Tuesday, July 31, 2007


I confess that I am one of those people who sometimes take a perverse pleasure in the misfortune of others.


The latest bunch of smart guys to have their asses handed to them are the people at Sowood Capital Management, a hedge fund started a couple of years ago by alumni of the Harvard Endowment. It was reported today that funds they run have lost 50% of its value in a month. This is getting to be a commonplace event lately but the news with Sowood is that they didn't invest in sub prime paper but in regular corporate debt.

How does such a thing happen? Major hedge funds have entire departments dedicated to risk management.

Was it a fatal combination of leverage, lack of liquidity and hubris? Was it a reliance on impenetrable mathematical black boxes that tell you the pricing relationship between different securities but that never seems to work in times of market crisis?

We'll never know. The principals at Sowood will no doubt move on and start another hedge fund with an equally impressive sounding name and raise another billion from people who are supposed to know better.

Monday, July 30, 2007

Festival of Stocks # 47

Our first entry come from Average Joe Investor, someone who needs no introduction given his prominence in the investment blog community. Average Joe comes in with two posts this week.

The first is at his Investment Jungle Blog and is called Stock Analysis - Landstar System Inc (NASDAQ:LSTR)

Joe loves the high ROIC and ROE of the stock but the volatility of the earnings is a little too much for him and the market seems to be paying too much for it.

The second post is at Dividends Matter and is called Dividend Analysis - Fifth Third Bancorp (NASDAQ:FITB)

His conclusion is that although FITB has a healthy dividend he has some other concerns about the company that prevents him from adding it to his dividend portfolio.

Our second entry comes from an unusual source - a bartender. George gives general advice on wealth and how to build it. The blog is called The Authentic Bartender Blog and his post is here

Millionaire Making Assets

The third entry comes from a blog I have never come across before. It is called Highest Conviction and I love the design and layout of the blog. It reminds me that I need to work on the graphics of my own site. Michael writes about Heely's where his emphasis is on when to get into the stock on a technical basis.

Read more at Heelys - Initiation

Next up is Wealth Building Lessons who gives his take on the attractiveness of Canadian Royalty Trusts. Read his post here

Buying Opportunity For Canroys

Dr. Barry Burns presents New York, New York posted at Top Dog Trading

Dr. Burns describes his recent trip to NYC and ties it all into trading by the end of the post.

The Mad Money Analyst has two for us this week. First off is When is The Right Time to Sell an Investment? posted at The Mad Money Analyst

Mad Money makes a good point - a sell discipline is one of the most important things to have in any active management process. I've worked in professional money management for 10 years and found a problem with this in every place I've worked.

The second post from Mad Money Analyst is Choosing a Stock That Beats the Street

Here he talks about the successful characteristics of a winning investment.

Jason Elder presents Offshore Options For Bankrupts And Those With Poor Credit posted at A Bankruptcy Lawyer's Blog

Jason discusses an interesting strategy to sidestep some of the problems with filing for bankruptcies in the United States.

Trent presents ASD: American Standard Riding the Trane posted at Stock Market Beat

Trent talks about American Standard and why he believes that the sale of one of its divisions may be a catalyst for the stock.

Another fan of dividend paying stocks is Tyler who wrote Dividends You Can Bank On! posted at Dividend Money

Tyler describes the advantages of some high yielding Canadian bank stocks.

Steve Faber presents More Alternative Energy Investing News posted at Debt Free

Steve discusses the latest developments in the Ethanol Industry and other news in the Alternative Energy space.

Cade Krueger presents Trading In The Zone: How To Mentally Approach Your Home Based Business posted at Small Business Opportunity

Cade explains the psychological angle of trading. This is an important area and is critical to being a successful trader.

TradeRadarOperator presents Unlock Stock Market Profits - Key #1 posted at Trade Radar

The TraderRadarOperator gives us a detailed look at the first of the ten keys to finding profitable stock trades. Stay tuned for the other nine keys.

KCLau presents When is the Perfect Time to Rebalance our Investment Portfolio? posted at KCLau's Money Tips

KCLau discusses the different methods of rebalancing a portfolio. I remember when I studied for the CFA exam, there were entire readings on this subject. His post was a good refresher for me.

Larry Russell's entry this week is called Summary Table of Traditional IRA and Roth IRA Tax Rules posted at THE SKILLED INVESTOR Blog

Although it may seem a long way off for most of us, you'll be 59 1/2 years old quicker than you think, so take a look.

Super Saver presents Stock Purchase Update - 7/23/07 posted at My Wealth Builder

Super Saver reviews his portfolio performance through last Monday. It will be interesting to see his performance at the next weekly update after the carnage of this past week.

