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August 11, 2008

Actions Speak Louder Than Words… And Quarterly Returns

Bill MillerNot long ago, Bill Miller who serves as the fund manager of Legg Mason Value Trust mutual fund (LMVTX) issued the fund’s semiannual letter to shareholders for 2008. Miller laments the fund’s poor performance over the last year (July to July), down 34%. Famously, Miller’s fund beat the S&P 500 index a bunch of years in a row. However, as a Fortune magazine article points out, Miller doesn’t provide much guidance for how his fund (or investors) can return to the glory years going forward.

I disagree. The old maxim “Actions speak louder than words” can no doubt be applied here. Throughout this troublesome market, Miller has spoken loudly by adhering to his investment principles. A few of those principles, distilled beautifully by Janet Lowe in her book The Man Who Beats the S&P, are to:

Observe, but don’t forecast, the economy and the stock market. The market has so many players all using different bases from which to compete and adapt to one another. This results in unpredictable short term movements in the economy and the market. There is no simple formula that can predict these movements. Forecasting is folly. However, observing these movements and behaviors provides investment insights.

Seek companies with superior business models and high returns on capital over time. Over long periods, companies meeting these criteria have proven to provide high returns to their shareholders.

Buy businesses at a large discount to the central tendency of their true value. In true value investing style Miller always provides himself a margin-of-safety. In his latest letter, Miller points out that Financials now provide this margin-of-safety as the market prices of these companies are at all time lows compared to their underlying economics. However, remembering that “forecasting is folly”, the performance of these investments in the short term cannot be predicted. Over the long term they should do well.

Sell when 1) the company reaches fair value; 2) you find a better investment or bargain; 3) the fundamental logic for the investment changes. Miller sells to when it maximizes the returns of his portfolio. Most investors, amateur and professional alike, sell at the most inopportune times, like now when the market is depressed.

I doubt Miller will ever be able to duplicate the previous success he enjoyed with Value Trust. But if investors hold fast to his fund or his principles, they should do well.

Disclosure: I did no own, nor did the clients of Brick Financial Management, any shares of Legg Mason (LM) or Legg Mason Value Trust (LMVTX) mutual fund.

 

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April 21, 2008

When Diversification is Good

Eggs

In case you haven’t heard the old saying, “Don’t put all your eggs in one basket”, the collapse of Bear Stearns (BSC) is a great example of why the phrase exists. As you may recall, last month Bear’s stock plummeted to less than $3 per share from a 52-week high above $150. Although Bear employees seemed to be a little better off than the former employees of Enron and Worldcom whose retirement savings were obliterated by the collapse of those companies, as Bear’s employee stock ownership plan accounts for only 3% of total shares.

However this belies the point. About 1.5 million Americans are invested heavily in their employer's stock and another 11 million Americans participate in employee stock ownership plans and the like. Should these companies fail, and the stock of those companies fall significantly, you’ll see a lot of folks working in their golden years. Although I believe in prudent concentration in one’s investment portfolio, there is such a thing as too much of a good thing. The best actions an employee can take is not to make their own company’s stock more than 10-15% of their overall portfolio.

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May 02, 2006

Right About Being Wrong on JetBlue

A sound selling discipline is an oft-neglected part of a sound investing approach. A sell discipline will get the investor out of situations that show little promise and allow him to be available for situations that do. One of the sell criteria we employ at Brick Financial imparts us to sell a stock if “we have made a mistake in calculation or judgment.” Last August the clients of Brick Financial saw the criteria at work.

