The Value trail...

[petekoch]

Originally Posted by npg

Now, when you project earnings into the future from past performance, there is a big danger that one assumes uninterrupted growth for long periods of time. Phil projects the earnings 10 years into the future --which is a long time frame.

This is one of Greenwald's main points in Value Investing: From Graham to Buffett and Beyond and why he advocates what he calls Earnings Power Value, which he builds from the most current earnings. He argues that going 10 years out with any method, e.g., DCF projections, is a very imprecise undertaking. So you work from 'adjusted' current earnings. The adjustments, of course, depend upon one's knowledge of the company, its business, its competitive environment and its financial statements.

Knowledge of the company, a familiar refrain.

Another thing I'm picking up in just about everything I have read lately is that the vast majority of companies are inexorably headed for a condition where returns (at best) equal the cost of capital. Those companies which provide excess returns year after year and decade after decade are rare birds, indeed. In other words, the moat had better be wide and deep.

I have owned 3 stocks for over 25 years and still retain a small position in one (thru an acquisition) and most of my original position in another; two have wide, deep moats. I can't take credit for any stock picking acumen, because I had nothing to do with selecting them. It was fortune/luck. But I know what they have meant to my overall net worth, so my search is for more like them.

[onerule]

Originally Posted by npg

This page from the intelligent investor is absolute dynamite!

On that page, this little gem is a true classic

Extremely few companies have been able to show a high rate of uninterrupted growth for long periods of time. Remarkably few, also, of the larger companies suffer ultimate extinction. For most, their history is one of vicissitudes, of ups and downs, of change in their relative standing. In some the variations "from rags to riches and back" have been repeated on almost a cyclical basis.

Now, when you project earnings into the future from past performance, there is a big danger that one assumes uninterrupted growth for long periods of time. Phil projects the earnings 10 years into the future --which is a long time frame. This is one of the reasons why I believe you need to be very careful when using this valuation. This can turn sour very quickly, and the 3 tools give you little protection. Their signal is sometimes ambiguous.

Comments?

I'm not trying to defend Phil's methods; I agree, they have their limitations and I think the whole 3 tools thing is pretty much hogwash.

However, built-in to his calculations is the requirement for a 50% 'margin of safety' which provides a degree of risk management. Small-cap, high-growth companies are impossible to value properly; that's why, for the most part, they are speculative. However, larger, established companies with sustained growth of 15% or more over many years offer better prospects for a satisfactory outcome. Buying them at half-price offers about as much protection as you can get with these types of companies. Take Coach (COH), for example; its growth record is impressive, and it has been sustained over many years. At 30+ its PE is high in comparison to the average for the S&P, but is it expensive?

(NB. I'm not touting Coach, I don't have a position in the stock, and it's nowhere near its MOS price.)

At some point, Coach's growth will slow significantly, but is that enough to avoid buying the stock? I agree, though: you've got to know these stocks inside and out, and keep your eyes on the horizon.

[npg]

Please be as critical as you like. The reason I am posting thoughts is to test how well they stand scrutiny.

[Rooster]

A new opportunity, perhaps, is presented with MRO. I am attempting to purchase Western Oil Sands (WTOIF) before the merger so I can benefit from the spinoff WesternZagros as well as from the parent company. I got this idea from reading Greenblatt's "You Can Be a Stock Market Genius."



Marathon Oil Seeks Canadian Deal

By TINA PENG
August 1, 2007

Marathon Oil Corp. offered to purchase Western Oil Sands Inc. for $5.45 billion, which would give the Houston company a foothold in Canada's massive heavy-oil deposits and deepen the ties between the northern Alberta oil reserves and U.S. refineries.


The proposed deal is the latest example of growing production from Canada's oil sands being sent by pipeline into the Midwest to be turned into gasoline for U.S. drivers.


It follows a deal last year between the U.S.'s ConocoPhillips and Canada's EnCana Corp. to create a joint venture with oil sands and U.S. refining assets. Husky Energy Inc., based in Calgary, bought a refinery in Ohio earlier this year to turn gunky heavy oil into high-value transportation fuel.
Western Oil Sands' primary asset is a 20% interest in the Athabasca Oil Sands Project, which is operated by Royal Dutch Shell PLC's Canadian subsidiary. The Athabasca project is comprised of a facility outside Fort McMurray, Alberta, where oil-soaked sands are mined from the earth, and a processing unit near Edmonton.


Calgary-based Western Oil Sands generates about 31,000 barrels a day of crude oil, but that figure is expected to rise to more than 130,000 barrels a day by 2020 because of planned expansions. A subsidiary of Western Oil that operates in the Kurdish portion of Iraq will be spun off to current shareholders.


Marathon's cash-and-stock offer represents a 4% premium for Western Oil Sands shareholders, based on the stock's close Monday, potentially leaving the door open for other suitors.