George presents Biggest Losers of Today’s Stock Market Panic posted at Fat Pitch Financials

George has posted a list of the biggest losing stocks in the S & P 500 after the sell off last Thursday. This is a good place to start to look for bargains to take advantage of the fear of the crowd. Beware though, some of them probably deserve to be down now that the private equity takeover premium has oozed out of them.

Leon Gettler presents Gen Y and the looming funds management crisis posted at Sox First

Leon is another blogger with an excellent design, and he reviews a report from KPMG detailing the demographic wave that some predict will hit the funds management area one day. We also have a new acronym - KIPPERS - kids in parents' pockets eroding retirement savings. And I have four kids that will be eroding mine.

John presents Foot Locker posted at CONTROLLED GREED.com

John likes Foot Locker and is not afraid to put his money where his mouth is and took some down despite the volatility last week.

Silicon Valley Blogger presents Historical Financial Charts: Are You Invested In These Markets? » Money and Personal Finance Blog In Silicon Valley posted at The Digerati Life

He is an engineer who has done an excellent post with long-term charts going back in some cases more than 100 years. I have a book from Ned Davis with charts like these but it's much easier seeing these on line. The second chart is the scariest one showing three times in the last 100 years where the market was flat for a generation. Look out indexers, you may be in for a big shocker.

Ispf presents Campaign Against Financial Myths: Part 6 - Stock Market Investing posted at Grad Money Matters

Ispf tackles some of the myths out there in the financial world, and does it quite convincingly.

The last entry in the Festival of Stocks this week comes from Mark. He is the first blogger that I ever communicated with when I started blogging back in February and I would urge you to check out his blog at

Investment Quest

Mark presents Is LJ International (JADE) a Bust?

He urges caution on this name despite the recent sell off.

That's it for this week. It was definitely a full week with lots of interesting posts out there.

Friday, July 27, 2007

Conundrum Solved?

Has the great Wall Street conundrum been solved? I wrote 2 days ago about the disconnect between deal fever and the viability of financing those deals, and the decline in the market yesterday may have validated my words. The market was down 447 points at one point in the afternoon and it was a little unsettling to watch such a free fall.

Is it over? Wall Street is notorious for having a selective memory so maybe the buy on the dips investor will drive things back up. But remember 300 points is not what it used to be. The market is down 4.8% from the high reached a week ago but that statistic is deceptive since it is from the intra day high of 14,121.04. The market closed that day at 14,000.41, giving us a correction of 3.9% from that close.

I had some serious flashbacks yesterday to the late 1980's, when Wall Street was riding high. It was the age that gave us "Bonfire of The Vanities" by Tom Wolfe, and the movie "Wall Street" directed by Oliver Stone. Everyone remembers the famous "greed is good" line from that film but the one I remember was spoken by Martin Sheen who played the father of Bud Fox.

"Stop going for the easy buck and start producing something with your life. Create, instead of living off the buying and selling of others."

We thought it was the age of excess but now 20 years later we know it is nothing compared to today.

I remember sitting at my desk when the news came out that Michael Milken had earned $550 million in one year heading up Drexel's junk bond unit. Today that might not even get you a table during the evening rush at the 21 Club. And then one day in October 1989 it came to an inglorious end when the leveraged buyout of United Airlines fell through. It was a watershed event that precipitated a 7% drop in the Dow in one day.

Does Chrysler equal United Airlines? With hindsight it just might be.

Thursday, July 26, 2007

Bye Bye Book Value

DR Horton (DHI) reported earnings this morning and is the first of the homebuilders to finally recognize reality - that its main asset - land, is not worth anywhere near what it says it is. They took an impairment charge of $823.8 million to the value of the land on its balance sheet. As a comparison, last quarter DHI wrote down only $ 67.3 million for inventory impairments. While it may seem that DHI just reported a "kitchen sink" quarter, remember that total inventory on its balance sheet is $10.6 billion, and home and land prices are still dropping in many states.

The conventional wisdom on Wall Street has been to buy Homebuilders at book value, which incidentally, virtually every analyst said would never happen. But here we are about 18 months into the downturn and many of them are bouncing off tangible book value, with some well below. This belief that book value is the bottom is ingrained in the industry as well. I remember attending a Homebuilding marketing tour in Atlanta about 5 years ago and during the question and answer period an investor asked the management if they would consider making any acquisitions. The group was trading at around 1.5-2.0 times book value at the time.

The speaker looked dumbfounded for a minute and then said simply that the only value to him in a competitor was the value of its land – he already had a brand established and the infrastructure to support it – so why would he pay two times what its land is worth? Now did it occur to him at that time, that this was exactly what he was asking us as investors to do? To pay twice what his book value was? I’ll never know the answer to that and I can’t recall which homebuilder it was.

