Buffett Invests in Harley Davidson

As many of you know, I'm an avid Warren Buffett follower, so I was interested to read that Buffett agreed to buy $300 million of debt issued by Harley Davidson (NYSE: HOG) yesterday.

(Note: many people use Buffett and Berkshire interchangably, as if he makes every decision at the company he runs. While I am sure this is not true, I often use the two interchangably as well, so whenever you see me mentioning Buffett and Berkshire in the same entry, assume I'm referring to Berkshire Hathaway in all cases unless I specify otherwise. I promise to try to be more precise in the future.)

Harley announced that it was selling $600 million of senior unsecured debt to two investors: Berkshire Hathaway (Buffett's company), and Davis Advisors, LP, which is Harley's biggest shareholder. According to an article I read, Buffett hasn't invested any other money in Harley besides this purchase. The notes are a pretty sweet deal. Though unsecured, they are senior in the capital structure which means they get paid pretty quickly if the company goes bankrupt. I am not sure what Harley's capital structure looks like, but being that Berkshire bought the notes, I'm willing to bet that Buffett or someone at BRK took a good look at it and feels there is a good chance the notes will be repaid when they mature in 2014. The best part of the deal? They pay FIFTEEN PERCENT INTEREST. So for lending Harley $300 million now, Buffett will collect a check for $45 million each year for the next five years. That's a total of $225 million in interest, plus the return of his original principal.

Harley plans to use the money for its consumer lending unit, ie to lend money to people so that they can afford to buy its motorcycles. I don't follow the company too closely, but apparently it is in the midst of a turnaround plan.

The stock jumped something like 15% yesterday on the news that Buffett was "investing" in the company. I noticed it fell about 7% today. I think it's pretty crazy when people view Berkshire buying preferred stock (as he did recently with Goldman Sachs) or loaning money via a debt purchase as some kind of an endorsement from Buffett that the company's equity is undervalued. If he thought Harley was undervalued, he could have bought the entire company, which has a market cap of only about $3 billion compared with Berkshire's $30 billion pile of cash. But he didn't. Instead he chose to lend them money for a relatively short period of time at a high interest rate. Being one of the few people with $30B cash in hand during a financial crisis helps Buffett to get some very favorable investment opportunities. 

I noticed that Moody's poured icewater on the announcement by immediately downgrading Harley Davidson Funding Corp., which is the fundraising arm of Harley's consumer finance unit. This will make it more expensive for the unit to raise money, which is not a good thing. Though Moody's does not directly come out and say it, it appears that the new $600M of debt was the catalyst for the downgrade.

In any event, I assume Buffett did his homework on this one and in the end he will get his 15% per year. 

Is now a good time to buy stocks?

I get this question a lot: "Is now a good time to buy stocks?"

It's actually pretty easy to answer this right now. But first you have to ask yourself a few questions: 

1) Do I need the money I would be using to buy stocks? Your answer should be no. If you are planning on using this money for a down payment on a house in less than 5 years, then you should not be buying stocks with it. If you need to live off this money and couldn't afford to live your life without it, then you should not be buying stocks with it. Stocks are risky and you could lose every cent you put into them (not the most likely scenario, but a possibility that you can't completely ignore). Another way to phrase this question would be "Do I have a long time horizon of 20-30 years?"

2) Do I understand the difference between investing and speculating? Most people do not. If you want a good explanation, read The Intelligent Investor by Benjamin Graham. (I actually own this version of the book, which is hardcover and will hold up better over time, but the one I linked to first is cheaper.)

3) Do I have the time and skill to research individual stocks? If your answer here is "no", this does not rule out stocks as a whole but to me it would rule out purchasing anything but a small amount of individual stocks. Instead, I would personally invest in index funds and look for the lowest fees possible.

You'll notice I didn't mention anything about the market. This is because I don't know if it is high or low right now as compared to where it will be in a couple of months or years from now. I do know that equity investments look more attractive to me (and to Warren Buffett and Scott Adams) than they did a year ago, but I'm not going to make any forecasts.

And yes, the rumors are true: you have me to thank for the recent market declines. One of my 2006 year-end wishes was for lower stock prices in 2007 and although it took until 2008 for the market to fully grant it, my wish was fulfilled. Thank you, Mr. Market. You really helped my retirement years by allowing me to buy your shares so cheaply in 08 and hopefully for the next couple of years as well.

Please invest responsibly.

Oh, and for the majority of my readers who rely on a salary like me, you should worry more about your job than where you invest your money. Now is not the time to be slacking off at work trading stocks when you should be working to dodge the next round of layoffs. That said, there are some great bargains out there.

CEO Compensation

So we all know that CEOs are paid ridiculous amounts of money. I've often thought that if I spent a week or 2 as CEO of a major corporation, I'd be set for life. I would be able to pay cash for a pretty nice house and then only work to pay my basic bills every year. Not only would one paycheck be more than I make in a few years, but I'd also get the nice golden parachute to boot.

