Selective Readings of Data - Weekly Blog # 892

 

 

 

Mike Lipper’s Monday Morning Musings

 

Selective Readings of Data

 

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018

                             

 

 

Assumption

I assume as a careful reader of these musing one cannot avoid the “happy talk” produced by most of the media. For balance, as a public service for my blog readers, I’ll focus on data and other information supporting the other side.

 

Long-Term

Jaime Dimon, the CEO of JP Morgan Chase, was recently quoted as follows: “If we are not the pre-eminent military and pre-eminent economy in 40 years, we will not be the reserve currency…” He is pleading with you to develop four views that he considers critical to a sound investment philosophy. They are the importance of military standing, economic position, having a forty-year view (the bulk of institutional and individual money is invested for long periods), and the significance of being the sole reserve currency.) I will be happy to discuss your views on these questions.

 

Others’ Views Focused on the Short-Term

Recently, 17 well-known investment advisors made estimates of the Standard & Poor’s 500 Index 2025 closing price. Nine estimates were higher and eight lower. The lowest was JP Morgan Chase, 13% below Friday’s close. (Of all the various stock market indices, I believe the S&P 500 Index is the best to gage the level of the market. On Friday it only gained one tenth of 1%, showing the stickiness of the movement.) Morgan Stanley is expecting the US dollar to drop 9% over the next year.

 

Unfavorable Conditions

Retail investors of all sizes are being told to invest in private investment vehicles, including private equity. These investments represent some 30% of the M&A market. History suggests the public buyers come into many trends last.

 

Currently, there are 7.5 million unfilled job openings. Employers can’t find suitable workers. I believe many potential employees lack sufficient motivation, discipline, and/or integrity for these jobs. This is leading to a low growth rate in labor productivity.

 

The employees themselves are one reason for these conditions at commercial, government, and nonprofit institutions. Due to the slow growth of our society there are pressures at all levels of management to improve labor productivity. Managers strive for efficiency, defined as output divided by input. The simple way to do that is to assign generated revenue to each worker. This is relatively easy to do for line employees, by leaving out the supervisors. The next step is to reduce the number of supervisors. This creates efficiency. However, supervisors create most of the worksite culture, which leads to product and service quality.

 

In just about every sector of modern life we are experiencing a decline in the quality of the products or services we receive. However, as a result of employers not hiring more experienced quality supervisors, this has led to customer dissatisfaction, lower customer/client loyalty, lower sales, and fewer recommendations. Employers should be hired for effectiveness, which would reduce costly mistakes and improve relationships.

 

Two World Realties

As long as we have politicians and their advocates chanting happy talk about the economy while employers cut back on hiring, we are going to experience a dichotomy in the investment world. We can hope for the best but should be prepared for the worst.

 

The Form Does Work

As many subscribers already know, I count my former time at the New York racetracks as a critical learning experience. Consequently, the running of the Belmont Stakes, which was run early Saturday evening, is very important to me. The race is now one quarter mile shorter than the traditional 1½ miles, which means its long history of winning times is no longer relevant to racing analysts (handicappers).  From a betting/investment standpoint, the job of the analyst is to evaluate the odds of a particular horse winning vs the odds posted on the tote boards. These odds are derived from the amount of money invested on each horse, including taxes and fees paid to the track. The smaller the odds, the more popular the payoff selection on the winning horse. In many ways this is similar to the most popular investments in the marketplace. It is important to remember that the most popular bets, called favorites, win a minority of the time. But they do win more often than the less popular bets.

 

The first three horses crossing the finish line at the Belmont Stakes were the same three horses finishing in that order at the Kentucky Derby. Thus, the history of these horses proves to be a good predictor. Can stock buyers count on a similar phenomenon in picking stock investments? It is occasionally possible, but not all the time.

 

If using lessons learned at the racetrack seems a bit odd, think about Ruth and I attending a New Jersey symphony concert on Sunday afternoon. This featured two great classical performers, Xian Zhang, conductor and Conrad Tao, pianist. They impressively played Sergei Rachmaninoff’s second piano concerto. This piece was a breakthrough work marking Rachmaninoff emerging from a three-year depression. The length of the depression could be a useful guide to an investment depression, unless the government lengthens the period of the depression, as FDR did in 1937.

 

Thoughts?      

 

 

 

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My Triple Crown - Weekly Blog # 783

 

Mike Lipper’s Monday Morning Musings

My Triple Crown:

Berkshire, Coronation, Derby, plus analytical insights

 

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018

 

 

 

Berkshire Hathaway Annual Benefits

One of the advantages of owning shares in this unique company, both personally and professionally, is having the opportunity to learn from Warren Buffett, Charlie Munger, Greg Able, and Ajit Jain. The side conversations with a number of deeply involved investors and managers is an added benefit. For me, my wife, and my son Steve, this is truly an educational experience.

 

In terms of Berkshire, the following is a brief list of short-term (one year) comments:

1. The “float” is expected to be higher than in 2022. There should also be earnings from the railroad.
2. They have heavy property insurance exposure in Florida real estate.
3. GEICO will not be getting the full benefit of the switch to fully automate until at least 2024, possibly longer.
4. The stock is selling below “going-concern value”, suggesting it’s a good use of cash, particularly for heirs.

 

Coronation

While the coronation of King Charles III and Queen Camilla is important to many in the English-speaking world, it is also important to those of us entrenched in the investment world. King Charles produced a more modern version of the over 1,000-year-old coronation with all its pageantry and significance. Globally, he should give us hope we can remodel a financial system showing serious signs of disarray, with the inability to produce good value for all direct and indirect participants. Among which are the problems related to regional banks, commercial real estate, government sponsored inflation, inadequate education, inefficient healthcare, and getting the optimum benefits from layoffs. (More on the latter subject later in this blog.) We should learn what we can from King Charles’s discipline, especially his ability to make painful decisions with a clear view of a desirable future.

