Value-Stock-Plus

by Jeremy Grantham

Waiting for Markets to be Silly Again
A year is certainly a long time in markets, and so is a quarter. A year ago, equities globally – and everything else for that matter – were very overpriced, particularly if they were risky. A quarter ago, in mid March, prices everywhere were cheap. Now they have all – or almost all – converged for a few unusual moments at fair value. A year ago, it was very easy to know what to be: a risk avoider. It was not so easy reinvesting when terrified, but most of us knew that we should have been doing more. But today? It’s difficult to be inspired at fair value. Since early March, the market has had the type of strong speculative rally that often follows extreme declines. The danger of a breathtaking rally is that it leaves those few investors who raised considerable cash waiting for a pullback and psychologically invested in the case for a new bear market leg. This was covered in our mid-March posting, “Reinvesting When Terrified.” That theme was developed a few weeks later for me when the penny dropped: the extreme stimulus and moral hazard of recent quarters resembled the stimulative third year of a Presidential Cycle. Indeed, it seems to have turned this usually restrictive Year One into a giant Year Three effect.

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If you find a stock that you believe is undervalued, it is important to try to determine the reason for the undervaluation. As Buffett wrote about poker in his 1987 letter to shareholders, “If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.”

Interestingly, some value investors, such as David Einhorn of Greenlight Capital, invert this process. Rather than first looking for undervalued stocks based on quantitative screens, for example, low multiples of price to earnings or price to book value, they first identify areas of the market where undervaluation is likely to be present and then search for good companies within that undervalued sector.

When Buffett purchased shares of the Commonwealth Trust Co. of Union, New Jersey, he indentified the reason that was largely responsible for the depressed price of the company’s stock. It was because the company was not paying a cash dividend. Identifying this reason reduced the probability that there were other unknown or poorly understood reasons why the stock price was depressed which could have materially reduced the intrinsic value of the company and lead to a permanent loss of capital.

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How to implement a Buffett-inspired fund strategy.

by John Coumarianos

Financial advisors and consultants are always giving themselves intellectual hernias trying to figure out which mutual funds work well together in a portfolio. Everyone’s looking for funds that all do well over time but take different routes to good long-term returns, thereby providing the entire portfolio with stability along the way. In this piece, instead of trotting out the rules of Modern Portfolio Theory, we’ll review the two segments of Warren Buffett’s investment career and suggest funds that should work well together based on their correspondence to those segments. Basically, choosing two funds, each one corresponding to each equally successful major part of Buffett’s career, should produce a well-diversified domestic stock portfolio.

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Seth Klarman is nobody’s idea of a fast-buck, quick-change investor. Since helping to found Boston-based Baupost Group in 1982 with $27 million pooled from four families, he has emulated prototypical value-investment role models like Warren Buffett and the late Benjamin Graham. He buys underpriced equities and securities of bankrupt or distressed companies and usually steers clear of leverage and shorting, though last year he made very profitable investments in credit protection and recorded his best-ever annual return (52 percent). Klarman credits his “very strong team” and stresses that he doesn’t even consider himself a hedge fund manager in the traditional sense (though he accepts only legally qualified investors and charges a 20 percent performance fee). Yet his nearly 20 percent annualized returns rival those of larger peers who take more risks. A professorial 51-year-old who manages $12 billion today, Klarman has an economics degree from Cornell University and an MBA from Harvard Business School but traces much of his success to two Wall Street mentors, Max Heine and Michael Price.

How did you decide value investing was for you?
I was fortunate enough when I was a junior in college — and then when I graduated from college — to work for Max Heine and Michael Price at Mutual Shares [a mutual fund founded in 1949]. Their value philosophy is very similar to the value philosophy we follow at Baupost. So I learned the business from two of the best, which was better than anything you could ever get from a textbook or a classroom. Warren Buffett once wrote that the concept of value investing is like an inoculation- — it either takes or it doesn’t — and when you explain to somebody what it is and how it works and why it works and show them the returns, either they get it or they don’t. Ultimately, it needs to fit your character. If you have a need for action, if you want to be involved in the new and exciting technological breakthroughs of our time, that’s great, but you’re not a value investor and you shouldn’t be one. If you are predisposed to be patient and disciplined, and you psychologically like the idea of buying bargains, then you’re likely to be good at it.