Our new president is very public about his disdain for CEO salaries, and as I read in today's Wall St. Journal, Sen. Claire McCaskill (D., Mo.) has now introduced a bill to limit CEO salary to no more than what the president earns: $400k a year. The next sentence was a classic and I applaud the authors of the story for putting it in there: "In 2007, Goldman Sachs Group Inc. Chief Executive Lloyd Blankfein earned that much in about two days."

Two days!

I gotta get me one of them jobs.

New Fico Credit Score

An article in the Wall Street Journal caught my attention on the train in to work today. I'd heard the credit bureaus were coming up with a new credit score calculation called "FICO 08", but I wasn't sure when it was coming into play. According to the article, TransUnion is going to begin offering the score today, but it could be months or years before it comes into common use and consumers can find out their own scores.

Supposedly the new methodology will make credit scores more accurate at predicting defaults, which will allow lenders such as mortgage companies to more properly price loans to consumers.

My FICO score is very high (I don't think much has changed since the last time I looked at it), but the problem I've run into being in my late 20s is that my credit history is relatively short, which worked against my credit score. From what I've read in the article, FICO 08 is supposed to correct this somewhat:

"The score, which will still range from 300 to 850 -- the higher, the better --
is fine-tuned to do a deeper analysis of subprime borrowers or those with "thin"
or young credit histories, according to Fair Isaac. More consumers with accounts
in good standing should also see their scores increase slightly, says Tom Quinn,
vice president of global scoring solutions at Fair Isaac. Overall, Fair Isaac
predicts FICO 08 will improve the accuracy of lending decisions by as much as
15%."

Not life-changing news by any stretch of the imagination, but as someone who is potentially in the market to buy a home, it piqued my interest.

Personal Finance Blogger Falls off the Map

One of the PF (personal finance) blogs I've read regularly for the past few years is PF Blog, which detailed "MM's" (the author) quest to reach $1 million net worth by the age of 40 in the year 2016. When he was roughly 27 years old at the end of 2003, the author's net worth was approximately $132,000 (details here) and this had grown to about $885,000 as of the end of May 2008 (details) at the age of 32. If I'm following his story right, he is a Microsoft employee who was sent over to Asia to work overseas. He is pretty well paid and has a side business he used to generate extra income.

At the end of May, his portfolio was worth about $900,000. 30% of this was in 12 stocks he selected himself, with roughly $20k in AIG, $20k in American Express and other positions, with a heavy concentration in financials, which he felt were becoming undervalued. Another 12% was in US mutual funds, 30% in international mutual funds, and the remaining 30% was in cash, divided between the US Dollar and the Chinese Yuan.

Unfortunately, May 2008 is the last time he posted a net worth update. Since then, the S&P 500 Index has fallen from about 1400 to about 750, a decline of almost 50%, and his blog has been relatively silent, except for some irate comments made by readers. Some of my favorites are "Even though he seems to have abandoned his blog I hope he wasn't ignoring the market and sold out of his AIG position with at least a little something. He bought it at $62 and its now essentially worthless." and "I made a copy of his portfolio with where it stood in May and since then it has lost about $148,000 from those May prices."

I have enjoyed reading his posts over the past few years and I have to say he was much more diligent that I've been in terms of posting frequency. Some months he made 30+ posts. He also kept meticulous records of his net worth and updated them monthly for five years. That required an incredible amount of discipline and was an extremely valuable case study for everyone reading his blog. I didn't agree with everything he's written (for example I am not a fan of taking short-term zero interest credit card loans and putting the money into a bank account, which I believe he does to earn extra income), but I've been a fan of the site. His English and writing skills aren't fantastic, but they were good enough to get his points across.

So why has he stopped posting? I can think of a few reasons. I know that many people find it hard to look at a stock portfolio that has fallen in value. During down markets, I always hear the phrase "I don't even open my 401(k) statement anymore." Looking at your 401(k) statement is hard enough, but going through the detailed analysis that "MM" goes through each month probably gets pretty grueling when your net worth, which is heavily exposed to the stock market, is taking 30% hits.

Also, if he is like me and every other working person, he is probably facing increasing demands and stress at work lately. With layoff announcements in the news every day, it can be hard to focus on the work you have to do, and companies often cut back on staff without cutting back on work, placing increasing demands on those who remain behind. This would not leave much free time for him to devote to his blog, which is most likely not a priority in his life.

I don't think the reason he has stopped posting is embarassment about recent net worth declines, as some of the commenters on his site seem to suggest. For example, I think this comment was a bit harsh: "MM was very quick to post his net worth updates when things were going well, now he's essentially abandoned the blog. And I guess I do see what you mean by that certain "hubris" and "ego" he used to display. I just shrugged it off though as another finance blogger who thought he was some sort of pro stock picker. They are a dime a dozen."

