Monthly Archives: November 2010

My Watchlist – November 15, 2010

I have reviewed issue 12 of Value Line and added companies that have exceptional returns on equity, strong book value growth or strong “guru investor” sponsorship.

The idea here is to have a dashboard of substantially all the larger-cap high quality businesses in the U.S. in one place that you can review at least weekly to see what Mr. Market is making available to you.

Because of a limit on the number of functions that Google allows in a single spreadsheet, I had to split the spreadsheet into two parts.

This week’s update is in part 2.

Watchlist – Part 1

Watchlist – Part 2

Stocks Added This Week (see Watchlist – Part 2)

Harley-Davidson, Inc.

Matthews International Corporation

Polaris Industries Inc.

Pool Corporation

The Walt Disney Company

News Corporation

International Game Technology

The McGraw-Hill Companies, Inc.

John Wiley & Sons Inc

Omnicom Group Inc.

The author of this blog is NOT an investment, trading, legal, or tax advisor, and none of the information available through this blog is intended to provide tax, legal, investment or trading advice. Nothing provided through these posts constitutes a solicitation of the purchase or sale of securities/futures. The data and information presented in this blog entry is believed to be accurate but should not be relied upon by the user for any purpose. Any and all liability for the content or any omissions, including any inaccuracies, errors or misstatements in such data is expressly disclaimed.

Keep It Simple

Noise, noise, noise everywhere. Keep it simple. Begin with the end in mind. What are you trying to accomplish? Value investing is a big world. It’s really a framework that can be applied to any asset. Accept the fact that you won’t understand many – if not most – of these assets and how to value them. Develop the habit of not worrying about it. Focus on what you can do and be at peace. Filter out the chatter. There are people making a lot of money playing basketball, winning the lottery, writing screen plays, selling software, trading cocoa beans – the list goes on and on. You don’t (or shouldn’t) worry about these people, so why should you worry if another investor is able to make a bundle in potash and you don’t even know what it is? Invest with a margin of safety even if you must accept lower returns, particularly if you have already built up some wealth. Don’t go back to zero or take a major haircut. Don’t overreach. It’s easy to understand why using leverage is risky (although many still do it); investing in something you don’t understand is too.

Market Valuation Update – November 10, 2010

I have updated the market valuation data based on closing prices for November 9, 2010. The S&P 500 has advanced almost 18% since September 1, 2010. Equities still appear attractive on a relative basis given the historically low yield on government and corporate bonds. However, stocks do not look cheap at these levels. Never invest without a margin of safety.

Generally speaking, from month to month relatively little changes in these indicators. The trick is to develop the discipline to follow them on a regular basis. Doing so, along with developing a rational investing framework, should improve your odds of being greedy when others are fearful and fearful when others are greedy.

Giverny Capital on Lessons from the Crisis

For a number of years I have followed Canadian value investor Francois Rochon who runs Giverny Capital. Rochon focuses on great businesses with durable competitive advantages. He looks for companies that are growing their earnings twice as fast as the S&P 500, which over the longterm he expects will lead to market-beating performance. $100,000 invested with Giverny on July 1st, 1993 would have grown to $984,096 vs. $342,349 if invested in the S&P 500.

In Giverny Capital’s 2009 Annual Letter to Partners, Rochon reflected on the lessons he has learned from the financial crisis, noting that some of these were already known.

Everything that cannot rise forever will someday stop. This certainly occurred with the speculation on derivative products, technology stocks in 2000, American residential real estate in 2005, Dubai real estate earlier this year, biotech companies in the early 1990s and with the price of oil in more recent years. These are just a few recent examples!

It is the nature of things that with every economic cycle, some businesses disappear while new ones are born. This reminds us of the cycle of life here on Earth.

Companies that went bankrupt all had faced a common pitfall: too much debt. The companies that withstand crises are most often the ones with solid balance sheets and with leadership that is prudent, trustworthy and devoted. Isn’t this perfectly logical?

Warren Buffett once said that investors should not be in the market if they are not willing to accept a temporary drop of 50% in the values of their portfolios. I always mention to our partners that that this was likely to happen once in their life as an investor—I knew it would happen but I didn’t know “when”.

Many investors who were on margin at the beginning of 2009 were forced to sell at the worst possible time. An investor who uses margin to invest can do well for 30 years and then lose everything in a single day of irrational market movements.

The irrationality of short-term market fluctuations makes derivative products extremely volatile (options, swaps, etc.) When many people try to sell these instruments at the same time, derivative products can become worthless overnight. When this is combined with leverage (debt), you end up with an explosive cocktail.

The good news is that the market, as Ben Graham wrote 60 years ago, ultimately renders an accurate assessment of the intrinsic value of companies over the long term. To remain calm and rational in the face of wild fluctuations in stock prices is, beyond the shadow of a doubt, the most significant quality an investor can have or try to have.