In August I wrote,

"We were cautious when we bought JetBlue: JBLU back in the spring of 2003… at the time it was trading at about 35x earnings which we thought was expensive… What we did not fully appreciate were some of the challenges that JetBlue faces. One was its vulnerability to rising oil prices. Although all transportation businesses were affected, airlines seemed to be especially so, and JetBlue was no exception. The other issue was the realization that although JetBlue’s operating and labor costs are presently low - as planes age, as employees become unionized, as new markets become more scarce – the company’s costs are bound to rise... We made several mistakes on this purchase... [ultimately] we did not provide ourselves a wide enough margin of safety [and] we should have weighed JetBlue’s rich valuation more heavily in our analysis…”

Since then, JetBlue has declined from a split-adjusted price of $12.71 to $9.69 at today’s (May 2nd) close. That move represents about a 24% decline. The company’s last two quarters were net losses, with the latest loss reaching $32 million. I would not say that I am clairvoyant, but some of the concerns I covered last summer have come to fruition. Larger competitors are pilfering the company’s business model and the company’s costs are catching up to it. The company, though nimble compared to other carriers, could not escape the ever-increasing rise in oil prices. It has also been forced to scale back on its expansion plans, sell some of its planes and shorten many of its routes.

A recent Wall Street Journal article underscores the company’s difficulty:

“ ‘We haven't done a good job at managing our business’ with aviation fuel costing more than $2 a gallon, said David Neeleman, JetBlue's founder and chief executive officer. The company's fuel bill rose 85% in the first quarter compared with a year earlier, and the average cost per gallon jumped 43% to $1.86. But the ‘silver lining’ in the record fuel price is that it is ‘helping us focus on becoming a better company,’ he said.”

 A sound sell discipline, and the ability to admit I was wrong, saved some money.

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February 07, 2006

Misgivings About BofA

Excerpt from Brick Financial's January 2006 Client Letter:

 

...The BofA sell was a little different. It too faced the daunting condition of a nearly flat yield curve. It, like most other large banks, is likely to see its net interest margins get worse before they get better. The recent earnings miss is a symptom of this. Although the company’s management expects their acquisition of credit card issuer MBNA to begin adding to earnings as soon as 2007, we’re skeptical.

 

Not that we think MBNA is a questionable business. Just the opposite. We think it’s a fine business. It is more that we think the management of BofA, especially its CEO Ken Lewis, has an uncomfortably optimistic outlook (euphemism for “misleading”) no matter the conditions of the economic climate. An example of what we mean is when management consistently reports pro forma figures rather than the more conservative GAAP figures. Pro forma figures have many assumptions or hypothetical conditions built in which allows for an alternative view of the financial statements. But that’s just semantics. Usually companies use pro forma figures to hide all the bad stuff.

 

On a recent conference call Ken Lewis stated that the company was able to grow earnings by 31% over a two year period. The GAAP figures revealed something not quite in line with what Lewis’s statement. Hedge fund manager Thom Brown (bankstocks.com) pointed out this discrepancy and recounted an email exchange he had with the company.
“This is what we refer to around here as ‘Charlotte math. By the lights of my Bloomberg, BofA earned $3.57 per share in 2003, $3.86 in 2004, and $4.15 in the year just ended. So over the past two years, earnings have risen by 16%, half the 31% growth that Lewis alleges. In response to my inquiry, a company spokesman emailed to say that the 2003 EPS Lewis was referring to are the pro forma numbers the company filed at the time of the Fleet deal in 2004. Which is to say, Lewis’s statement is nonsense. [emphasis ours] The fact is that investors don’t have a claim on retrospective pro forma numbers, nor do those numbers help build economic value over time. What matters are actual, here-and-now GAAP numbers. Lewis knows that, of course, but he threw out those phony numbers to make his performance look better than it really is. That’s our Ken!”

Evaluating the management of companies is essential to our investment process. We look for capable management. We look for management groups that treat their shareholders (and customers) with high regard. We need to feel like management is speaking with us candidly and honestly. We do not want management painting a rosy picture, were there really is none. We want management to “give it to us straight”. We just don’t get that feeling from the management of BofA...

Read the rest of the January 2006 Client Letter by clicking here.

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About Brick Financial Management, LLC

Blogged by Brick Financial

51 JFK Pkwy, 1st Fl. West
Short Hills, NJ 07078
973-486-9860
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Brick Financial Management, LLC is a Registered Investment Advisor specializing in providing investment management services to individuals, families, organizations and institutions. We implement highly focused stock, bond, and balanced portfolios using an investment approach commonly referred to as value investing. Disclosure

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