My life lately: wake up at 6am, leave house 6:45am, work for a long time, return home at 9pm.
This has not been leaving me with any free time to blog. I promise to have something thoughtful up here soon. In the meantime, feel free to comment on anything I've written.
I'm also taking requests. If you have a financial question, please email it to me and I'll try to get to a few questions in a reader's mailbag.
You can reach me at moneymanblogger at yahoo dot com.
Thanks for your patience.
Thursday, March 29, 2007
My life lately: wake up at 6am, leave house 6:45am, work for a long time, return home at 9pm.
Monday, March 19, 2007
I haven't had much time to post with some big projects at work keeping me busy, but trust me, I have been following the financial markets. The story that really caught my eye today was the fact that Servicemaster is being acquired, which boosted the stock 12% today. Not to be confused with funeral services firm Service Corp. Intl, Servicemaster provides residential and commercial services in the US (notably, the company owns the Terminix termite-control brand, and the Merry Maids housekeeping service, among other businesses).
I thought it was interesting that the EBITDA multiple seemed pretty high on the business 11-12x vs last year's typical multiple of 8-9x. It shows that buyout firms are still going strong despite some of the recent volatility in the market. This is one of those franchise businesses I really like, especially since the company doesn't face much foreign competition (in order for someone to get termites out of your house, they probably need to be in the country first).
Anyway, this and some other news sparked a slight rally today.
Friday, March 16, 2007
For some reason I've never taken this deduction, allthough I've moved around a few times for school within the past few years. However, I have just gotten started on my 2006 tax return and I noticed that there was a "moving expenses" deduction. My wife moved from out of state to marry me and take a new job in NYC this year, and I'm going to be sure to deduct some of the related expenses (we're filing jointly).
Her previous home is a few hundred miles away from here, and she took two trips that I would call "moving-related," one to specifically take a weekend apartment hunting with me, and another to move most of her stuff via her car. I am going to deduct mileage and tolls for these trips.
It ends up being a small deduction, but I think I'm already taxed at a ridiculously high rate, so I'm going to keep as much of my hard-earned money as i possibly can.
There are many sites on the internet that list "deductable" moving expenses, but I've found that many of these stretch the rules (for example, the IRS says that the cost of meals during a move is not deductable but some sites say that it is). Your best bet is to thoroughly read the most recent IRS publication 521 and keep good records during your move. I am not a believer in risky tax strategies, especially for the $100 or so of income my moving expense deduction is going to end up being.
Tuesday, March 13, 2007
Shhh! Don't tell anyone, but I've had a small trading account for about 8 years now. I use it as a way to make more speculative stock market bets. It is purely money that I can afford to lose, and I have considered it part of my financial education. (I opened it when I was 20 years old, but my first few stock trades were in my teenage years via my father's account). I make a clear distinction between that account and the accounts I use for investing.
Anyway, I decided I would try to short a subprime lender or two in this account today because I think there is more pain coming in this sector. However, when I tried to do so in Ameritrade, it told me that there was "no stock available to short" for the particular companies I tried.
Shorting is a way to bet on a stock going down, for those of you who are unfamiliar with it. It can be very dangerous, but I had some limits in mind in case the stocks bounced (hardly likely).
I guess shortable stock runs scarce when these companies implode. One of the companies I was going for in the morning was Accredited Home Lenders (LEND), it ended up dropping another 20-30% after I tried shorting it, telling me it would have been a good bet for a one-day gain.
Some of the stories I read today mentioned that around 13% of subprime loans were delinquent, or had payments 30 days past due. Some others mentioned the possibility of government aid to people who were missing payments on subprime loans. This made me extremely angry.
People who bit off more than they could chew in terms of mortgage payments do not deserve to be bailed out. They deserve to have the second homes, investment condos and other properties they bought hoping to flip (bidding up prices and pricing people such as me out of the market when they did it) taken from them. Foreclose on the homes that have mortgage payments people can't make. These homes will be sold to people who can make the payments, most likely at more reasonable prices, and the market will return to equilibrium where people who have saved and can afford houses will be the ones who own them, not people who are financially unqualified.
