Monday, September 28, 2009

Last Investment Thought of September, 2009

If you are a first timer, please read the following pieces first. It will provide you with important background information.
1. Why I created this blog?
2. How am I going to operate this blog?

This is a fruitful weekend. I watched Ken Burns' new spectacular – “The National Parks”. You have to admire the wisdom of the Americans designing such a wonderful system contrasting to the park system elsewhere. A friend just back from China told me the abusive fees charged by the Chinese parks. I also visited the Polaris Mall Sunday afternoon. I was pleasantly surprised by the traffic. I saw no signs of recession at the mall. Although the recession certainly was not over as I continued to see little traffic in the local casual dining restaurants, my spirit got lifted.

Will the rally continue? Should I buy now or should I wait for a dip? Those questions always get asked. For the first one, even the prominent investors I always admire don't have consensus. Last week, James Grant of "The Interest Observer" penned a piece on Wall Street Journal arguing that the harder the market falls, the higher the rebound jumps. Therefore, the loss of 2008 is so horrendous that it enable the bouncing of 2009 to keep propelling. John Hussman, among others, continue to hold that the current market is overvalued on his weekly comments. And Warren Buffet contends that while the businesses stopped getting worse, he doesn't see a quick recovery.

For the second question, it is a more practical one. As Buffet insists on no recovery, he is buying stocks on the same day. He buys regardless of the interest rate outlook, general economic condition or the likelihood of dips. As long as he feels he is financially flexible and he can find something cheaper than its intrinsic value, he buys. We should do the same.

Humans are always tempted by the unpredictable and the uncontrollable. Some want to find the most complex schemes to hedge. They believe US dollar will continue to devalue against Chinese Yuan. But if you earn US dollar and spend US dollar, why introduce currency risk? Even if you are right, how do you know the devaluation of US dollar against Chinese Yuan will be disruptive enough for you to earn satisfactory return? Are you going to use leverage to add more layers of risk? Some use the stop loss order at, for the sake of argument, let's say at 8%. I always wonder how we know if a stock drops exactly 8%, the next move it makes must be downward.

For me, as long as I have enough cash at hand, by "enough", I mean if I have 5 years' spending cash, and I can find attractive opportunities, I will keep buying.

Saturday, September 26, 2009

How to generate new ideas?

If you are a first timer, please read the following pieces first. It will provide you with important background information.
1. Why I created this blog?
2. How am I going to operate this blog?
I always have more ideas than cash. It is my desire to turn this situation around. I believe once I have more cash than ideas, my struggle against poverty is near its end. But some of my friends rely on BBS stock board for ideas. It is an awful choice. BBS stock board is full of rumormongers, penny stock promoters and day traders. The stock tips on BBS stock board offer no concrete analysis but some conglomerates of fear, greed, anxiety and boast. If you are looking for ideas for your money, here are some places you can start your search.

1.Steal from prominent investors
Some prominent investors disclose their investments every quarter. Here is one area I like about US security law. Some of those investors are so convinced on their ideas that they take huge positions. Usually, it takes more than a quarter before the idea produces extraordinary returns. Let's say Warren Buffet takes on a big position at $X. Three months later I have an opportunity to buy the same security only 25% cheaper than Warren has paid. I usually will jump on the wagon for a ride. Some my friends are logical thinkers. The only fact that Warren takes a big position is not logical enough for them. The bad news is that Warren rarely comments on the securities he is buying or selling. But some other prominent investors do highlight some of their best ideas in their shareholder letters, sometimes in great details. I don't know why they are doing that. But I don't care. As long as the case is convincing and I have ample fire powder at hand, I will fire. However, be sure you are following the right one. I don't think a certain celebrity throwing chair on TV is a prominent investor. And some my friends are certainly going to disagree. Here are two of the website I visit periodically for ideas.

1. Baron's funds
1. Ariel funds

2.Read some good magazines
I go to local library every weekend. I can almost guarantee you that you can find Barron's, Fortune and Forbes in any US library you visit. This is another area I love US. You can easily find a library and the library is usually well equipped. For an article to show up in those high quality magazine, a lot of fact checks happen behind the scene. I am not saying that all the facts are 100% accurate. But I think the situation are way better than the anonymous world wide web. This is for some detailed account for current events. You can find enormous information on some spin offs and merger and acquisition activities. The most recent stories I read including: the failed attempt for EXC to buy NRG and CAH's spin off of CFN. I didn't act on either case but perhaps I should.

3.Read Joel Greenblatt's book
"You can be a stock market genius" listed more places you can look for ideas. But some of those are not free. I am a cheapskate with the belief “Free is the Best”. I only list free and simple things. Remember, you don't need all the profitable ideas to build wealth. If you have 20 good ideas and you act on them in your lifetime, you are going to have a very successful investing career. By the way, continue to read my blog may be another way to generate good ideas.


It is close to the end of September, the only activity for the month is buying LUK.

Operating principles

If you are a first timer, please read the following pieces first. It will provide you with important background information.
1. Why I created this blog?
2. How am I going to operate this blog?

I have been contemplating on real estate investments for some time. I am not handy. If I want to do real estate without being ripped off by a contractor, I have to found some partners who are handy. It is really hard to find the right partner. The following is the operating principles I wrote for some potential partners. If you know a lot about how to fix houses and agree with my principles, email me and we may be partners.

1. Cost Control

Operating a business is simple but not easy. We want to increase revenue while lowering cost. However, growing revenue is a trial and error process. We are going to try many things but not knowing which one will produce the results we have wished. Cost control is usually more predicable. If we can reduce labor and use a less expensive brand of tools, we know what the saving will be. Buying, fixing and renting houses is a simple business. We will compete with numerous experienced veterans and a lot of would be investors. Being the lowest cost producer will give us competitive advantage helping us grow our business. Our goal should be to use the most durable, easy to install, simple material and process to fix houses.

