Monthly Archives: February 2011

Links of Interest – February 25, 2011

GMO Quarterly Letter – All good but Grantham’s speech beginning on page 6 is worth a close read.

Richard Koo | Institute for New Economic Thinking – Leading economist talks about the lessons learned from Japan’s great recession and how they apply to the United States.

Jean-Marie Eveillard – Interview with

Buffett’s Berkshire Hathaway Buoyed by Insurance ‘Float’ – – The rich get richer. Berkshire”s insurance moat continues to grow.

Bronte Capital: A small hedge fund manager’s lament – A perspective on the current market.

Interview with Prof. Bruce Greenwald; Insight in Value Investing —

Distressed Debt Investing: Greenstone Value Opportunity Fund Annual Letter

On the critical task of risk management

We live in a very uncertain world. The unfolding of events in the Arab world was unforeseen. Moreover, the future course of events is difficult, if not impossible, to predict.

Add to this the uncertainty that surrounds our economy. Few would argue that the U.S. economy and the global economy are benefitting from an unprecedented level of fiscal and monetary stimulus. Given its vast scope, the effects of this stimulus will be far reaching and many of its consequences will only be known and understood in hindsight. Smart and reasonable people disagree on whether these policies – along with the serious economic problems they are meant to address – will lead to inflation or deflation. Add to that the reality that the duration and shape of these policies will largely be determined by future political outcomes and it’s no wonder investors sometime feel like they are playing three-dimensional chess.

Yet, this is the world we live in. As investors it is critical that we consider the downside first. You are the risk manager of your portfolio. Just as CEO’s of many of our leading financial institutions badly miscalculated by delegating this task to others, it would be a mistake to stick your head in the sand and not understand the risks you are taking with your precious capital.

Paying lip service to risk management is easy. Everyone does it just like every businessman is fond of saying that his people are his most precious asset. Words and deeds are two entirely different things. Buffett is fond of the book When Genius Failed because it shows that even very smart people can do very risky and dumb things with their capital.

Here are a few ideas that may help you with managing risk.

  1. Set aside a regular period of time to carefully go through your holdings and consider the risks involved in each position? Create a checklist to use in doing this assessment.
  2. Are you exposed to life changing economic risk, meaning can you envision a scenario that has any likelihood of happening where you could be wiped out?
  3. Are you exposed to ignorance risk in that you don’t understand a given position and why you are holding it? Consider that it appears likely that Buffett liquidated Lou Simpson’s stocks picks (Buffett’s motive is speculation on my part) when Simpson left Geico because Buffett does not back into positions and hold things that he does not understand (in the Buffett predictive sense of the word), even if they are otherwise good companies. Remember that you are much more likely to succumb to fear and dump a position in a downturn if you lack conviction born of your own work.
  4. Are you holding overvalued securities that subject you to permanent loss of capital in a downturn?
  5. Is your concentration in long-equities too high or are you overly concentrated in one stock or one industry?
  6. Have you considered how the businesses in which you are invested would do if high inflation ensues? How about if deflation and low-GDP growth develop?
  7. Do you have positions that are overly leveraged and overly dependent on the capital markets?
  8. If a company’s valuation is predicated on growth, how certain are you that the growth will materialize?

This list is not exhaustive, nor is it intended to be. The point is that you are your own risk manager and that is something that in my view should be taken very seriously. Develop your own process and then have the discipline to follow it. Many great investors are great because they managed the downside and let the upside take care of itself. You can’t win if you don’t finish. Moreover, serious permanent loss of capital disrupts compounding and makes it much more difficult psychologically to step up to the plate when future fat pitches appear.

Financial Porn

I recently watched a video of a lecture that Tim McElvaine gave at The Ben Graham Centre for Value Investing at the Richard Ivey School of Business in Ontario. Tim now runs his own investment management company and worked for many years with the celebrated value investor Peter Cundill.

There are many lessons in Tim’s talk and it is worth watching. One simple but important point Tim made was the importance of filtering out financial porn. Buffett understood this many years ago when he located back to his home in Omaha in order to get away from people whispering stock ideas in his ear. Now, with the Internet, it takes more than going to a different location to get away from the financial porn that Wall Street spews worth.

Don’t get me wrong. The Internet is a transformational tool for an investor. The problem is the sheer quantity and quality of the information. Blogs, financial forums, RSS feeds, stock recommendations: the information flows like a mighty river. The problem with most of it is that it is an inch deep and a mile wide. No nutritional value.

As I have written before, good ideas cannot be produced according to the dictates of a publishing schedule. Pay close attention to the incentives of those publishing stock ideas. Only rarely do they remotely align with your own.