I have said it before and I'll say it again- I hope subprime foreclosures wipe out the real estate speculators and lead to a large correction in home prices in 2007.
Monday, March 12, 2007
Warren Buffett is a big critic of the US Trade Deficit. In fact, he made a well-documented bet against the US Dollar in 2003 precisely because he thought our deficit spelled bad news for our currency.
According to oanda.com's currency converter, a dollar could buy about 1.14 Euros back on March 11, 2002. Today, a dollar only buys about .76 of a Euro, 33% less than it did back then. Buffett got it right. A dollar bought .7 of a British Pound on 3/11/02, where it only buys about .5 of a pound today. Again, he got it right, and the case holds up against most other currencies.
Buffett updated this bet in his current shareholder letter. He says that BRK has "come close to eliminating our direct foreign-exchange position..." which has earned the company about $2.2 billion since 2002. The largest portion of that, $839 million, came from betting on the Euro. The number 2 gainer was (of all things) the Canadian dollar, which earned the company $398.3 million since 2002.
He still thinks that there is a high probability that the US Dollar will continue to weaken over time due to its trade imbalance. As he says "I fervently believe in real trade - the more the better for both us and the world. We had about $1.44 trillion of this honest-to-God trade in 2006. But the U.S. also had $.76 trillion of pseudo-trade last year- imports for which we exchanged no goods or services.... Making these purchases that weren't reciprocated by sales, the US necessarily transferred ownership of its assets or IOUs to the rest of the world. Like a very wealthy but self-indulgent family, we peeled off a bit of what we owned in order to consume more than we produced."
However, he is not playing the US Dollar weakness via direct foreign currency ownership anymore. Why? Again, I quote: "When we first began making foreign exchange purchases, interest-rate differentials between the US and most foreign countries favored a direct currency position. But that spread turned negative in 2005. We therefore looked for other ways to gain foreign-currency exposure, such as the ownership of foreign equities or of US stocks with major earnings abroad. The currency factor, we should emphasize, is not dominant in our selection of equities, but is merely one of many considerations."
As a side note, Buffett says he doesn't think this is going to ruin America or Americans' standard of living every time soon, but he thinks that "at some point in the future, US workers and voters will find this annual "tribute" [ie paying a portion of their production to foreign countries we are indebted to] so onerous that there will be a severe political backlash. How that will play out in markets is impossible to predict- but to expect a "soft landing" seems like wishful thinking."
The final interesting point in this whole foreign currency discussion is Buffett's mention that all of the direct currency profits the company has made "have come from forward contracts, which are derivatives." He says they have also entered into other types of derivatives contracts as well.
When I read that, I thought it was very strange, since Buffett has gone out of his way to criticize the use of derivatives. Anticipating that thought, he went on to explain: "The answer is that derivatives, just like stocks and bonds, are sometimes wildly mispriced. For many years, accordingly, we have selectively written derivative contracts- few in number but sometimes for large dollar amounts. We currently have 62 contracts outstanding. I manage them personally, and they are producing tax-free profits in the hundreds of millions of dollars.... Though we will experience losses from time to time, we are likely to continue to earn- overall- significant profits from mispriced derivatives."
So what I got out of that section was that 1) Buffett expects the US Dollar to decline, but isn't making direct currency bets anymore 2) Buffett thinks there will be "a severe political backlash" against the trade deficit... and it will be ugly and 3) Derivatives aint so bad if you use them correctly.
I'm still very curious as to the exact derivatives Buffett has bets on at the moment, and how he valued them.
Sunday, March 11, 2007
If you're like me, your life revolves around 5-10 excel spreadsheets a day. If you're not like me... consider yourself lucky.
If you're learning excel, or if you already know how to use it and want to know more (looking up a specific formula or a way to do something, for example), I highly recommend you head over to John Walkenbach's site. The Spreadsheet Page. He's the closest thing to an Excel guru that I know about, and there are some great tips on his site.
Some of the excel tasks I do at work everyday have grown to a point where I need to automate them, and to do so, I am writing a few macros with the help of one of my favorite Excel books:Microsoft® Excel 2000 Power Programming with VBA by Mr. Walkenbach himself.
