief goal will be to restore confidence in the market and get people working. Unfortunately, in the President-Elect’s first time out, he fell short of calming the markets. The Dow Jones fell 100 points during his 18-minute press conference. [video]

Are Democrats Good For The Market?

The market’s drop was understandable. The bi-partisan rhetoric dubs Obama “the-most-liberal-senator”. According to Karl Rove, he out-Democrats most Democrats. John McCain picked up this “too liberal” stance at the end of his campaign. The purpose of which was to equate Democrats as being bad for the economy and the stock market. Of course there are those who buy into this, but is it true?

In a recent New York Time article, the returns of the stock market are plotted over an 80-year period, according to the political party in office. The results? The market does better under Democratic Presidents. Under Democratic administrations the average return for the S&P 500 since 1929 was 8.9% and 0.4% under Republican administrations. [click image for larger view]

Party Power

Obama will be coming into office with a Democratic House and Senate as well. I have heard the talking heads on stock market television shows say this too is bad for returns. Again, the evidence does not support this view. According to the research conducted by Wharton professor, and stock market historian, Jeremy Siegel,

“…a Democratic president and a Democratic Congress? Well, Siegel's research shows that such a combination has generated annualized returns of nearly 14% since 1948. That's more than 4 percentage points better than under a GOP president and GOP Congress, and more than 3 percentage points better than under a GOP president/Democrat-controlled Congress.”

Here is the dirty little secret. The party that is in power probably has only a slight effect, if any at all, on the trajectory of stock market returns. Stock markets are like living organisms and are affected by many interlacing influences. So the best an investor can do is to invest consistently no matter who sits in the oval office.

Diclosure: none

Obamanomics And The Stock Market

2008-11-04T21:55:02Z

Meet Joe-The-Dentist

Joe-The-Dentist earns over $600,000 per year. Although he earns a high income from his dental practice he also earns a good bit of income from capital gains from his stock holdings of publicly traded companies. Most of Joe’s holdings are in consumer oriented businesses. His largest holding is Walmart stock.

Unfortunately, Joe has seen his passive income from stock holdings decrease during the Bush administration – a period of low tax rates. Gone were the days of the Clinton era bull market – a period of high taxes. So Joe hasn’t paid much in capital gains as of late, because Joe’s passive income hasn’t been much to brag about.

Joe has an epiphany. Obama’s tax plan is very Clintonesque and middle-class oriented while the McCain plan is an aggressive version of the Bush tax policy which heavily favors the wealthiest Americans.

Joe contemplates if the middle-class had more income to spend, they might spend it at Walmart. Which means Walmart’s revenues would go up, which would increase the value of the stock, which would in turn allow Joe to have more passive income. Joe also realizes the even though he might pay a higher tax rate under an Obama/Clinton tax policy, it would mean little as his take-home-income would be at its peak. Under the McCain/Bush plan, middle-class incomes would be relatively lower, not allowing them to spend as much thus stalling the economic recovery, depressing Joe’s stock holdings.

Joe-The-Dentist as well as the average American need only look back at the last 16 years. Paying lower taxes will not necessarily, as smart people like Warren Buffett have pointed out, hurt economic decision making. Thus an Obama/Clinton tax policy will help all Americans by helping the middle-class. The following chart shows how the stock market performed during the Clinton administration (from the time of the election in 1992) to how it performed during the Bush administration. Under Clinton, the stock market nearly quadrupled while under Bush the market stood still. [Click chart for larger view.]

Implications for the National Debt

Much of the argument from the John McCain camp against voting for Barack Obama is that Obama will raise taxes. The truth of the matter is Obama simply wishes to return to the modified Clinton administration tax policy. Under such a plan very few of us will see a rise in our overall tax rate and most will see an increase in their take-home-income.

According to the Tax Policy Center (TPC), the wealthiest among us, the top 1% of households with incomes of $600,000 per year or more, would see their after-tax income decrease under the Obama/Clinton plan by about $19,000 representing a mere 1.5% decrease in after-tax income. The next 4% of households would see their after-tax incomes remain about the same. Most Americans, about 95% of households, would see their after-tax income increase by about $2,200 per year.