Big money is made the old fashioned way: by doing deep fundamental analysis that requires time and solitude to read and think. There are no short-cuts. We all need to find ways to filter out financial porn. There is some great stuff out there, but a lot of it – if not most of it – will not help you make money and become a better investor. Make it a point to plan your business/investing day around the things that really matter and then practice the discipline of sticking to your plan.

Links of Interest – February 18, 2011


SHLD? – a discussion on Sears from

Citi Unit Grows — With Feds’ Help –

UPDATE 3-Buffett-backed BYD slashes car prices | Reuters


Tim McElvaine, CA, CFA at The Ben Graham Centre for Value Investing, Richard Ivey School of Business (disciple of Peter Cundill)

Peter Cundill and Tim McElvaine in OID, August 8, 1996

CONTROLLED Peter Cundill Book Excerpt

Comparing Recoveries: Job Changes –

The Peak Oil Chronicles, Part I: When The Giants Run Dry | FINANCIAL SENSE

Longleaf 2010 Annual Report

Graham & Doddsville – Winter 2011

Citigroup Offers Attractive Risk-Reward Opportunity

I recently took a position in Citigroup (NYSE:C). I think the stock has the potential to double or triple over the next three to five years with relatively little risk of permanent loss of capital from current levels. The stock was hammered by bad judgment and poor risk management. Prior shareholders were massively diluted. The bank now appears to be moving past the crisis and is well-financed. Its new management is focused on capitalizing on Citi’s unique strengths.

The Business

Citi is well positioned to capitalize on globalization with its unique global franchise and assets in approximately 140 countries. Under Vikram Pandit’s leadership, the bank is focused on a core strategy of serving affluent, globally-oriented retail customers and multinational corporations. Citi already has a leading position in serving these markets and this strategy exploits Citi’s competitive advantages. This strategy gives Citi large exposure to faster growing markets in Latin America and Asia.


Vikram Pandit is a very smart, high-integrity CEO, who is driven to “right the ship” and put his mark on Citigroup. He was hand-picked by Robert Rubin, who, notwithstanding criticism for his prior role at Citi, has been around a lot of very talented people. Pandit had no part in Citi’s prior leadership regime that led to Citi’s near collapse. In addition, he has been characterized as being prudent with regard to risk, which is obviously an important trait in someone running a large bank. Finally, I like his strategy of focusing the bank on areas where Citi has competitive advantages and shedding non-strategic assets. Pandit is also on record as wanting to begin returning capital to shareholders in 2012.

What is the downside?

The first question to focus on with Citigroup is, “What is the downside?” How do you get comfortable with the Citigroup’s bad loans and what they mean to its intrinsic value?

In my judgment, although the company is still dealing with its credit problems, they have turned the corner, and over the next few years they will work through the bad loans and return to normalized earnings. I look at this as similar to Buffett’s investment in Well Fargo in 1989 and 1990 after the California real estate crisis.

To get comfortable with Wells Fargo, Buffett assumed a worse-case scenario where 10% of its loans would become problematic leading to eventual losses averaging 30% of principal. Buffett concluded that Wells Fargo’s annual pre-tax earnings power was sufficient to “roughly break even” in such a scenario. Buffett wrote that he was happy to invest in a company with Wells Fargo’s economics and valuation, even if he had to face the possibility that the company would generate no earnings for a single year.

Consider the mathematics of Citi’s situation. Citi currently has gross loans of $608 billion. If 15% of those loans were to go bad and all the principal were to be lost – a scenario far more draconian than that envisioned by Buffett (and arguably deservedly so) – it would be a loss of $97 billion. Citi has loan loss reserves of $41 billion, so the net loss would be $56 billion. Citi generated $38 billion of pre-provision, pre-tax income in 2010 so such a meltdown would amount to far less than two years of earnings. Citi’s actual loan loss reserves are less than 7% and it has slowly begun to release reserves as conditions improve.

Here is what Bruce Berkowitz said about getting comfortable with Citigroup in an interview with Morningstar.

In the U.S., this was not a bankruptcy, but it’s gone through a scrubbing process, very similar to a bankruptcy, by the U.S. Treasury. Citigroup has spent a good amount of time with the U.S. government and many of its financial regulators, going through every liability and asset in the books.

After such a period of time, you normally are able to count the cockroaches. That is, the liabilities have been under a microscope for quite a period of time. There’s been huge capital injections by the government. There’s been a massive amount of dilution to old shareholders. And you’re starting to see some stability, the beginnings.

It’s very much what I call now the pig in the python. You have to look at their liabilities. So you have to look at their bad debt, and you have to continue to watch how the company is digesting its bad debt.