Some of these macros go beyond what the macro recorder can do in Excel, and most of the stuff the macro recorder creates ends up being highly inefficient, so if you have the time, the need, and the inclination, you might want to brush up on your VBA (Visual Basic for Applications) programming skills.
A word to the wise- if you expect to be doing VBA programming after an hour's reading, you might want to temper your expectations. If you don't have any programming experience, it's quite a bit to wrap your head around. I'm by no means an expert, but I find that when I'm really motivated, I tend to pick things up pretty quickly. If I get this automation work done, I can save myself about a half hour a week that I would normally spend generating these reports, which would be a huge benefit over time. I can spend this time working on more visible projects that will hopefully bring me closer to a promotion and a pay raise.
Perhaps even more importantly, I'll save my company that time and I'll leave these timesavers behind me so that the person who takes over my job can build on them. This might make my company more productive, and make the American economy more efficient. In a tiny way, I am contributing to the future of my country. If you've seen the recent slate of presidential hopefuls, you'll know that I'm going to be giving help where help is needed!
For more on the topic of non-programmers like you and me getting into the software business, see Steven Smith's excellent blog post "When Non-Programmers Write Software."
Wednesday, March 7, 2007
The Federal Reserve published its latest edition of the Beige Book today. I usually like to get a copy of it from the Federal Reserve Website, print it out, and read it on my way home from work. You can take the easy route and read some of the news coverage on Reuters, Bloomberg, or MarketWatch, or you can check out a copy yourself.
The Fed's description of the book is "Commonly known as the Beige Book, this report is published eight times per year. Each Federal Reserve Bank gathers anecdotal information on current economic conditions in its District through reports from Bank and Branch directors and interviews with key business contacts, economists, market experts, and other sources. The Beige Book summarizes this information by District and sector. An overall summary of the twelve district reports is prepared by a designated Federal Reserve Bank on a rotating basis."
I like how it's sort of an informal "ear to the ground" survey of different parts of the country. In particular, I think it's a good way to follow things like employment and housing.
I havent read today's version yet, but I just wanted to point it out as a good information source. As Peter Lynch might say, it's one of my "bedside thrillers."
It takes nerves of steel to get through the 401(k) rollover process. When we last visited my rollover, I had sent my paperwork out, along with my check, to get processed and deposited into my new account.
A week or 2 went by and I still didn't see the amount show up in my 401(k). So I emailed my plan sponsor.
They told me I left out one of the documents and that I should send this document to them soon, or else they will send my check back to me. The implication there was that they would be sending me back into my 401(k) rollover nightmare.
I know I sent them this particular document, because right before I sent them all of the documents, I photocopied every single one, in order.
I spoke with them on the phone, and they asked me to fax them the document. So I did, earlier this afternoon. I got so busy at work that I wasn't able to call and see if they received it. I am going to be sure to follow up with them tomorrow, though.
If all goes well, that should be the last piece of the puzzle and by this Friday or next Friday, I will have my rollover complete.
If the funds were deposited in my account last Friday as I expected them to be, it would have worked out extremely well for me because that was the end of a bad week for the market. My funds are up a percent or so since then.
My opinion is that this process is a lot more complex than it should be. I'm transferring money from one account of mine into another. It should not require multiple paper forms to be filled out for multiple parties, multiple phone calls, faxes, and it should happen in days, not months.
But I think it will be worth it because when it's all over, I will have one less account to worry about.
A lot of people will tell you about how great it is to do a direct rollover of an old 401(k) balance:
The Motley Fool
The ever-wacky Suze Orman
But they aren't writing from experience. They are writing to you about the theory behind the rollover. In theory it's a great thing. In practice, it is not fun (unless you like paperwork). I guess the difference between a blogger and a journalist/financial advice person like Suze Orman is that bloggers are more likely to do something, then write about it, whereas a journalist will just read about it, then write about it. There's a big difference!
Monday, March 5, 2007
When I got to work at 7:30AM this morning, I fired up Yahoo! finance and grabbed a quote for New Century Financial (NYSE: NEW). It didn't look good. Premarket activity showed the stock trading down about 60%, around $6 per share from somewhere in the $14 neighborhood where it had closed on Friday. New Century is one of the subprime mortgage lenders I have blogged about in the past, and that have been making all the financial news headlines lately.