Western shareholders will receive 3.8 billion Canadian dollars (US$3.6 billion) in cash and 34.3 million shares of Marathon common stock and securities. Marathon will assume Western's debt, which was valued at $650 million at the end of June.


In 4 p.m. New York Stock Exchange composite trading, Marathon's shares were down $1.80, or 3.2%, at $55.20. Western Oil Sands' shares rose C$3.19, or 9.4%, on the Toronto Stock Exchange to C$37.32.


Analysts generally viewed the acquisition move favorably. "More companies are going to have to make additional acquisitions to replace their reserves and production or they're going to have to shrink their companies dramatically," said Ben Halliburton, chief investment officer of Tradition Capital Management in Summit, N.J.


Marathon said Western Oil owns about 2.6 billion barrels of crude in the ground, which, if mined at 2020 rates, would last almost 55 years.
Marathon also reported an 11.3% drop in second-quarter net income from a year earlier, when it recorded a large gain. Lower oil production, coupled with higher exploration costs and taxes, contributed to a 39% drop in exploration and production operating income to $400 million from $659 million.

[Rooster]

Marathon seems, at first blush, to be a solid company. Any thoughts, especially contrary ones, would be appreciated. I used
V = projected EPS * (8.5 + 2G) * 4.4/AAA to calculate the alternative MOS.

[npg]

Originally Posted by Rooster

A new opportunity, perhaps, is presented with MRO. I am attempting to purchase Western Oil Sands (WTOIF) before the merger so I can benefit from the spinoff WesternZagros as well as from the parent company. I got this idea from reading Greenblatt's "You Can Be a Stock Market Genius."

Maybe you would like to explain your reasoning further?

[joshuat]

Originally Posted by onerule

However, built-in to his calculations is the requirement for a 50% 'margin of safety' which provides a degree of risk management. Small-cap, high-growth companies are impossible to value properly; that's why, for the most part, they are speculative. However, larger, established companies with sustained growth of 15% or more over many years offer better prospects for a satisfactory outcome. Buying them at half-price offers about as much protection as you can get with these types of companies.

I'm going to disagree with this strongly, mostly to play devil's advocate, and to refine my thinking. Certainly a long term 15% gainer is a beautiful thing.

Small caps may be hard to "value" - i.e. place an intrinsic price on it, but we really don't have to do that. Pabrai writes about this in detail in his book Mosaic. Basically, what we need to do is identify stocks with strong potential with limited downside. So, if you get the call wrong (and we call call 'em wrong sometimes), you don't lose much money. But, if you get it right, you have a multi-bagger.

It's instructive to build a fake portfolio of 10 stocks. Make 2 of them total loses. Another 3-4 losses in the 40% range. Another 3 flat. And 2-3 home runs. You end up with tremendous gains - far beyond the 15% steady gainer.

Look at Buffet's investing strategy when he was running his partnership. He was not searching for 15% gainers. They are very hard to find. He was looking for smaller caps, stocks that could give him multiples on his capital. Of course, some didn't manage that, but look at his returns over those years. Look at Pabrai's returns following this strategy.

Right now some of the mega-caps look pretty yummy, so picking some up may not be a bad idea. But we really don't need to be following the BRK method of investing, because we aren't trying to put $50B into play.

To take a few examples. I own a couple of regional banks which have been absolutely hammered by the subprime news. Thing is, they don't have any subprime loans. Their finances are rock solid. I haven't calculated intrinsic value, and feel no need to - they are dirt cheap, and getting hurt by them is just about impossible at current prices. Sure, it could turn out the CFO is a crook, and I could suffer permanent loss of capital, but I put that at a very conservative 1%. I don't know when they are going to turn around, nor how far they will go when they do, but it is very, very likely (I estimate 80-90%) that they will. So they are part of my portfolio. If I'm wrong, 10% of my portfolio will take a hit. I have 8 other stocks (in other fields) that I bought under the same condition. I can't tell you which ones are going to be the multi-baggers, but they all have the potential,and all prices are very depressed right now despite very strong fundamentals and low debt. So what if there is no money to borrow - they aren't borrowing.

Time will tell, but I expect a portfolio constructed like this will handily beat out a portolio of wide moat, 15% gainers. Buffett confidentially states he could earn 50% per year investing this way. I don't think we can all make that level of returns, but I think we can beat the S&P and wide moat mega-caps.

Thoughts?

[npg]

Hmmmm, I like the obligatory 1% total downside bit. That's soooo Pabrai %)

In essence you are almost there. The Buffett Partnership followed pretty much a Newman-Graham selection style of arbitrages and companies below net asset value. I heard Buffett mention that back then they were not allowed to call the companies up and ask them questions. Ben did not want to use any information that was not publicly available (Graham tried to prove a point back then). To quote Warren: "...once the numbers were right the stock was in".