At the same time, you have to see the new debt that’s coming in, the new loans that they’re giving out. It’s fascinating. It amazes me, with financial institutions, the extent, the amount of new loans that are being created in relation to the total loan portfolio.

So it’s just now, in my opinion, a question of time, an ingestion period, where how many more quarters is it going to take before the new loans start to outweigh the old, existing loans?


Like Buffett, I focus on earnings power when valuing a bank, as opposed to book value. The key driver in a bank’s earnings is normalized return on assets (ROA). Citigroup has a long history of strong returns on assets with normalized ROA. Moreover, Citigroup has reorganized and is now focused on growing its core, higher return franchises, and it is shedding its non-core assets. Pandit’s guidance is for a normalized ROA of 1.25% to 1.5% on Citigroup’s assets, not including the assets that are marked for eventual divestiture or run-off.

I think these levels represent Citi’s normalized earnings power.

In my base case, I assume Citigroup will grow assets at a CAGR of 3% over the next three years and reach a normalized ROA of 1.4%. This puts normalized EPS three years out at about $.80 a share. (This may prove conservative given Citi’s new asset mix and exposure to emerging markets.) At its current price of about $4.90 that is about six times normalized 2014 earnings. In addition, I estimate that the assets in Citi Holdings and Citi’s $21 billion operating deferred tax asset could be worth another two dollars a share, which would drop the multiple to less than four times earnings.

If ROA only reaches 1.2% and the other assets are only worth $1 per share, the current price is still only about 5 1/2 times 2014 earnings.

I believe the current price, strong reserves and liquidity, and the quality of the global franchise provide a margin of safety and that investors are being compensated for the risk involved.


Price moving above $5 per share (economically meaningless, but possibly important to some institutional buyers).  Citi’s institutional ownership is less than 50%, whereas Wells Fargo and US Bancorp’s are 76% and 67%, respectively.

Return of capital to shareholders in 2012

Continued improvement in operating results

Other Positives

Large positions held by high quality value-oriented funds: Pershing Square (Ackman), Fairholme (Berkowitz), Paulson, Appaloosa Management (Tepper), Viking Global Investors (Halvorsen), MFP Investors (Price), and Kingdom Holdings (Alwaleed).

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.

A few good lessons from Buffett

I am in the process of improving my use of investment checklists. As such, I am always on the lookout for new items that I should include in my list. I have tried to make it a habit that anytime I read or hear about a good idea, I jot it down for consideration in my checklist.

One list I maintain, which was inspired by Monish Pabrai, contains investing mistakes which I have learned from others (although the list also contains my own mistakes). The list continues to grow, but it does not take much time to run down the list in thinking about an investment idea and the potential upside is huge.

Over the last couple days, I listened to Warren Buffett’s testimony for the U.S. Government’s Financial Crisis Inquiry Commission. The Financial Crisis Inquiry Commission was created to “examine the causes, domestic and global, of the current financial and economic crisis in the United States.”

Here is an account by The Motley Fool.

My purpose today is to share a few valuable lessons from Buffett (which he has stated before) that I think should be included in an investment checklist.

Have I drawn the wrong conclusion from a sound premise? Buffett quotes Ben Graham who said, “You can get in more trouble with a sound premise than an unsound premise because you’ll just throw out the unsound premise.” In the financial crisis, people took a sound premise – that real estate prices generally go up – and acted on it as if it would happen with a kind of metaphysical certitude. This led to taking risks based on this assumption that led to massive exposure to a “black-swan” event.

Buffett reminds us that people did the same thing in the twenties when they took a sound premise – that stocks generally outperform bonds, at least over long periods of time, because of stock’s higher earnings yield and reinvestment of earnings – and distorted it to conclude that they would always do so. Finally, the Internet bubble was based on a sound premise that the Internet would change our lives. It did not follow from that premise that one could invest in Internet stocks regardless of earnings or competitive forces.

A second lesson Buffett states is that a warning should go up if a company begins making investments that are totally unrelated to its core mission. It reminded me of how Buffett began to zero in on Coca-Cola as an investment just after the time when Roberto Goizuetta divested the company of non-core businesses such a shrimp farming. It is worth looking for businesses that are jettisoning lower margin businesses to focus on their core mission. Think American Express spinning off Ameriprise Financial or Citigroup’s ongoing divestiture of its Citi Holdings assets.

The third takeaway from Buffett’s testimony is that you should probably sell a stock if it goes up too much in price and becomes overvalued. Buffett said he probably should have sold Moody’s in 2006. This reminds me of similar remarks he made about not selling Berkshire’s Coca-Cola stock when it became grossly overvalued.