I fired up the bloomberg machine when the market opened at 9:30 to check on NEW's trading levels, and that guy was going ballistic. The volume was through the roof, and the stock was off 60%.
The company is now officially on the verge of bankruptcy. It's a casualty of the capitalist system, and its fate is no longer in the hands of management. It's no longer in the hands of the company's owners, the stockholders... Its fate is now in the hands of NEW's creditors. That's right, those boring people who loaned money to the company, and made it promise to return that money after a certain amount of time, with interest. Like the smart lenders they were, they have the whole thing in writing.
When a company borrows money from someone, it usually makes a few covenants with them. These are just promises. "I promise I won't lose money for two quarters in a row," is a covenant New Century made to 11 lenders. The company is now saying that the odds are that it already broke that promise, which is known in Wall Street Jargon as a breach of covenant. The good news is that six of the 11 lenders said "you know what, NEW, that's ok that you broke that promise. No biggie. I'm not going to sue you and make you pay me all of the money you owe me. I'd rather you keep on keepin on so you can get through this rough patch of business." This is known in Wall Street Jargon as a "waiver."
However, five of the other lenders have yet to make up their minds.
These lenders are thinking to themselves right now "Oh snap, this company is hitting the crapper. There's an SEC probe, there are civil lawsuits, subprime borrowers are defaulting left and right... I don't know if I'm going to be able to get my money back if this nastiness keeps up for long." This is known in Wall Street Jargon as "credit analysis."
If one of these lenders decides not to grant a waiver, that lender can force NEW into bankruptcy. Most likely what that means is that NEW will be is forced to sell all of its assets (which are mainly mortgage loans), a process known on Wall Street as "liquidation."
That's why you have all of the stock analysts doing liquidation scenarios, and that's what the market is pricing in to NEW's stock today. Basically, people are trying to figure out "If all of NEW's creditors get paid off, what's left over for equity holders?" The price NEW closed indicates that the general consensus of the market is "not a hell of a lot."
If you're curious, a quick back-of-the envelope calculation that gets you in the neighborhood of New Century Financial's Liquidation value might go something like this:
1) Go to www.ncen.com and click on the investor relations link. Click the link for financial information. Notice the funny disclaimer that pops up "In light of New Century Financial Corporation's February 7, 2007 news release (New Century Financial Corporation to Restate Financial Statements for the quarters Ended March 31, June 30 and September 30, 2006), the financial information related to the quarters ended March 31, June 30 and September 30, 2006 should not be relied upon and is included on this Web site for historical archive purposes only." Agree to that and go on to the company's financial statements. We're looking for a balance sheet, and we've found one here, New Century Financial's Most Current Balance Sheet, courtesy of its third quarter 10-Q filing. You can find it on page 8 of this document.
2) Value its assets.
The company lists all of its assets first, which is very standard for a balance sheet. Our goal is to guess how much it could get for all of these assets if it had to sell them for cash in a relatively short period of time. Once we have that amount, we assume the company uses all of the cash to pay off its debtors. Whatever is left over belongs to the stockholders. Sorry folks, but stockholders are on the end of line when it comes time to collect in a liquidation.
This is the part that takes time, so be patient, I promise we're getting to a point here.
Total assets were $25.059 billion as of September 30, 2006. Of course, the disclaimer noted above tells us that this number might be bogus, but it is the best we have for now. Some of these assets are already cash and they do not have to be sold. So we'll take $409 million and $572 million as a given. (I'm going to bold these numbers as we go along, so we can add them up easier. I'm also going to round them off to make it even easier. What's a few million among friends?)
Next we come to the meat of the company's balance sheet... the mortgage loans. You know how Robert Kiyosaki is always fond of saying "a mortgage is an asset on the bank's balance sheet, but a liability on yours?" Well, this is why. This is that asset on the bank's balance sheet, in the flesh. NEW has all of this money it lent to subprime people that it can expect to be paid back in the future, with interest. They are listed at $8.9 billion and $14 billion. We won't distinguish between mortgages held for sale or investment here. Let's just lump them together into one nice round $22.9 billion sum. And since subprime mortgages aren't exactly the hottest item flying off the shelves these days, lets assume that NEW would have to discount them by 5% if it wanted to sell them. I don't know if that's a good discount. It's just a guess but being in finance and knowing that these are basically fixed income securities with known default rates (that are rising as of late) and payment schedules, I'm going to assert my wisdom and say 5% is the discount. So lets say that NCEN can get $21.76 billion (22.9B x .95) for these mortgages.