So is it time to get in the group? Investors need to get their hands around several issues before jumping in here. It will be tempting because you will start reading articles soon about how Value investors are “sniffing” around the industry. Value investors love to sniff around stocks and industries. There are stocks that I have been watching for years without buying. I stalk them, watching and waiting for the 100-year flood to come.

The first issue is book value. It’s great to buy something at book value because it makes you feel warm and cuddly at night but what happens when you wake up and type that stock ticker into the box and you find out that the company just wrote down 20% of its book value? Oops. Sorry, you no longer own a homebuilder at book value anymore. An analyst report released last week from Deutsche Bank says that on average a group of 13 publicly traded homebuilders have written off 11.1% of its equity base. Is this enough for what may become the worst cyclical downturn in the last 50 years? My opinion is no.

The second issue is what sort of hidden bombs are there that are not on the liability side of the balance sheet of homebuilders. Homebuilders utilize off balance sheet partnerships and joint ventures fairly frequently. Have these all been disclosed to investors and do we understand completely the ramifications of them?

Third, the biggest boom in the history of residential housing deserves the biggest bust. The excesses need to be washed out of the system before things get back on track.

Fourth, the sub prime reset wave has not peaked. What happens when these hapless homeowners go to refinance, as they were promised, but they have negative equity so can't get a lender to touch them. Back to renting I guess and the house is put up for sale. Inventories have not peaked.

Fifth, the industry can trade at a much lower price to book value than the conventional wisdom believes. Stocks traded down to 0.5 times book value back in 1991. I think we can all agree that this downturn is worse than that one.

Wednesday, July 25, 2007

Pink Sheets - Part II

Another Pink Sheet/Bulletin Board stock I came across recently is the Mills Music Trust (MMTRS.OB). Mills is a trust that owns the rights to a music catalogue dating from the 1960’s. The trust receives the royalties from songs in the catalogue, which is currently paid by EMI Music Publishing Co. It is owned 28% by MPL Communications, Ltd., which is Paul McCartney’s music company.

It sells at $38.50 per share and paid out a $4.48 per unit dividend in 2006. The downside of this company is that the trust has a finite life since the copyrights will eventually expire and the songs will enter the public domain. It is also involved in a legal dispute with EMI that has been ongoing for several years.


The stock did fairly well for a while but has plateaued the last couple of years, and has had a sharp drop the last week or two as the chart above shows. Mills is also a transparent company. I couldn't find a web site but they do file with the SEC.

Tuesday, July 24, 2007

The Conundrum

The Conundrum is simple and is this - the market continues to climb based on a "buy on the dips" mentality fed, at least in part, on continued takeover speculation that is embedded in the value of equities. Every time the market declines significantly, it bounces right back as investors jump into names they have been stalking. I think that at every buy side shop there is an investment thesis template that reads "potential buyout candidate" and all the analyst has to do is fill in the name and symbol, and give it to his Portfolio Manager.

However, the financing that supports that takeover activity is starting to undergo a repricing by investors based on a reevaluation of the perceived risk. Many investors have stopped investing at all here or have paused, while other investors are rejecting covenant lite and toggle or pay in kind bonds while demanding higher yields. Higher yields mean less of a return on these deals which will shrink the universe of potential buyout candidates.

There are at least 6 "hung up" bridge loans held by investment banks where Wall Street firms provided interim financing to buyout shops, in anticipation of replacing the bridge loan with permanent financing. Until this pipeline clears or the investment banks feel that conditions in the credit market are returning to normal (I hate to even use the word normal) this type of stop gap financing will be harder to come by.

The latest deal financing to fall through was reported today by The Wall Street Journal - the buyout of Allison Transmission, a unit of General Motors. Investment banks postponed an offering of $3.1 billion in loans.

We have a conundrum here. The stock market cannot continue to be propped up by the private equity buyout frenzy if the financing that supports that frenzy is no longer viable. There are a number of possibilities here:

1) The market is seeing through the current turmoil in the credit markets and expects the financing to return. If true, this would be extraordinary considering the market usually has a one-week time horizon.

2) The market believes that even if risk reprices at a higher level - the internal rate of return (IRR) on private equity deals will still be sufficient enough that the buyouts will continue.

3) There are other things that are pushing the market higher besides the buyout frenzy. This could be a number of things, perhaps even the dreaded "liquidity" excuse that I hate so much as OPEC and the Chinese have so much money they have to put it somewhere.

4) I am completely wrong and have no idea what I am talking about and shouldn't be writing an investment blog much less running a hedge fund. If this is true please send me an e-mail privately and tell me.