Some other commenters also talked about another blog - "Millionaire Mommy Next Door" and suggested it had fallen off the map as well, but a simple google search would have answered that question - her account was hacked and she moved to a different domain.

I do think we will hear from MM again when he gets more time on his hands, but for now, wish him the best as he copes with the financial crisis.

(Fear not readers, my next post will be one of my long-anticipated net worth updates, a special "financial crisis" edition. I am sure you are all waiting with baited breath.)

How Scott Adams Manages His Money

I came across an interesting blog post the other day... it was written by Scott Adams, the creator of Dilbert, describing how he manages his money.

Statements like this make me very jealous: 

"When I first started making serious Dilbert money, I let experts manage half of it, and I managed the rest, as a hedge against both the experts and myself."

Can you imagine making "Dilbert money"? Me neither. I'd imagine Dilbert money amounts to a pretty tidy sum.

But I digress. The part of the post that most interested me was this part: "The experts invested in Enron, Worldcom, and a number of other companies that promptly exploded. The experts reduced their portion of my money by about a third over five years. (The experts work for one of the most respected financial institutions on Earth, by the way.) My own investments did better, precisely because they were more diversified. So now I handle my own investments, probably incompetently."

I smiled when I read that. One of the biggest lessons the current financial crisis has driven home again and again is that nine times out of 10, the so-called "financial experts" aren't worth the paper their MBA degrees are printed on. Tens of examples appear in the papers every day. From the "geniuses" who created the whole mess by engineering clever securities to the Wall Street research analysts who scrambled to lower their price targets and ratings every time the market dropped 15% this year, the majority of "experts" were outed as frauds. If you had followed their advice, you would find yourself extremely poor right now.

I went to school with these people. I worked with them in investment banks and I worked for the companies they peddled their wares to. Half of the time I couldn't follow what they were saying and the other half I couldn't understand why someone would want to take the kinds of risks they were talking about taking, or why someone would want to hedge against the risks they were trying to get them to hedge against. Warren Buffett warned that derivatives were a "ticking time bomb" back in 2003 a warning that put a bad taste in my mouth for the "financial engineering" I was just beginning to get exposed to at the time. Derivatives and complex financial instruments got really popular though. The big stars at the companies I worked for were those who understood the lingo, who could create increasing layers of complexity to get around accounting rules and "redistribute" risk. Incidentally, these kinds of people were also the big stars at Enron. (And ended up being relocated for their troubles). 

I'm getting into rant territory, so I'll stop here. I realize a variation on this theme has been repeated thousands of times over the past hundred years or so. The most recent one I read was Andrew Lahde of Lahde capital, who wrote a similar rant when he recently quit his job. I highly recommend you read the letter he sent to his shareholders- if nothing else, it's quite an entertaining read. (And I think Lahde money would actually make me more jealous than Dilbert money.)

In an interesting twist, Adams ended his blog post with an endorsement for stocks: 

"In order to diversify more, I started migrating money over to the stock market during this recent plunge. The market could go a lot lower still, but this is either the beginning of the end of the United States as we know it, in which case it doesn't matter how I invested, or it is a once-in-a-lifetime stock buying opportunity. It was an easy decision."

Not quite the same reasoning Warren Buffett gave, but an endorsement nonetheless. When America's preeminent corporate cartoonist starts endorsing stocks, is it a buy signal? You make the call.

One final note: I received an email misinterpreting my prior post as "calling a market bottom." Re-read my posts. I would never call a market bottom. My argument is that stocks are selling at more attractive prices now than they were last year, but nobody is treating them that way.

Warren Buffett Recommends Buying American Stocks

I started this post on October 11th and never got around to finishing it. Fortunately, Warren Buffett himself finished it for me with his op-ed in the New York Times on October 16th. I can't say it any better than he did, so I'm not even going to try. Let me first show you what I wrote, then I'll add a link to Buffett's letter.

"I feel like I need to preface anything I write about investing in stocks with the following disclaimers:

1) You should only invest money you can afford to lose in the stock market

2) You should not have a high allocation to stocks if you are close to retirement

3) You should be prepared to see the value of your holdings drop 50% without worrying

That said, I want to make the following statement: now is a good time to buy stocks. And bonds.

How can I say this, when the markets are at 10 year lows and when we've had the worst week in history? Who am I to contradict the headlines?

Let me put it this way: were you happy buying stocks a year ago, when the market was at its peak and the dow was above 14,000? Chances are, you were. (I wasn't.)

When I see Tiffany & Co. selling for $22 a share.. it makes me happy."

I'm not calling a market bottom, and neither is Buffett. That said, people are now fearful and I'm happier in equities right now (see the three disclaimers above) than I am in anything else.

To see how he finished my post for me, I highly recommend you read Warren Buffett's Op-Ed in the New York Times.