An aside here, Wall Street calls the 5% a "haircut." So, vulture investors (those who swoop in to profit off of potential bankruptcies like these) might say they're "Assuming a 5% haircut" when they do this liquidation value of NEW. Discount, haircut, 5% off sale... call it whatever you want.
OK, continuing down the balance sheet... another aside: you might notice something else here. The less liquid something is (ie the less cash-like and easy to sell), the further down it is listed on the balance sheet, in general. So, if you were listing your assets, you would probably list that $20 bill your grandmother gave you at the top of the list, followed by your collection of state quarters, followed by your furniture, followed by your picture of dogs playing poker, followed by your house, followed by your "mojo." Notice how the things get progressively less easier to sell as you move down the list? The same thing happens on a company's balance sheet, and believe it or not, companies do list their "mojo," only they give it a fancy Wall Street name: "Goodwill" or "Intangibles." This means the big haircuts must be coming up fairly soon.
The next item is "mortgage servicing assets." I have an MBA in finance and I have no idea what the hell that means. So, I did a ctrl+f to search for that term in the document, to see if it is defined somewhere else. It is explained in the footnote on page 24: "The Company records mortgage servicing assets when it sells loans on a servicing-retained basis and when it sells loans through whole loan sales to an investor in the current period and sells the servicing rights to a third party in a subsequent period." This gets us into the nitty gritty of the mortgage world. If I wasn't just trying to do a back of the envelope, I'd look into this, swear to God. But to be honest nothing could possibly seem more boring to me at the moment. So lets just say this is a "loan type product" for the moment and lump it in under the 5% discount.
OK, who am I kidding? There is nothing in finance an idiot using 10% of his brain can't understand. Let's dive into servicing rights via this article on servicing rights that I found on the google.
"Servicing rights -- the right to bill for the loan and collect payments -- are worth about 1 percent of the total loan amount for a 30-year mortgage. But when interest rates go down, borrowers pre-pay their loans and the value of the rights evaporates.
Booking the rights as an asset removes a cushion many mortgage lenders use to soften rate-induced swings in their business. In slow times, when rates are relatively high, lenders like to sell rights garnered from originations done in low-rate, boom times, injecting some previously unrecognized earnings."
OK, so servicing rights seem to be something you can sell about as easily as you can sell a loan. I'm going to keep them in the 5% haircut camp. I'm probably wrong and it might be more than that, but I'm not doing any more work on this. 95% of $60 million is $57 million. Big freakin deal.
Real estate owned is $84 million dollars. The only way a mortgage company gets a hold of actual real estate is... you guessed it... foreclosures. Someone defaulted on a mortgage, and NEW got the deed to the property as a result. If you listen to the radio, you'll know that foreclosed properties can often be had for a steal. Im torn between a 15% and a 25% discount here, so Im going to guess NEW can sell these foreclosed properties for 80% of their current balance sheet value. I'm guessing these prices might make some radio listeners very happy. That $84 million becomes $67.2 million.
Next esoteric asset on the books is "accrued interest receivable," weighing in at $109.6 million dollars. I don't have much of that lying around my house, so I had to dive into the footnotes to figure out what it represents. My first guess was that this represents interest receivable on some kind of asset, such as a bond, that NEW owns. This is the same principle as when I check my ING direct account and see the "interest earned this month" at the top of my account screen, even though I haven't been paid that yet. I figured that was a slam dunk, money in the bank with no haircut... but then I thought to myself "why is this so far down on the list?"
So I did some more investigating and I found this letter from the Office of Thrift Supervision, which led me to believe this is a little riskier than I first thought. I've had my fair share of run-ins with the OTS when I used to work for a bank, so I know one of the things they do is keep tabs on the kinds of assets banks hold.