McCain espouses a Bush-like “trickle down” tax plan which aims to cut taxes across the board. His plan leaves most American with an increase in after-tax income of about $1,400. But his plan most favorable to the wealthiest Americans. The top 1% under the McCain plan would see their after-tax incomes rise by $125,000, according to TPC. [Click chart for larger view.]

Each of the candidates’ tax plans has implications for national debt. It can certainly be argued the McCain/Bush tax plan will cost the nation more in the long run. According to the Tax Policy Institute (TPC),

“The main differences are two: first, McCain’s plans would reduce revenues by significantly more than Obama’s; and second, McCain’s would be substantially less progressive, especially among very high income taxpayers.”

The McCain/Bush policies would cost (reduce tax revenue) $4.2 trillion over 10 years while the Obama/Clinton plan would cost $2.9 trillion during that time. If interest costs are included, McCain’s plan would boost the national debt by $5.1 trillion and Obama’s would increase it by $3.6 trillion.

However, as the above anecdote suggests income for everyone, even the government, will potentially be higher under an Obama/Clinton tax policy. Even though both candidates’ tax plans will be expensive, the Obama/Clinton plan has relatively more upside for the economy than the McCain/Bush plan. Basically, under the Obama/Clinton plan, all boats will rise.

Disclosure: none

Greed (When Others Are Fearful) Is Good

2008-10-28T21:49:15Z

Buffett’s Detractors
Warren Buffett has had his share of detractors since his New York Times Op-Ed piece in which he announced he would be buying American stocks in his personal account. According to Buffett, “…fears regarding the long-term prosperity of the nation’s many sound companies make no sense… But most major companies will be setting new profit records 5, 10 and 20 years from now.”

The crux of the detracting argument is Buffett’s call is untimely, he is too rich to worry about asset allocation or time horizons and you, we are not him. Dianne Francis of Canada’s National Post sums up this viewpoint:

"…guys like Warren Buffett also operate in a parallel universe of Cash-Rich, Long-Term, Value Investing. He’s making big bets on American stocks. We should not for lots of reasons. He's just plain wrong and I wrote about that yesterday. The stock markets are not capable of being a valid pricing mechanism for anyone for some time. Besides that every day brings more bad news, and new developments.”

Seems to me the detractors have cherry-picked certain lines from Buffett’s piece. Buffett in no way suggested the near term picture would be pretty. In the near term, markets are likely to continue their record breaking volatility and investors may suffer yet more loses. Buffett wrote,

“In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.”
“To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions.”
“…businesses will indeed suffer earnings hiccups, as they always have.”
“Let me be clear on one point: I can’t predict the short-term movements of the stock market.”

But Buffett’s qualifying statements are beside the point. His overall point was clearly missed or ignored - due to the widespread fear in the marketplace, stocks of strong businesses are cheap. And, in the long term, these businesses are likely to grow through economic booms and busts. Since, in the long term, stock prices are highly correlative to the performance of businesses, it makes sense to buy when the prices of stocks are below the value of the underlying businesses. That time, according to Buffett, is now.

The Typical Investor Buys High and Sells Low
Buffett goes on to point out the resiliency of the market. He also emphasizes most investors’ uncanny ability to miss out on those gains because of their tendency to buy when they are comfortable (at market tops) and sell when they are fearful (at market bottoms). To underscore Buffett’s point, consider the following:

Research conducted by DALBAR, Inc shows for the 20-year period ending December 31, 2007, the typical mutual fund investor failed to capture the returns of the market. Although the average mutual fund trailed the market by about 2.5%, during this 20-year period, the typical mutual fund investor received a return of 4.48% while the market returned 11.82%. In fact, the investors’ returns were barely above the rate of inflation which clocked in at 3.04% during the period.

The disappointing results received by equity investors is totally due to the manic depressive buying and selling described by Buffett. As the chart below demonstrates, investors sell their mutual fund shares [demonstrated by the downward blue bars] just when market performance deteriorates [demonstrated by the orange line in negative territory].