Graham had a diversified portfolio. So yes, a couple of nice home runs did make it big for the company. You got that one alright (imo).

Out of favor stocks? Definitively the ones to look at. The resulting lack of analyst coverage in them can result in great opportunities for the next upswing (again, refer to the Intelligent Investor for a more thorough explanation).

Reading Rule#1 igives the impression that it's ok to bet the farm on one company alone. A company most readers are not able to explain the core business to an outsider, never mind explaining the accounts. But running a spreadsheet suddenly makes em better than highly qualified Analysts. On a intensely followed stock it is quite unlikely that the individual investor will do better than an Analyst (re: Intelligent Investor).

So yes, that whole subprime thing is creating a lot of angst. Somebody once mentioned to me that he did not like a top notch insurer (BER) because they had a lot of mortgage backed securities. So obviously, like your banks, he shys away from these fantasic companies because of ignorance. What he failed to appreciate was that mortgage backed securities always carry a resonable risk and having them is totally ok, even sensible. What is not ok is having them in high risk loans and in excessive, speculative amounts. So you got to call them and acually ask them the question how many of them, if any, are sub-prime. A qualified analyst can be expected not to make such grave mistake. It would get picked up immediately.

I would not try and 'outsmart the pros'. Because that won't happen.

What the intelligent investor can do however (and that was brilliant advice from Ben) is buy companies institutional investors can't. They can't because when a client calls up and asks: "How are we doing?" you don't really want to answer: "We are doing great. I bought some wonderful companies and we are 30% down". In some cases you may be able to say that, but not for long. Now try that for a longer period, say 3 years. You won't have any customers by then.

There are some exceptions though. When Warren transferred some of his clients to the Sequoia fund the performance in the first few years was abysmal (yes, about 30% down--it was that bad. But people trusted Warrens judgement). The guy felt like never answering the phone and hiding under his desk in shame. Then all of the sudden, the investments matured, the cycle turned, and the profits were back with a vengance. The upswing is almost too insane to believe. This explains why often fund managers buy totally different stocks for their own retirement funds than for the fund they actually manage.

Fact is, I cannot time the market. What I can do however, is buy cheap and wait for the cycle to turn.

Rule#1 makes it sound so easy. Punch in a ticker and then have the computer spit out a price for you. And all of a sudden you understand the company. Oh, and I have these secet tools that tells me what the fund managers are doing.... I can beat them. I know something they don't. MEEEEEEP WRONG BUSTER! They can buy that book too. And guess what, they learned nothing new reading it.

Fragments of the book are ok. It is a good introduction. But if you believe that's all you need to know then you are in for a hell of a ride (see the teamwork thread).

There is some very bad advice in that book. Arguably, diversification can have an impact on performance. YES. But are we a Warren Buffett or a Bill Rouane? No. We need to diversify until we have such good grip on the fundamentals that we can start stacking the odds differently. Until then it's diversify time, baby. Having your entire life savings in one security doesn't make you less of an ignorant. In contrary. If you cannot explain your investment thoroughly then you are not only an ignorant, but also an incredible fool whose wealth will be sucked up by wall street when the day of the reckoning comes.

That old rule, substract your age from 100-the result is the percentage you should hold in securities-is still valid and stellar advice. If you cannot save, don't invest. Always invest like a rich man, not to make money, but preserve capital.

The problem with this is that it's extremely counter intuititve. Also, it can take years for the positions to develop and snap back to a fair valuation. A lot of people don't like to be 15% or even 30% down over a period of time.

Amen.

Disclosure: One of my bridge partners is a professional fund manager.

[capp53]

[quote=npg;9327]Hmmmm


What the intelligent investor can do however (and that was brilliant advice from Ben) is buy companies institutional investors can't. They can't because when a client calls up and asks: "How are we doing?" you don't really want to answer: "We are doing great. I bought some wonderful companies and we are 30% down". In some cases you may be able to say that, but not for long. Now try that for a longer period, say 3 years. You won't have any customers by then.

I think when you buy a stock and watch it go down 30% the term "Intelligent Investor" is an oxymoron. I am not prepared to lose that kind of money and continue to sit with the stock. While there is a lot of bashing of technicals, I believe they do work. The main purpose of the techs is preservation of capital. Do they gave false positives? Sure! Are they perfect? No! But they do give an indication of money flows and that is what moves a stock. Add in low transaction costs and there is no reason to watch your money fade away!

[Gunnski]

"Amen".

I am not a smart guy. I am a nuts and bolts guy. I need the tools. I do not want to think outside the box. I like grounded, simple workable rules!

I am not silly enough to think investing is plug and play or R-1 investing is the Rosette Stone. But, I do believe in the rules and the tools. I am sure I can use stops, trailing stops and limits, but I like the tools. It fits my style of investing.