I'm not going to make this much clearer, but basically NEW sold off some kind of loans or something to a trust which packaged and sold them to investors in some manner, and interest gets paid back through the trust to NEW. However, this line in the OTS letter is what gave me pause "any of the accrued fees and finance charges that the institution collects generally must be transferred to the trust and will be used first by the trustee for the benefit of third-party investors. Only after trust expenses (such as servicing fees, investor-certificate interest, and investor-principal chargeoffs) have been paid will the trustee distribute any excess fee and finance-charge cash flow back to the seller, at which point the seller may or may not realize the full amount of its AIR asset."
So basically the letter is saying NEW might want to pull money out of this thing, but there are a few people in line who will want to get paid first, and NEW might not get the full value of that asset. Further on down the letter, it says that "The seller's right [ie: NEW's right] to the excess cash flows related to the AIR assets is similar to other residual interests in securitized assets in that it serves as a credit enhancement to protect third-party investors in the securitization from credit losses." Well I'll be danged. The AIR is used to protect third party investors from credit losses. And since New Century peddles sub-prime mortgages, it is likely that there will be some credit losses that the investors will need protection from. I hereby discount this asset by another 20%. This puts accrued interest receivable at 87.68%.
Next on the list is the Income Taxes, net. I did some of my best sleeping in accounting classes where professors tried to show me how to calculate these things. I vowed I would never learn how to calculate an income tax asset, but I understand the general point of them. They basically make up for the difference between taxable income that is reported to the government, and taxable income that is reported according to GAAP on the company's financial statements. If it's an asset, it will provide a future benefit to the company in that it will reduce taxes in future periods.
NEW won't have too many future periods if it enters the liquidation process. Big discount here....let's go with 60%. Drops this down to $32.2 million from $80.5 million.
Office property and equipment is easy... 87 million sells for 60% of that (based on the fact that im sitting on a former office chair that I bought for $10 from this place full of liquidated office furniture) so it's $52.2 million.
Now... Goodwill! The company's mojo! If NEW was Derek Jeter, Goodwill would be his ability to deliver a big hit in a tight spot. That's right, it's an intangible. Yet, in accounting, they have found a way to put a dollar value on intangibles. Technically, goodwill is the excess amount NEW paid when it bought another company for more than its book value. Let's assume the current New Century can sell its name, its web address and the right to use its trademarks for something. I'm a pessimist so I'm going to say that value is $20 million, a nice round number and roughly 80% of the book value of its goodwill.
Prepaid expenses are hard, but not impossible to recoup. Lets say NEW paid $500 at the beginning of the year to insure the company Yugo from Jan - June. It liquidates in May and is entitled to get back a refund for the month in which it did not need the insurance coverage (June). Same thing goes for other things like medical insurance, lighting, and whatever else the company might have paid up in advance. I'll call this another 80% discount because Im getting really bored, but I promise there's a point to all of this. $360/2 = $180 million.
So add up all of the numbers in bold, and you come up with $23.1496 billion dollars, which is what we think we could get for NEW's assets, based on the analysis above.
For those of you who think better in pictures, this works out to a pile of one dollar bills, each one .0043 inches thick, reaching about 1,600 miles into the sky.
Total liabilites are about $22.995 billion so when the liability holders get through with that stack of bills, there will be only about 155 million of them left for common stockholders.
The front cover of the 10-Q shows NEW as about 55.5 million outstanding shares. So these starving shareholders will divide the $155 million equally amongst themselves, leaving about $2.79 per share.
Compare this with NEW's $4.56 closing price and you can make a few conclusions:
1) I did this wrong because I know little about mortgage finance. I will grant you that.
2) The market thinks NEW will get more for its assets than we calculated above. I will grant thats a possibility. There are people out there who can compute almost exactly how much these haircuts will be. They have experience doing it, and they know the markets for the assets.
3) Some people think that NEW will be able to avoid bankruptcy somehow, so they bid the price up above liquidation value. This is again, a possibility.
Anyway, all I wanted to illustrate was a back of the envelope calculation but I got a bit too into it and this would have to be one HUGE envelope to fit this blog entry on. Hope you found this useful. This is exactly the analysis many professional investors went through today as they made decisions to buy and sell NEW.