When Ms. Francis suggests the market is a “valid pricing mechanism” she demonstrates, as do her fellow Buffett detractors, she does not understand that price and value are not the same. In the short term, stocks markets are never valid pricing mechanisms. Investors who believe otherwise allow their emotions to dictate their investment timing, a sure way to diminish investment results as the chart/table above demonstrate.

Investors Make Easy Things Difficult
Buffett has given the world one of his golden rules to investing: Be greedy when others are fearful and fearful when others are greedy. In fact, one might say this is the definition of value investing. However, as Buffett noted in his 1984 essay “The Superinvestors of Graham-and-Doddsville” there are not likely to be many converts to the practice. He writes,

“Adding many converts to the value approach will perforce narrow the spreads between price and value. I can only tell you that the secret has been out for 50 years [now over 75 years], ever since Ben Graham and David Dodd wrote Security Analysis, yet I have seen no trend toward value investing in the 35 years I have practiced it. There seems some perverse human characteristic that likes to make easy things difficult… There will continue to be discrepancies between price and value in the marketplace, and those who read their Graham and Dodd will continue to prosper.”

I’ll be re-reading my Graham and Dodd.

Disclosure: none

What Goes Up Must Come Down... And Up Again

2008-10-14T02:10:30Z

Benjamin Graham’s proverbial Mr. Market is manic depressive and thusly causes much of the daily up, then down, then up again movements in stock prices. When pessimism pervades, Mr. Market will be so eager to sell his shares he will eagerly drive down stock prices to levels that make little sense. We saw Mr. Market do that over the last couple of weeks, driving the S&P 500 down 28% in just 14 days.

Mr. Market was so depressed in fact and so willing to sell, the CBOE VIX Index reached record proportions, topping 50 for the first time since it started measuring all 500 stock of the S&P Index. However, in his haste, Mr. Market has thrown the baby out with the bath water. Values abound as an article in the Wall Street Journal by Jason Zwieg points out:

“Out of 9,194 stocks tracked by Standard & Poor's Compustat research service, 3,518 are now trading at less than eight times their earnings over the past year -- or at levels less than half the long-term average valuation of the stock market as a whole. Nearly one in 10, or 876 stocks, trade below the value of their per-share holdings of cash…”

Zwieg also points to a Benjamin Graham measure of valuing the stock market adopted by Yale professor, Robert Shiller, is at its lowest levels since 1989. The Graham P/E divides the price of major U.S. stocks by their net earnings averaged over the past 10 years, adjusted for inflation. At Friday’s close, when the S&P 500 was 899.22, the Graham P/E stood at less than 15 times earnings. This is good news for those on the other end of Mr. Market’s transactions.

But low and behold, Mr. Market heard some good news over the weekend that the world’s governments were doing all they could to handle the credit crisis. Mr. Market became irrationally exuberant, deciding to buy back all the stocks he had sold the two weeks prior. Today, the S&P 500 gained 11.6% - the highest percentage gain since 1933 – settling at 1003.35.

With the today’s advance, long-term investors might fear all the values Mr. Market left us last week have disappeared. I doubt this is the case. For the S&P 500 to return to its previous high of 1576.09, stocks would have to gain nearly 60% from current levels. Under “normal” circumstances, it takes nearly 5 years to gain 60% in stocks. In other words, the bargains will remain for some time. And as the following chart points out, returns to previous highs can take years. [Click image for larger view.]

In the meantime, for long-term investors, it is best to heed Jack Bogle’s advice [video]:

“Visualize investment as growing as a steady line, which it does [red lines in charts below], and visualize the crazy market as being all these jags up and down and around this steady line [blue lines in charts below], upward, upward, always upward, I think, then you’ve got to say, I know I’m not smart enough to get out at the high, I know I’m not smart enough to get back in at the low, so I’m just going to stay the course… what you want to do is keep investing…”

Bottom line is, while this is a scary time to be in the market, it is best to simply keep plugging along. No one will know where the bottom of the market is and it is equally hard to know where the top is. But Mr. Market will always be willing to give you a clue as to what you should do. Buy when he’s selling and sell when he’s buying.