At the end of the day, in order to build wealth, there is a simple approach which we have followed for 17 years at Giverny Capital: investing for the long term in high-quality companies purchased at attractive valuations—investing in companies that will survive the crises of our civilization and the short-term irrationally of our economic system.

Rochon also likes to look back and assess his “best” errors of the prior year. This is a great practice and way to learn from your experience. Here is his Bronze Medal for 2009: BYD.

During the Berkshire Hathaway shareholder meeting last May, I listened attentively to Charlie Munger’s discussion of BYD, a Chinese company led by Wang Chuan-Fu. Charlie said with great admiration that “Chuan-Fu is a combination of Thomas Edison and Jack Welch: I have never met such a businessman.” When we consider that Charlie is 86 years old and that he has probably met the greatest businessmen of the last two generations, it’s an extraordinary comment. His words didn’t fall on deaf ears and I was instantly interested in BYD.

The company manufactures an array of products but the most important is a revolutionary battery used in electric cars. Based on this invention, BYD launched itself fearlessly into the car manufacturing business. As a fervent believer in the future of the electric car, I became enthralled with this highpotential company. Keep in mind that, with revenues of over $5 billion in 2009, BYD wasn’t exactly the new kid on the block.

My enthusiasm was cooled when I saw the company’s valuation on the market. The stock was trading at $15 on the Hong Kong market while the company only had EPS of $0.50 in 2008. A P/E ratio of 30 times seemed exaggerated in my mind. So being a persistent man, I woke up each morning to look at BYD’s closing price in Asia hoping that the stock had dropped so I could buy a stake in the company at a more reasonable valuation. This was in vain.

The company had an exceptional year in 2009. After nine months, BYD’s revenues climbed 39% and their new car division grew 50%. The company’s EPS has yet to be announced but it’s likely to have doubled to $1.06 for 2009 and analysts expect $1.84 in EPS for 2010.

The stock has soared 400% in a year, reaching its current level of $65. Sometimes, the artistic side of investing is to know when to let go, in a rare and exceptional moment, of market valuations and simply make a leap of faith based on an exceptional human being.

Here is the entire letter.

In addition, Francis Rochon was recently featured in Value Investor Insight.

My Watchlist – November 8, 2010

I have reviewed issue 11 of Value Line and added companies that have exceptional returns on equity, strong book value growth or strong “guru investor” sponsorship.

The idea here is to have a dashboard of substantially all the larger-cap high quality businesses in the U.S. in one place that you can review at least weekly to see what Mr. Market is making available to you.

Because of a limit on the number of functions that Google allows in a single spreadsheet, I had to split the spreadsheet into two parts. This week’s update is in part 2.

Watchlist – Part 1

Watchlist – Part 2

Stocks Added This Week (see Watchlist – Part 2)

Gildan Activewear Inc. (USA)

AutoZone, Inc.

CarMax, Inc

Costco Wholesale Corporation

Family Dollar Stores, Inc.

Kohl’s Corporation

Target Corporation

Wal-Mart Stores, Inc.

NIKE, Inc.

Aeropostale, Inc.

Bed Bath & Beyond Inc.

Best Buy Co., Inc.

Coach, Inc.

Fossil, Inc.

Hibbett Sports, Inc.

RadioShack Corporation

Ross Stores, Inc.

The TJX Companies, Inc.

A few thoughts…

Many stocks are close to new highs and are well above their lows. Some caution is in order.

Please take the expected return estimate with a large grain of salt. This projection is based in large part on the company’s growth over the past ten years. This may OR MAY NOT be indicative of its future growth.

The author of this blog is NOT an investment, trading, legal, or tax advisor, and none of the information available through this blog is intended to provide tax, legal, investment or trading advice. Nothing provided through these posts constitutes a solicitation of the purchase or sale of securities/futures. The data and information presented in this blog entry is believed to be accurate but should not be relied upon by the user for any purpose. Any and all liability for the content or any omissions, including any inaccuracies, errors or misstatements in such data is expressly disclaimed.

Links of Interest – November 5, 2010

WHO HAS THE PRICING POWER? | PRAGMATIC CAPITALISM

The best investors have this… Do you? — GuruFocus.com

David Winters Video – Consuelo Mack WealthTrack

Marty Whitman’s Outlook on Investing in the U.S. and China – Barrons.com

Why sitting all day is slowly killing you – Health – Men’s health – msnbc.com

Tweedy, Browne 3rd Quarter 2010 Letter

David Einhorn & Greenlight Capital’s Q3 Investor Letter

Yacktman Fund 3rd Quarter 2010 Letter

Weitz Funds Semi-Annual Report September 30, 2010

East Coast Asset Management: The Joys of Compounding


Benjamin-Graham-Common-Sense-Investing

How to Turn $11 Million into $1 Billion

In a 2000 article published in Money, Jason Jweig profiled a remarkable investor and friend of Warren Buffett named Joseph Rosenfeld who oversaw the investment committee for Grinnel College, a small school in Iowa.