Me, I'm just glad I don't own the thing, and this doomsday scenario makes me glad that I favor investing in companies without much debt, because things get ugly if a highly-leveraged business stumbles.
By the way it's too late to check all of my math above. It seems right to me but if you see any mistakes don't hesitate to point them out. It's all simple calculations...
Sunday, March 4, 2007
One of the investments Buffett has long been known for is newspapers. He loved the business models of newspapers for a long time because they worked as mini-monopolies which served people their local news and made plenty of money from advertisements. One of his most successful investments was The Washington Post Company, which sold for about $150 a share in 1991 and recently topped out at about $1,000 a share in 2005.
According to Buffett (p. 11), "fundamentals are definitely eroding in the newspaper industry... The skid will almost certainly continue."
Buffett admits he first saw indications of the coming decline of the newspaper's monopoly-like business model back in 1991, when he said in his shareholder letter "the media businesses... will prove considerably less marvelous than I, the industry, or lenders thought would be the case only a few years ago."
The reason for the decline of the newspaper is the availability of information through other channels, in particular cable TV, sattelite broadcasting and the Internet.
Buffett hopes that "some combination of print and online will ward off economic doomsday for newspapers," and said that Berkshire's Buffalo News unit will work to develop a sustainable business model, but ends his discussion conclusively, saying "... the days of lush profits from our newspaper are over."
A lot of books written about Buffett talk about how great the newspaper business is, and how much he loves it. That information is no longer correct, and if you're an investor looking to emulate Buffett's style, you might want to look elsewhere when picking stocks to invest in.
Of course, none of this is news to most people. There has been plenty of press around the troubles newspapers have been facing recently. The real significance is the fact that Buffett devoted a page to this Epitaph of the industry. To be clear- Buffett isn't selling the companies. He thinks they can continue to make money, but he no longer finds the industry fundamentals to be as favorable as they used to be.
Take a look at income statements for Dow Jones (DJ) the aforementioned Washington Post (WPO) or Gannett (GCI) to get a sense for how the industry has suffered from competition from other forms of media. Look at steps some of the companies have taken to try to adjust to the needs of their current audiences. It's clear that the party is over.
Saturday, March 3, 2007
2006 Berkshire Letter Review, Part 1: Why Don't We Evaluate or Stock Portfolios Like Warren Buffett Does?
Of all the topics discussed in Warren Buffett's 2006 annual letter to Berkshire Hathaway shareholders (warning: links to a .pdf document), the one that I think applies directly to most investors comes on page 15, under the section entitled "Investments." This is the section where Buffett talks about Berkshire's investment portfolio- the common stock investments that the company owns. You can compare this to your own investment portfolio, though I would be more than willing to bet you own many fewer shares of the companies than Berkshire does.
The letter breaks out the 17 different investments that Berkshire owns with a market value of more than $700 million. Buffett notes that there are 2 investments with market values over $700 million that were left off the list because Berkshire is still buying the shares and he doesn't want to tip the market off and drive up their share prices. Referring to these two mystery companies, he says "I could, of course, tell you their names. But then I would have to kill you."
Allthough the makeup of the portfolio is very interesting, (the usual suspects: American Express, Coke, Wal-Mart, Moodys, and some relative newcomers like PetroChina "H" shares and POSCO) that wasn't the part that interested me the most. What interested me most was the way Buffett described the performance of his portfolio, how it is fundamentally different than the way most people describe their own portfolios, and how much better off people would be if they took his approach. You'll see my point when you read what he had to say about his stock portfolio’s performance in 2006:
“We are delighted by the 2006 business performance of virtually all of ourGo back and read that again.
investees. Last year, we told you that our expectation was that these companies,
in aggregate, would increase their earnings by 6% to 8% annually, a rate that
would double their earnings every ten years or so. in 2006 American Express,
Coca-Cola, Procter & Gamble and Wells Fargo, our largest holdings, increased
per-share earnings by 18%, 9%, 8% and 11%. These are stellar results, and we
thank their CEOs.”
Did you find anything missing from that description?