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We asked a 15 year old summer work intern, Matthew Robson, to describe how he and his friends consume media. Without claiming representation or statistical accuracy, his piece provides one of the clearest and most thought provoking insights we have seen.

Teenagers are consuming more media, but in entirely different ways and are almost certainly not prepared to pay for it. They resent intrusive advertising on billboards, TV and the Internet. They are happy to chase content and music across platforms and devices (iPods, mobiles, streaming sites). Print media (newspapers, directories) are viewed as irrelevant but events (cinema, concerts etc.) remain popular and one of the few beneficiaries of payment. The convergence of gaming, TV, mobile and Internet is accelerating with huge implications for pay-TV.

For mobiles, price is key – both in terms of handset prices – £100-200 – as well as taking pay as you go as opposed to contracts. Mid-range feature phones still dominate, meaning that Sony Ericsson does well as that’s their sweet spot. High-end smartphones are desirable but too expensive. Most prefer to own separate devices for music, and messaging. Texting is still key and use of new data services limited due to cost. Wi-Fi is more popular than 3G.

Report by Morgan Stanley (via FT.com)

Global Banking Economist Warned of Coming Crisis

by Beat Balzli and Michaela Schiessl

William White predicted the approaching financial crisis years before 2007’s subprime meltdown. But central bankers preferred to listen to his great rival Alan Greenspan instead, with devastating consequences for the global economy.

William White had a pretty clear idea of what he wanted to do with his life after shedding his pinstriped suit and entering retirement.

White, a Canadian, worked for various central banks for 39 years, most recently serving as chief economist for the central bank for all central bankers, the Bank for International Settlements (BIS), headquartered in Basel, Switzerland.

Then, after 15 years in the world’s most secretive gentlemen’s club, White decided it was time to step down. The 66-year-old approached retirement in his adopted country the way a true Swiss national would. He took his money to the local bank, bought a piece of property in the Bernese Highlands and began building a chalet. There, in the mountains between cow pastures and ski resorts, he and his wife planned to relax and enjoy their retirement, and to live a peaceful existence punctuated only by the occasional vacation trip. That was the plan in June 2008.

And now this.

White is wearing his pinstriped suits again. He has just returned from California, where he gave a talk at a large mutual fund company. Then he packed his bags again and jetted to London, where he consulted with the Treasury. After that, he returned to Switzerland to speak at the University of Basel, and then went on to Frankfurt to present a paper at the Center for Financial Studies. From there, White traveled to Paris to attend a meeting at the Organization for Economic Cooperation and Development (OECD). Finally, he flew back across the Atlantic to Canada. White is clearly in demand, including in North America.

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Almost a year after A.I.G.’s collapse, despite a tidal wave of outrage, there still has been no clear explanation of what toppled the insurance giant. The author decides to ask the people involved—the silent, shell-shocked traders of the A.I.G. Financial Products unit—and finds that the story may have a villain, whose reign of terror over 400 employees brought the company, the U.S. economy, and the global financial system to their knees.

by Michael Lewis

Six months ago, I received an odd phone call from a man named Jake DeSantis at A.I.G. Financial Products—the infamous unit of the doomed insurance company, staffed by expensively educated, highly paid traders, whose financial ineptitude is widely suspected of costing the U.S. taxpayer $182.5 billion and counting. At the time A.I.G. F.P.’s losses were reported, it became known that a handful of traders in this curious unit had sold trillions of dollars of credit-default swaps (essentially unregulated insurance policies) on piles of U.S. subprime mortgages, but its employees hadn’t yet become the leading examples of Wall Street greed. And so this was before Jake DeSantis and his colleagues found themselves suburban-Connecticut outcasts, before their first death threats, before the House of Representatives passed a bill because of them (taxing 90 percent of their large bonuses), before New York attorney general Andrew Cuomo announced he was going after their paychecks, and before Iowa senator Charles Grassley said that A.I.G.’s leaders should follow the Japanese example and “either do one of two things, resign or go commit suicide.”

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