“Joe,” says Buffett, “is a triumph of rationality over convention.” By ignoring the conventional wisdom about investing, Rosenfield has made money grow faster and longer than almost anyone else alive. Since 1968, he’s turned $11 million into more than $1 billion. He has heaped up those gains not with hundreds of rapid-fire trades but by buying and holding–often for decades. In 30 years, he’s made fewer than a half-dozen major investments and has sold even more rarely. [emphasis added] “If you like a stock,” says Rosenfield, “you’ve got to be prepared to hold it and do nothing.”

Here are the lessons from Joe Rosenfeld as summarized by Jason Jweig.

Do a few things well. Rosenfield built a billion-dollar portfolio not by putting a little bit of money into everything that looked good but by putting lots of money into a few things that looked great. Likewise, if you find a few investments you understand truly well, buy them by the bucketful. However, I think Rosenfield is a rare exception. Without his kind superior knowledge, skill and connections, most of us mere mortals need to diversify broadly across cash, bonds, and U.S. and foreign stocks.

Sit still. If you find investments that you clearly understand, hold on. Since it was their long-term potential that made you buy them in the first place, you should never let a short-term disappointment spook you into selling. Patience–measured not just in years but in decades–is an investor’s single most powerful weapon. Witness Rosenfield’s fortitude: In 1990, right after he bought Freddie Mac, the stock dropped 27%-. Rosenfield never panicked. Instead, he just waited. “Joe invests without emotion,” says Buffett, “and with analysis.

Invest for a reason. Rosenfield is a living reminder that wealth is a means to an end, not an end in itself. His only child died in 1962, and his wife died in 1977. He has given much of his life and all of his fortune to Grinnell College. “I just wanted to do some good with the money,” he says. That’s a lesson for all of us. Instead of blindly striving to make our money grow–or measuring our worth by our possessions–each of us should pause and ask: What good is my money if I never do some good with it? Is there a way to make my wealth live on and do honor to my name?

Coca-Cola (KO) Offers Good Risk-Adjusted Returns

To no surprise, Coca-cola (KO) showed up on my watchlist this week of companies with excellent long-term returns on equity. KO is widely regarded as one of the finest businesses in the world. Even after well over a hundred years of growth, the company is still expanding and has huge untapped and under-tapped markets ahead if it. Its moat is wide, and it has shown a great ability to not only grow its core brands, but also to adapt to local tastes and develop or acquire new products.

The stock has performed well as of late and is currently very close to its 52-week high.

Today, I am taking a look at KO’s valuation. I am using the general approach put forth in Prem Jain’s excellent book on Warren Buffett called Buffett Beyond Value: Why Warren Buffett Looks to Growth and Management When Investing.

Based on KO’s long-term track record, I am estimating that EPS will grow at a rate of 8% annually over the next decade. The mean EPS estimate for 2010 is $3.50. Assuming 8% annual growth, EPS will be $7.54 in 2020. I am further assuming that given KO’s superior economics it deserves a P/E of 20, if fully valued. Its median P/E over the past decade has been 21. That would give KO a price of $150.80 in 2020. Using a discount rate of 7%, the present value of KO’s stock is $76.67.

Now let’s look at KO’s dividends. I estimate that KO will pay a dividend of $1.84 over the next 12 months and that the dividend will also grow at a rate of 8% over the next decade. By my estimate, KO’s dividend has grown by over 10% annually over the past decade. Using the same discount rate of 7%, the NPV of KO’s dividends over the next decade is $17.94.

Add the NPV of the dividends ($17.94) and the present value of the 2020 stock price ($76.67) and you get an intrinsic value of $94.61, which is a discount of about 35% from where it is currently trading. The discount coupled with KO’s formidable moat gives you a margin of safety.

By comparison, using a discount rate of 12% in the same equations gives an intrinsic value of about $62 per share. KO traded as low as $50 per share within the prior 52 weeks. Director Barry Diller purchased $20 million of the stock at $39.91 in March of 2009. Diller recently raised his stake by purchasing another 120,000 shares at a cost of $7.4 million.

Of course, when doing this type of analysis it makes sense to plug in your own assumptions for the growth rate, discount rate and terminal P/E.

The author of this blog is NOT an investment, trading, legal, or tax advisor, and none of the information available through this blog is intended to provide tax, legal, investment or trading advice. Nothing provided through these posts constitutes a solicitation of the purchase or sale of securities/futures. The data and information presented in this blog entry is believed to be accurate but should not be relied upon by the user for any purpose. Any and all liability for the content or any omissions, including any inaccuracies, errors or misstatements in such data is expressly disclaimed.