Buffett and Cramer Agree: It’s Time to Buy

2008-10-10T17:39:10Z

It’s a little amusing to me how much attention Jim Cramer’s comments about pulling your “5-Year-Money” out of the market and sitting it in a safe place like cash or bonds garnered over the past few days. I for one, having given similar advice, didn’t find it that controversial. An investor, especially an individual investor, should never put their near term money at risk in the stock market.

Some professionals, like Henry Blodget [video], have even gone as far to say Cramer’s call to action is at odds with what Warren Buffett is doing, which is buying up strong franchises like, Constellation Energy, GE and Goldman Sachs. I beg to differ. Underlying Cramer’s call was any money investors do not need for near term purposes, should absolutely be at work in the market. It’s time to buy.

There are deals in the stock market that can be had right now that will likely not be seen again for quite sometime. A few are:

Berkshire Hathaway (BRK-A, BRK-B): If there was ever a time to invest in Buffett’s company it’s now. For years the firm held $50 billion in cash searching for investments to make. This year alone, Buffett has invested $40 billion. He received warrants on both the GE and Goldman Sachs deals and though both are currently out of the money, they stand to be highly profitable investments. Berkshire’s A shares are likely worth $150,000 to $160,000 before accounting for how the company’s new investments will impact the business. Shares ended the day at around $113,000 per share, representing a 25% to 30% discount.

Perini (PCR): Perini, a construction and general contracting concern has been trading well below the value of their backlog of sales and orders waiting to be filled. The company also recently announced $248 million in new contracts in Florida and Virginia. The stock gained almost 20% today skyrocketing at the end of the day to $17.64, but still trades near cash on the balance sheet of $15.55 per share.

Delia’s (DLIA): Recently Foot Locker (FL) offered to buy this clothing retailers direct marketing business CCS for $102 million. The enterprise value (market cap + debt – cash) for the entire firm is only $66 million. The market hasn’t responded yet as the stock continues to hover around $2 per share although it gained almost 10% today. The selling in the market is pervasive and there just aren’t any buyers right now. But there will be for this company which is likely trading at less than half it’s true worth.

Disclosure: I and the clients of Brick Financial Management, LLC owned share of Berkshire Hathaway, Perini and Delia’s at the time of this writing.

What To Do With Your 5 Year Money

2008-10-07T21:13:54Z

Jim Cramer, the self described innate optimist, has found himself the target of some scathing criticism today for giving a grim picture for the near future for returns in stock market. On Monday, on NBC’s Today Show, he advised viewers to pull their “5-Year-Money” out of the stock market and place it in cash. Almost instantaneously, and I might say coincidentally, the market dropped significantly. [Click chart for larger image.]

Although this makes for good television fodder, the criticism of Cramer in this instance is overblown. Cramer is exceedingly popular. His books are bestsellers. His show is one of the highest rated on cable television. But I doubt Cramer’s comments can move markets. Small, individual stocks, maybe. But not markets.

Despite the criticisms, Cramer’s advice is not only timely, it’s timeless. Your 5-Year-Money should always be in safe (low volatility) investments, even in the best of times. And I don’t say this because Cramer’s advice is identical to the advice I gave just a few days ago. I say it because it is simply sound asset allocation.

Stocks are great investments, but they are also the most volatile of investments. Thus if an investor’s time horizon is less than five years, and he needs to pay for his kid’s college tuition or put his mother in a retirement villa or finally replace his old jalopy to get to work, in that time frame, it doesn’t make sense to take the risk. Although stocks rise most of the time, they don’t all the time. In some situations, cash makes more sense.

In periods of 10 or more years, stocks beat cash 85% of the time. But in periods of 1 year or less, stocks only outperform 65% of the time. Although we just gave this advice, it’s well worth repeating:

For money you need within 5 years – “5-Year-Money”: Keep those funds in an interest bearing account at your bank of choice. Congress has approved and the President has signed into law that the FDIC will now insure up to $250,000 in deposits at banking institutions.

For money you need beyond 5 years: Invest or keep your money in a diversified (at least 20, no more than 30) portfolio of stocks of low leverage (companies that don’t make use of debt), high return on capital companies. If you have cash available, and it’s not paying for Johnny’s second semester at State U., you would be wise to add to your portfolio.