5) The investors who are propping the market up don't fully understand the reasons supporting valuation that I described earlier in this post so therefore they cannot stop investing when these reasons end.

6) There is a lag time before the financing problems impact the stock market.

7) Investors believe that private equity shops have so much money that they will spend it no matter what. If they make bad deals it will be years before the limited partners who invest in these funds feel it.

If I had to make a bet, it would be on reasons 2 and 7 (I hope it's not #4). Interest rates are still low historically, some marginal deals may fall through, but many would still work at least on paper based on a spreadsheet with optimistic projections of future cash flow growth and EBITDA exit multiples.

Monday, July 23, 2007

Tragedy of The Commons

The Tragedy of the Commons is a concept that refers to the use and ultimate damage done to resources that belong to the public. Here is how it works on a simple economy basis:

An economy consists of a single village. Each resident attempts to gain wealth by putting as many animals on the common pasture of that village as it can. As the village grows in size and more and more animals are placed on the commons, overgrazing begins to impact the pasture. Eventually, no stock can be supported on the commons. As a result of population growth, greed, and the use of the commons, the village collapses.

It occured to me that this concept can also be applied to what is happening with sub prime lending and credit in the economy. Banks and others would make loans and then the loans would be securitized and sold off. The purpose of the securitization was to minimize risk by removing that risk from a lenders balance sheet, etc.

It instead has the opposite effect - by redistributing risk - it increased risk because it made no one responsible for that risk. The risk was distributed to the "commons." A lender could make a bad loan and it wouldn't matter because that loan would be sold off to the marketplace. It is analogous to a common grazing site in a small village as described above.

Friday, July 20, 2007

Pink Sheets - Part I

The Pink Sheets can be a scary place to invest. They have a terrible and well-founded reputation for illiquidity, lack of financial transparency, fraud and pump and dump scams, and mainstream investors and publications generally scorn stocks that are listed here. However, to completely ignore stocks that trade here is a mistake as there are some wonderful stocks in this part of the market that have provided above average returns to investors for years, even for generations in some cases.

So I have done some poking around in this area and have discovered some real interesting companies that deserve a look by other investors. Now let me qualify what I mean when I say that I “discovered” these stocks. To claim that I discovered the stocks I mention in this post is analogous to Columbus saying that he discovered America, when we all know that there were native people living on this continent for tens of thousands of years. These stocks are well known to people who have been investing here. In fact, I found out about many of these names because I stumbled across another web site while researching a different stock. The web site was for an investment firm called Standard Investment Chartered, Inc., which specialized in these names:


I did notice that there is not a lot of chatter about these stocks in the Value Investing blogosphere, but I would be interested to hear from others about them. I am going to write a paragraph or so on some of the names and try to expand on them in future posts. As I have stated before, just because I post on them doesn’t mean that I am recommending that someone run out and buy them right here and now.

Limoneira (LMNR) is a pink sheet company out in California that owns 7,000 acres of farmland that they grow avocados and other produce on. They have another division that has been developing land in its inventory that has been converted to higher uses, i.e. development purposes. They are one of the more accommodating and open pink sheet companies out there. They have a web site, and even agreed to send out the annual shareholder report even though I am not a shareholder. Remember, pink sheet stocks are non-reporting companies so they are under no obligation to provide the standard financials even to shareholders. The stock has been on a tear the last 5 years, possibly coinciding with the rise in value of California real estate.


Calavo Growers, Inc. (CVGW), a NASDAQ listed company, owns a large stake in LMNR, so there is a back door way to own LMNR if one feels that it is a worthy investment.

Wednesday, July 18, 2007

High-Grade Bonds ?

Definition - A bond with a rating of AAA or AA, the two highest ratings.

Bear Stearns dropped the bombshell today on investors in its two sub prime hedge funds. The company stated in a letter to investors that "the preliminary estimates show there is effectively no value left for the investors in the High-Grade Structured Credit Strategies Enhanced Leverage Fund and very little value left for the investors in High-Grade Structured Credit Strategies Fund as of June 30, 2007."

The real stunner, at least for me, was this line in the letter, where they gave the cause of the loss in the value of the fund,

“Unprecedented declines in the valuations of a number of highly-rated (AA and AAA) securities.”

Well, I’m sorry but AA and AAA securities don’t go from par to effectively nothing in a couple of weeks. Well maybe if you lever up 5 to 1 they do but someone at the ratings agency or Bear didn’t do their job.

So just imagine the meeting where Bear salesmen were pushing this fund on its clients.

“Well isn’t this a little risky?” said the client.

“Oh no, don’t worry, we only buy AA and AAA rated bonds,” said the smiling salesman.