2. Leverage

Leverage is risky. It runs two risks: default risk and interest risk. But in real estate, we have to use leverage to produce acceptable returns due to its inherent nature: heavy initial investment and low yield. We should use non-recourse and fixed rate financing whenever possible. We will use government subsidized financing whenever possible. And we don't overgrow ourselves. If we are wrong, we only lose what we can afford to lose. For example, if we have $1m funding (our equity and borrowings), we should not do over 4 projects at the same time (if each projects costs $150K).

3. Commitment

Building a business needs commitment. No matter what kind of equity we put in, sweat or monetary capital, it takes time before the investments yield satisfactory returns. We also need to prepare for drawbacks due to happen and build enough reserves to seize opportunities when they present themselves. Before we can enjoy the fruit of our investments, we must retain our earning for the minimum of three years. There are going to be clauses in our bylaws to ensure the commitment to the business, the company and our partners.

4. Cash flow

We are going to focus on cash flow. We are a small operation with limited resources. To ensure the viability of the business, we must only do deals with safe positive cash flow from the very beginning. Bigger companies sometimes do long term project without positive cash flow for the first several years and reap the handsome return later. We don't have that luxury. Some smart firms have one subsidiary produce positive cash flow to support long term strategic investments in another subsidiary. When we become bigger, we may do something like that. But for now, we must focus on the projects which can produce positive cash flow in the first 6 months.

Sunday, September 6, 2009

Update: a controversial choice

If you are a first timer, please read the following pieces first. It will provide you with important background information.
1. Why I created this blog?
2. How am I going to operate this blog?

I bought 200 shares Leucadia National Corp (LUK) at $23.45 on September 3, 2009. I paid additional $4.95 for this transaction. During this downturn and previous Katrina disaster, I have bought BRK.B, BAM and L that have business models similar to LUK. I still have others on my watch list. In its 2008 annual report, LUK summarized its business model:

"We tend to be buyers of assets and companies that are troubled or out of favor and as a result are selling substantially below the values, which we believe, are there. From time to time, we sell parts of these operations when prices available in the market reach what we believe to be advantageous levels. While we are not perfect in executing this strategy, we are proud of our long-term track record. We are not income statement driven and do not run your company with an undue emphasis on either quarterly or annual earnings. We believe we are conservative in our accounting practices and policies and that our balance sheet is conservatively stated."

As management suggested above, I believe book value is the best proxy of LUK's intrinsic value. From its 2nd quarter 10Q, I easily calculated its GAAP book value per share to be $14.86. I am paying almost 60% premium on its book value. I don't believe, its management, brilliant as it is, deserves such a huge premium. It is in the hidden assets not showing up in their balance sheet. First, it has a Tax Loss Carryforwards of about $5B meaning if it has earnings of $5B, it doesn't need to pay the tax on the $5B. It perhaps worth $1.8B if LUK can generate earning of $5B in 2009. Of course, LUK can't, at least not in 2009. Therefore, the current value of this asset is perhaps only $1B. That brings its adjusted book value to $18.89. I would certainly not buy it at 25% premium on its book unless, yes, unless, I thought its book value was still way understated.

Second, let's look at its public listed holdings. IMN rose 25.47% since June 30, FMG rose 12.13%, JEF rose 5.8%, ACF rose 20.75% and HOFD rose 17.95%. Just for the securities listed above, I can raise the current book value per share to $19.95. It is harder to estimate its non-listed investments. If I believe they rose similar to the public listed investments, LUK's book value is close to $21. Furthermore, LUK usually picks up assets from the corporate junkyard. While those assets being fixed, they won't produce positive cash flow. But once they are fixed and sold, usually they generate big gains. The management has done this many times. I believe its operating business is also understated in its balance sheet. I don't know how much though. Anyway, I am not paying a big premium over LUK's adjusted book.

LUK is a controversial stock. But even the critique hinges on its book value. It is highly exposed to real estate and resources. From its most recent proxy statement, Cummings and Steinberg jointly own close to 23%. Its management's interest aligns nicely with shareholders'. Another prominent investor, Bruce Berkowitz and the organization he controls, own 7.5%. By the way, Bruce commented that he was a buyer when LUK was in 30's. Another big institution, Morgan Stanley owns a big block. Therefore, about 40% is owned by insiders or management friendly big institutions. You have to wonder where all the sell pressure comes from.

Among its peers with similar business model, BRK.B and L can use float (unpaid insurance premium) with close to 0 cost. That is a huge advantage. BAM and LUK have to access the capital market from time to time. LUK financed its portfolio through high yield debt. The positive is that the earliest maturity of which is in 2013. But LUK is way smaller. Its manager, poorer and therefore, hungrier and meaner. It made a couple of mistakes recently including relying on others to do the heavy lifting. But now, with networth halved, I guess Cummings and Steinberg will work harder for themselves and for me. Recently, LUK worked with BRK.B bought Capmark out of bankruptcy. I hope this is the good omen for a glorious new start.

“Fortress Leucadia” is the management's draconian look into the future and a basis for defensive planning. It assumes LUK will not make any more investments, continue watching its expenses, keep only assets that are promising and slowly turn everything into cash which will be used first to retire or pay down debt, while always maintaining at least $500 million in cash or liquid assets. Management acknowledged that in the current recessionary environment, earnings from its operating businesses and investments do not presently cover its overhead and interest. But it believes LUK has cash, liquid investments and securities and other assets that it expects to turn into cash that should carry it through these difficult times. And I believe LUK's management.