What I found notably absent was a discussion of the price performance of the stocks Berkshire owns. The majority of investors would have talked about how their portfolio was up X% during 2006, with some stocks outperforming their peers or other benchmarks in terms of share price appreciation. Buffett, on the other hand, focuses on the performance of the underlying businesses, taking his world-famous business owner perspective on investing which I touched upon in my review of Mary Buffett’s book Buffettology (you can learn more about this perspective from that book).
Ninety percent of investors who own individual stocks take the wrong point of view when investing. They see stocks purely as pieces of paper or ticker symbols that fluctuate in value every day. Warren Buffett sees stocks for what they really are: pieces of ownership in the underlying business. He sees the earnings of the underlying business as being his, in proportion to the amount of shares he owns.
Because of this perspective, he evaluates the performance of the business underlying his investment, not the performance of the stock price. Buffett knows that stock prices will be subject to the whims of the markets, so they are not in themselves indications of how well his investment is performing.
If you own a portfolio of individual stocks, I challenge you to take this perspective. Set up a spreadsheet or make a paper listing a few key performance metrics for each of the companies you are invested in. It could be as simple as listing out revenues, net income, assets, liabilities, operating cash flow, and if you’re even more ambitious, free cash flow. Review the performance of your investments against these metrics once or twice a year. Think of yourself as an owner of the business, instead of as an owner of a ticker symbol that moves around with seemingly no rhyme or reason. Chances are you will start to see your portfolio in a whole different light.
Hopefully this exercise will at least shield you from using fluctuations in the market price of a stock as the only reason to buy or sell a stock. I am often amazed when I hear people saying they’re going to buy a stock “because the price keeps going up,” and using that as their sole criteria for making an investment. Or, deciding to sell a stock they own because “it is down 50% from where I bought it.” Don’t let the market tell you what to do. The market makes mistakes. People get fearful. People get greedy. In the short run, the market price will reflect the greed and fears of the day. In the long term, the market price will reflect the performance of the underlying business as indicated by the metrics I listed above, the most important one being the earnings of the business.
In a world of Jim Cramer’s Fast Money, all of the financial press, the talking heads on TV, the real-time stock quotes, heat maps, online trading, and all of the marketing dollars being thrown around in the investment world, investors often get caught up in the wrong things. They buy and sell stocks on whims, subjecting themselves to whipsaw, capital gains taxes, commissions, fees, penalties, and other investment performance killers that erode the value of their investments over the long term. If they took a step back, a deep breath, a long term outlook, and Warren Buffett’s business perspective of investing, they would do much better over the long run.
I’ll leave you with a final question. Pick any stock in your portfolio. Now without looking it up, can you tell me if its earnings were higher in 2006 than in 2005? If you can’t, I think you should be paying more attention to the companies you own.
This was an interesting week in the markets, dominated by the fact that it was the worst week for the US Stock market in four years. There was also some evidence that credit woes in the subprime market are starting to spread to other markets, some comments from Alan Greenspan, and a GDP revision that gave people some things to talk about.
I’m not a big believer in acting on the day to day, week to week, or even month to month fluctuations of the market, so even though I find this stuff interesting and I follow the news, it did not have any effect on how I’m currently allocating my investment dollars.
In the midst of all this market action this week, one newsworthy item in particular rose head and shoulders above the rest. I was able to find some time on a slow Friday afternoon at work to read a publication that comes out every year around this time- Warren Buffett’s annual letter to Berkshire Hathaway shareholders. This letter can be found on Berkshire’s website along with archived letters from previous years. If you want to go straight to the PDF document for 2006, just click here (direct link to the pdf document).
I read the letter twice, and I found a few interesting themes, which I’ve decided to cover over the next few posts.
There is a reason why I link to Buffett’s letters on the side panel of this site. It is because I think they are one of the best investment guides you could ever read. In fact, I’ve noted before that many people think a thorough study of Buffett’s letters over the years is akin to an MBA in investments. It is a free resource, it is a valuable resource, and I think anyone who is saving or investing money, or is even the least bit interested in the markets should read these letters every year when they come out.
This week in particular, Buffett's letter was just what the doctor ordered.