“Oh, OK,” said the client

“We even put the words – High Grade – in the name of the fund to make you feel safe,” said the smiling salesman.

“Yes, but what about the word – leverage – that’s in there also?” said the client.
“Oh, don’t worry about it, we know what we are doing here. We are experts at this type of thing,” said the smiling salesman.

I even had to sit my wife down this morning and explain to her why this would never happen to the Hedge Fund where we have all of our life savings invested.

"I don't buy crap like this," I said.

"Well make sure you don't. I don't want to be working for a living when I am 70 years old," she said.

Tuesday, July 17, 2007

The Death of Liquidity – Part I

Liquidity…it’s Wall Street’s excuse for everything. Why does the stock market keep going up? Liquidity. Why do real estate prices keep going up? Liquidity. Why haven’t we had a significant correction in months? Liquidity. Why do the skirts of CNBC anchorwomen keep getting shorter? Liquidity.

Recent articles in the financial press represent an obituary for this pesky little word that has come to mean so much to so many people.

The Wall Street Journal, reported today that Wall Street investment banks are having trouble placing debt to finance the latest round of private equity buyouts. They even had to extend bridge loans with their own capital since bond investors seem to have finally realized that covenant lite and toggle bonds are dirty words.

Will the end of liquidity knock out one of the legs that are propping up this market? Time will solve that mystery. Could it be that it is not really the death of liquidity, but just investors demanding a higher yield for the risk that they finally realized they are taking?

Monday, July 16, 2007

Homebuilder Debt to Capital Ratio - Be Careful Out There

Lennar Inc. (LNR) just released its quarterly earnings report and highlighted what it considers its low debt to total capitalization of 31.6%. Investors should note, however, that the numerator of this calculation only includes the on balance sheet debt and Equity of Lennar. Lennar has not filed its 10-Q for the May quarter as of the day I wrote this, but the company has the following debt according to its 10-Q from the previous quarter (ended 2/28/07).

$ 278,232 - 7 5/8% senior notes due 2009
$ 299,766 - 5.125% senior notes due 2010
$ 249,461 - 5.95% senior notes due 2011
$ 345,719 - 5.95% senior notes due 2013
$ 247,559 - 5.50% senior notes due 2014
$ 501,851 - 5.60% senior notes due 2015
$ 249,694 - 6.50% senior notes due 2016
$ 300,000 - senior floating-rate notes due 2009
$ 109,212 - Mortgage notes on land and other debt

$ 2,581,494

This total debt number is close to the number in Lennar's press release of $2,585,286,000 for the May quarter, which when divided by total debt and equity of $8,168,841,000 gives us the 31.6% number. However, if you dig into the 10-Q for February you will see that Lennar calculates the debt to total capital of its unconsolidated entities as follows:

Debt of Unconsolidated Entities $5,619,394,000
Total Equity of Unconsolidated Entities $3,299,991,000
Total Capital $8,919,385,000

Debt to total capital of Unconsolidated Entities 63%

To be fair to Lennar, there is a footnote that says the Equity is carried at book value and the market value is $1.3 billion higher than book.

If you do a weighted average of the on balance sheet debt to capital and then the unconsolidated entities, then you get

Debt $8,200,888,000
Equity $9,074,972,000

Total Capital $17,275,860,000

Debt to Capital 47.47%

I believe that Lennar has a reputation as one of the more open and transparent Homebuilders so it may not be possible to calculate this for the other publicly traded Homebuilders, but investors should look twice at the official number that come out in press releases.

Now when I contacted investor relations to get the company opinion on this matter they said that:

"it would not be accurate to add the equity and debt from our JVs. Most of this debt is non-recourse to Lennar or has recourse via maintenance guaranties."

Well, now I am even more confused and need to do a little more work on the entire concept of these structures. I will come back to this at a later time. If anyone has encountered these structures before and has a more complete understanding of them, please comment.

Saturday, July 14, 2007

Smart Money vs. Dumb Money

Everyone knows the Wall Street concept of smart money. It’s a myth really since even great investors do stupid things every now and then, but assume it’s a viable concept for the purpose of this post. Here’s how smart money talks about investing capital in a business compared to how dumb money talks about investing in a business.

Smart Money

Warren Buffets six criteria of buying a business

We are eager to hear from principals or their representatives about businesses that meet all of the following criteria:

(1) Large purchases (at least $75 million of pre-tax earnings unless the business will fit into one of our existing units)

(2) Demonstrated consistent earning power (future projections are of no interest to us, nor are “turnaround” situations)

(3) Businesses earning good returns on equity while employing little or no debt

(4) Management in place (we can’t supply it)

(5) Simple businesses (if there’s lots of technology, we won’t understand it)

(6) An offering price (we don’t want to waste our time or that of the seller by talking, even preliminarily, about a transaction when price is unknown).