Fianally, Buffett reminds us to never invest in things we don’t understand. Virtually no one understood that complex derivatives that took down so many businesses in the crisis, yet people continued to invest in companies with massive exposure to these instruments.

In typical Buffett style, these are fairly simple lessons grounded in common sense and the core principles of value investing. The trick – as is often the case – is putting into place a rational framework that harnesses their wisdom and having the emotional temperament and discipline to put them into practice.

Links of Interest – February 11, 2011

Stock Ideas

CONTROLLED Clough’s Take on Microsoft

BYDDF – BYD Company Limited

How Berkowitz Got Comfortable with Citi

NetJets Posts Profits But Margins Remain Under Pressure | The Rational Walk (Berkshire Hathaway)

This Stock Has It All (AMD, INTC, TXN)


Goldman Sachs is not bullish about gold | PRAGMATIC CAPITALISM

FPA Capital’s Bob Rodriguez Says Economic Meltdown Looming: AdvisorOne Interview | Advisor One

Nygren: Don’t Compare Growth With Value

David Einhorn’s Speech at The UJA (February 3rd 2011) —

Howard Marks on The Human Side of Investing | The Rational Walk

Understanding The Modern Monetary System | PRAGMATIC CAPITALISM

Webinar Replay: “A Discussion With the Managing Directors of Tweedy, Browne” presented on February 3, 2010

Managing Priorities

Bill Ackman of Pershing Square on CNBC

“In the long run, everything is a toaster” – Nokia’s Cautionary Tale

Value investing guru and competitive strategy expert Bruce Greenwald of Columbia University has said that, “In the long run, everything is a toaster.” It is his own pithy way of summarizing the brutal realities of creative destruction and operating or investing in a business without a competitive advantage, or as Buffett famously calls it a “moat”.

Although this lesson has been learned – and re-learned – many times, Nokia once again reminds us that we neglect it at our own peril.

Today’s Wall Street Journal reports that Nokia’s CEO Stephen Elop has revealed his plan for turning around the ailing company.

“Nokia, our platform is burning,” Mr. Elop writes in the memo, reviewed by The Wall Street Journal. “It will be a huge effort to transform our company,” he adds.

Some believe that Nokia will now adopt Google’s Android platform.

It was only a few years ago that that the business press and investors were enamored with Nokia’s dominant position in the global mobile phone market. It enjoyed growing market share, nimble design and distribution resources, and a leading and growing presence in emerging markets.

What Nokia did not have was a moat.

Can they turn the company around? Maybe. But it will be very tough sledding given the prevailing competitive market.

The takeaway: add this lesson to your investing checklist – if you haven’t already – and resolve to use it as one of your fundamental filters.

Finding your Charlie Munger may boost your bottom line

In his book The Checklist Manifesto, Atul Gawande writes about how checklists are used in complex construction projects. One type of checklist that is used is a Gantt chart that lays out in infinite detail every step of a project.

Builders have found that this type of checklist alone is not enough. In the real world, there are inevitable clashes where one subsystem – a steel beam, for example – clashes with another subsystem – the placement of an HVAC duct. In such cases, experience has taught builders that the best way to manage these types of issues is to have all those affected come together and work out a solution. The inherent complexity involved requires human interaction and input from experts in various disciplines. This gives birth to a second checklist which is used to track and make sure that those conversations actually take place and the issues resolved.

In learning about this use of checklists to ensure dialog among experts, I could not help thinking about Warren Buffett and Charlie Munger. Here is Buffett – one of the best investors of all time – and over his career he has found great value in picking up the phone and discussing his investment theses with Charlie. Of course, Buffett is more than capable of making his own investment decisions, but he knows that Charlie may point something out to him that he missed.

I think all investors could benefit from having a Charlie Munger to speak with. Here is a list of what to look for:

Intelligence (although genius is not required)



Business acumen (actual experience a plus)

Understanding of value investing

Healthy skepticism

Broadly read

Not a “yes man” or “people pleaser”

Not prone to spouting Chauffeur knowledge

Links of Interest – February 4, 2011

Google Is Undervalued, Shares Are A Buy


CONTROLLED Richard Russell Turning Bullish on Stocks?

Whitney Tilson Reduces Short Exposure, Refocuses on Buying Cheap Stocks ~ market folly

Einhorn Takes Stake In Georgia Bank —

RAIL TRAFFIC REMAINS STRONG – relevant to gauging the economy and valuing Berkshire Hathaway.

What Has Worked in Investing – updated 2009. Further evidence that value investing works.

Indexed or not indexed? – written in 1997 by François Rochon. Rochon of Giverny Capital makes the case for value investing.

High confidence + humble approach = happy investor – by FRANCOIS ROCHON, February 1, 2011