Ian Cumming of Leucadia National Corporation (LUK)

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.

LUK also has its "Rules of the Road

1. Don’t overpay, no matter what the madding crowd is up to.

2. Buy companies that make products and services that people need and want and provide them as cheaply as possible with consistently high quality. Lower cost and higher quality is a relentless and never-ending task.

3. Earnings sheltered by NOLs are more valuable than earnings that are taxed!

4. Compensate employees for performance and expect hard work and honesty in return.

5. Don’t overpay!

William Thomas of Capital Southwest Corporation (CSWC)

Capital Southwest emphasizes the following elements in evaluating potential investments:

Management – Believing that the most important factor in any venture is the quality and integrity of the people who lead the company, we invest in financially committed management teams who share a vision of the future and have the ability and determination to achieve their goals. We prefer managers who have significant operating experience as well as an in-depth knowledge of their industries.

Markets – We search for companies serving markets which are large or expanding rapidly and have the potential to reach revenues of $100 million or more. In more mature markets, we invest in growth companies that have a clear competitive advantage or a strong market position.

Products – We invest in companies whose products or services are well positioned versus their competitors, offer significant value to customers, and are continually improved and upgraded. Proprietary products and services are attractive if supported by continuing development programs.

Dumb Money

Excite@Home buys Blue Mountain Card for $780 million in cash and stock – Dec 1999

"Excite@Home plans to leverage the Bluemountain.com audience reach and page views almost immediately to create more Excite@Home registered users, broadband subscribers and, ultimately, revenue," the company said.

"For Excite@Home, this acquisition promises to be a significant platform for future growth in both narrow and broadband content to generate increases in registered users, @Home broadband subscribers and revenue,"

Excite@Home sells Blue Mountain Card for $35 million in cash – Sept 2001

Google buys YouTube for $1.65 Billion

"The YouTube team has built an exciting and powerful media platform that complements Google's mission to organize the world's information and make it universally accessible and useful. This is just the beginning of an Internet video revolution."

"So by joining forces with Google, we’ll be able to sharpen our focus on this vision to create a new media platform for consumers and partners to distribute their media worldwide. This will allow us to, you know, with Google’s success in building a revolutionary new ad platform, this has inspired us to create a new model, a new platform for video content on the web. With this new relationship, we’ll combine Google’s experience and have the resources to continue on our mission to offer the most entertaining online video experience."

“There is a new class of sites that have developed very quickly and are very successful and delivering a lot of value.”

The smart money talks mainly about the numbers that are involved with the purchase. Is the business profitable? Are we paying a reasonable price for the asset? Does it have a sustainable competitive advantage?

The dumb money talks about conceptual information regarding the business that was bought. It will allow us to do this and it will allow us to do that, and it will provide a platform for moving into the next era, etc. They are short on details on the financial side because there is no financial side.

Why is the Internet industry like this? What makes successful and smart people suspend the normal laws of physics? Is it because they are using stock and not cash? When an individual wants to buy a small business, the first question to ask is – does the business make money? Would you pay 50 times sales to buy a corner grocery store or a t-shirt shop? I sure as hell hope not. Yet it happens all the time in Internet related businesses. Is it because of growth? Who cares about growth if profits don’t follow?

And yet investors love these stocks and crowd around them like a pack of teenaged groupies girls waiting backstage at a rock concert for the band to leave. "Oh, pick me! Pick me, please," they scream.

We will not give in to this madness.

Quotations from the Google/YouTube Conference call courtesy of Seeking Alpha

Sunday, July 8, 2007

So What is Wrong with Yahoo?

Yahoo just dumped Terry Sempel, its Chief Executive Officer, after it was decided that he was not the person to take Yahoo into the battle with Google. He no longer manages the day-to-day operations of Yahoo, as it has fallen on Jerry Yang, one of the original founders of Yahoo. So what is wrong with Yahoo? Why are shareholders not getting the return they deserve? After all, this is a tech stock.

Well here's my theory of what is wrong with Yahoo. Back in 1999 during the run up to the Internet bubble, Yahoo paid $4.9 billion for a company called Broadcast.com, and a few months before that they paid $ 3.2 billion for GeoCities, a web community page company.

Now wait a minute you say. That happened 8 years ago. How could that be affecting Yahoo today?

First, let's see what these companies were that Yahoo paid $8.1 billion for back in the day.

Broadcast.com was according to its final 10-Q filed on 5/17/99:

“A leading aggregator and broadcaster of streaming media programming on the Web with the network infrastructure and expertise to deliver or "stream" hundreds of live and on-demand audio and video programs over the Internet or intranets.”

Well, it sounds very YouTubish and not all that special but remember this was 1999, when most people on line were on dial up, so let’s give Yahoo the benefit of the doubt and say that this was cutting edge technology at the time. Here’s an image of its home page back in 1998.


And GeoCities? According to its final 10-Q filed also on 5/17/99:

“The Company offers a community of personal websites on the Internet within 41 themed neighborhoods. The Company's main source of revenue is from advertising, along with other revenue streams, including fee-based premium services and commerce. The Company's business is characterized by rapid technological change, new product development and evolving industry standards.”

Again it doesn’t sound like a big deal now that we have 70 million blogs on the Internet, but this was 1999, and it was the 5th most visited site on the Internet back then. Here’s an image of it in 1999:


So here is what Yahoo got for its money. In its last quarter as a public company, Broadcast.com had revenues of $10.2 million, with a loss of $3.8 million for the quarter. In its last quarter as a public company, GeoCities had revenues of $7.82 million, with a net loss of $10.2 million.

So if you annualize the last quarter for both companies, then Yahoo paid 112 times sales. The earnings multiple can’t be calculated obviously. So why am I rehashing this debacle by Yahoo? Dozens of companies overpaid for assets at the time.

The point I am trying to make here is that at the end of the day, there has to be consequences for a company that overpays for a business, ignores financials, issues shares that dilutes current shareholders and gets nothing substantial in return for what they bought. So could it be that the laggard share performance that we are seeing now is the result of the cumulative effect of that deal stupidity?

Now at the time most everyone loved the deals. Yahoo was falling behind, and needed to do something. Analysts applauded the deals. Yahoo thought it was great since they were using “funny money.” We’re not paying real cash; we’re only issuing shares.

These weren’t the only deals that Yahoo made over the years, there were dozens, and virtually every time stock was issued, Yahoo overpaid and existing shareholders were hurt.

So how does this tie into value investing? Investors should only buy into companies where management runs its business for the long term. Not companies like Yahoo that react impulsively based on newspaper headlines or when analysts whisper in their ear in between conference presentations. This is one of the oldest investment clichés out there but it is true.

So is Google the next Yahoo? It paid $1.65 billion for YouTube in October 2006, and the company issued shares despite its cash hoard. YouTube was a private company so I don’t know its financials but it is clear to everyone that the price Google paid was far in excess of its current financial value. Will Google monetize the site? Time will solve that mystery I suppose.

Let’s do an exercise and compare the comments of Yahoo in 1999 to Google in 2006. The similarity is eerie.

Google People in 2006:

“I’m confident that with this partnership we’ll have the flexibility and resources needed to pursue our goal of building the next-generation platform for serving media worldwide,” said Hurley, YouTube’s 29-year-old CEO.”

"This is just the beginning of an Internet video revolution," Schmidt said.

Yahoo People in 1999:

"We successfully completed the Broadcast.com acquisition ahead of schedule and are moving swiftly to integrate the company's audio and video programming, business services, and advertising programs into Yahoo," Yahoo president Jeff Mallett said.

There are few barriers to entry out there for user supplied video sites. In fact, there are hundreds of competitors out there with new ones starting every day. MySpace just announced they were starting up a rival site to compete with YouTube. Now none of these sites have the market share of YouTube but that didn't help Yahoo with GeoCities, which had large market share back in 1999.

I would venture to say that first mover advantage has never worked on the Internet. Does anyone remember Visicalc? It was the first commercially available spreadsheet program back in the early 1980's. Where is it now?

Just go to Google and type in the words "start your own video web site" and you will understand what I mean.

Saturday, July 7, 2007

What is a Value Stock?

I was talking to some one in the business the other day and they asked me if I owned any Energy stocks. My first instinct was to shudder in horror. Energy stocks value? At the peak of the cycle? After 5 years of unbelievable outperformance and with commodity prices higher than ever? And then I started to think about it and realized that value has a very slippery definition.

Value is one of the words like “beautiful.” Everyone has his or her own perception of what beautiful is. So just like the old cliché “beauty is in the eye of the beholder,” so to the definition of what a “value” stock is, is in the eye of the beholder. There have been times where I have looked at quarterly reports from mutual fund companies that are dedicated to value investing and just shook my head in wonder. How could that stock be a value stock? And then I would remember what a great long-term record that manager has.

Here is a theoretical argument about what value means in terms of Energy stocks. Let’s say that you are a believer in the theory of peak oil. I don’t want to get too deep on what that means so here is a good web site if you want to really get into it:


It basically states that the world is at or near its peak in terms of oil production, and we will soon see declines in that production. Since demand is rising due to global industrialization, this mismatch will cause a major step up in prices, etc.

Now if this comes true, and I am not passing judgment on this argument right now, doesn’t that mean that all those oil reserves on the balance sheets of the integrated oil companies and the exploration and production companies are vastly undervalued by the market? That would make them “value" stocks then I guess. If the market is valuing these stocks based on long term prices of oil at $30-$40 but the long term price will be twice or triple that, then owning those stocks is certainly a value play.

Now the stereotype of a value stock is one that has been beaten up in price, the fundamental outlook has deteriorated and most investors generally scorn the stock, but what if that is too narrow a way to look at the issue.

I am not making a call on loading up on Energy stocks mind you. I just wanted demonstrate theoretically how a market darling group like Energy could be viewed as "value."

Friday, July 6, 2007

I am a Moron

Here is a cautionary tale of what happens when you ignore illiquid and micro cap stocks, and your investment philosophy. Two years ago I was researching banks and I stumbled across the Pink Sheets web site at


It was a particularly slow day at where I used to work, so I figured why not? I’ll waste a few hours and have a laugh.

After clicking through the site I found the listings page for all pink sheet listed banks. I was stunned to find that there were so many bank stocks that trade off the main exchanges – there were literally hundreds of banks listed here. So I decided to pick one at random. Well it wasn't really at random, it was one in Atlanta, which is nearby where I live so I figured I would take a look at it. It was the North Atlanta National Bank (NANB). It traded both on the OTC Bulletin Board and the Pink Sheets.

It was selling at $10.00 a share, but there was very little news or financial reports on Bloomberg about it. So I dug some more and I found that they had a web site where they post shareholder reports. The bank had a single branch in Fulton County, Georgia. This is a northern suburb of Atlanta that is growing like a weed. I dug further. The loan and deposit growth was unbelievable – a compound annual growth rate of more than 100% since 2000. They were well capitalized.

And then the bombshell hit – its tangible book value was $9.03. I did a double take – was this a misprint? Fast growing, well-capitalized banks don’t sell at tangible book value. So I checked at the government web site where the banks file their call reports, and it was confirmed. So there it was, a fast growing, safe bank selling at slightly over tangible book value and what did I do? Absolutely nothing. I didn’t buy it. It wasn’t liquid enough I said. Its market capitalization was only $10 million. There wasn’t that warm cuddly feeling of being surrounded by other investors. There wasn’t some sell side analyst around to make me feel safe at night while I owned it.

I kept it on my screen though and watched it the next two years. It only traded twice a month but every time it traded it seemed to go up a buck or two. I lost track of it for a while, and the next time I looked it was at $17, and then $22 a few months later.

Then on June 29th, 2007, my nightmare reached a climax as I saw the headline – Shinhan Bank America to acquire North Atlanta National Bank at $23.44 a share. A South Korean bank looking for a foothold in a fast growing American city had bought it.

So what’s the point of all this? There are hundreds of other Pink Sheet and Bulletin Board Stocks out there in Banking and other industries that are being ignored by most mainstream investors. If you do this you will reduce your opportunity set immensely. There are some great stocks here so don't be a moron like me. They are hard to trade sometimes, but if you are a long term investor that shouldn't be a worry.

A great investor once said that there is a lesson to be learned in every mistake and I think I learned from this one.

Thursday, July 5, 2007

No Margin of Safety

Everyone knows the concept of the Margin of Safety in Value Investing. This is what happens when you ignore those words:

“United Capital Asset Management has temporarily suspended payments from four of its Horizon funds following losses from its investment in sub prime mortgage bonds. In the past ten days, the firm received an unusually high number of redemption requests, including one from its largest investor, which accounts for one-quarter of the firm's assets under management.”

Full Story

A similar situation occurred in the CMO market back in 1994, when a firm called Askin Capital Management lost hundreds of millions of dollars as the market disappeared for the products that they owned and the so called "proprietary models" to price these things no longer worked. The lesson? If the person who manages your money can't explain the investment to you - then don't go near it.

Wednesday, July 4, 2007

Focus Investing

I recently came across a website called Focus Investor run by Richard M. Rockwood. It has many good articles on Value Investing and a section where investors can download spreadsheets to calculate intrinsic value for stocks.

I want to bring attention to his article that he wrote on Pico Holdings (PICO) back in March 2000. It was selling around $12 a share back then and is now at $44. This is a fairly well known stock now but he was certainly ahead of the curve 7 years ago.

Pico Holdings

There are also solid reports on White Mountains Insurance (WTM) and Markel Insurance (MKL) in the articles section. These are a little outdated but provide good background on the stocks.