 

Kentucky Derby

The Kentucky Derby is America’s most famous horse race, which is unfortunate. The entrants in the race are 3-year-young horses with very little experience. This year’s winner, like many others in the race, had only raced 3 times and had only raced once at the Derby’s distance.  As most blog readers have learned, I believe whatever analytical talents I may have, I learned at the New York racetracks.

 

The payoff after both the tax authorities and track takes their share is important in figuring out if a particular horse is worth betting on. It’s a critical element of my handicapping skill, which I carry over to my financial analysis responsibilities. Not surprisingly, Warren Buffett also learned a great deal from attending local racetracks. One can see this when he explains the key to Berkshire’s insurance success, which is getting the right spread between the rate charged and the risk of loss.

 

One of the determents in this analysis is who you are competing against. This was an unusual Derby in that a number of horses were scratched. The betting crowd (the market) was left without a strong preference or favorite, much like one of the five largest market-caps in most sectors. At the track, the odds-on favorites are often 2 to1, or less. In this year’s race the winning odds-on favorite was 4 to 1. This should have been an alert to bettors that there was a low level of confidence in the crowd’s or the market’s choices. Somewhat similar to a number of market periods we have gone through recently. This filter might have suggested giving a more earnest look at horses with longer odds. Opening up the possibility of identifying a horse with 9 to 1 odds who finished first barely beating the second finisher, a horse with 5 to 1 odds. This type of behavior is why I often favor less popular investments, including small-caps and companies with somewhat blemished records. Particularly when there is a change of jockeys or other key managers. The keys to success in this type of thinking is not the win vs. loss ratio, but the number of dollars won or lost. Or if you prefer, Berkshire’s rate vs risk.

 

Analytical Insights

Hardly a day passes without the media reporting on a company with a new layoff. This is not newsworthy because of the number of people being laid-off, but because it’s happening during a period of high employment where there’s a surplus number of job openings relative to the number of people unemployed. Clearly there is an imbalance, or phrased another way, the people unemployed are different that those employed.

 

This condition requires careful and thoughtful analysis based on incomplete data. I suggest disaggregating the layoffs by presumed causes. The following is a list of types of layoffs and their significance:

1. LIFO (Last In, First Out) is usually directed by HR people from an easy date of employment list, without any further consideration. (I avoided one such occasion personally by going to a senior partner of an institutional brokerage firm which had 5 junior analysts. I pointed out that the likely salaries in aggregate were roughly equivalent to that of one aging but knowledgeable senior analyst. Perhaps my logic or guts worked, all five junior analysts were saved. I left the firm for another opportunity soon thereafter. Of the 4 that remained, at least 2 became productive firm partners.)
2. The opposite approach is sorting by perceived talent and keeping the best. In effect create a talent bank.
3. Friends for life. As I moved up, I recognized that some talented individuals did not fit where the firm was going. I suggested they find a better place and they became friends for life.
4. A layoff can be an essential part of a plan to move an operation, disposing of an activity that no longer fits.

 

Good analysts should try to determine which of the four alternatives most likely fits their described motivation. The LIFO layoff is only helpful in improving overall short-term productivity, as it does not make the remaining workers feel good about working for the employer. This may be unavoidable if the company is a union shop with built in official or unofficial rules governing layoffs. If so, the employer has deeper problems. 

 

In Conclusion

I had a good learning week, and I am happy to discuss my views with subscribers. Whether you agree or not, I can learn from you.

 

 

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Observations: “You can see a lot just by observing” Yogi Berra - Weekly Blog # 679

 

Mike Lipper’s Monday Morning Musings

Observations:

“You can see a lot just by observing” Yogi Berra

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

                          

Investors Should Learn by Observing Others

The art of investing is based on observing elements that others do not see or interpret. One example is a comment from a young person about investing. She asked, isn’t the most distressing investment Bitcoin? I saw this as a learning moment and replied that the most distressing investment is cash.

Except at the very beginning of an individual’s investment career, cash should never be the predominate asset in their portfolio. However, cash whether people know it or not, sits at the very center of the concentric circles that make-up an investor’s portfolio. Even when one buys or sells an investment, it momentarily passes through a cash phase. A more important point however is that when an investor contemplates their entire portfolio, they do so in terms of its cash value. Furthermore, the level of cash serves as a rough guide for the current confidence in the remaining holdings, which should include perceived liabilities.

Most investors prefer to combine their investments into a single documented portfolio. This minimizes the time and emotion of comparing current assets with future needs and desires. Just as I don’t have only a single hammer in my tool kit, I also don’t believe in a single investment view or portfolio.

Managing and Measuring

You can’t cope well with problems/benefits or assets/liabilities you can’t measure. Every element of our lives cannot and should not be measured to the fifth decimal place. Initially, the most important decisions are binary, good or bad. Only later can you attempt to analyze how good is good or how bad is bad. Some portion of  concerns may revert to using cash as an imperfect measuring tool. 

At this point in the development of my thinking I find it useful to divide tasks into segments, assigning problems/benefits and asset/liabilities to separate portfolios, usually based on when cash will be needed to pay for the desired result. This segmentation allows me to assign different assets to different problems, potentially suggesting the use of different assets and investment strategies.

Regardless of whether you maintain a single portfolio or multiple portfolios, you need a framework to decide whether you are accomplishing your goals, moving in the right direction or need a mid-course correction. In the next section I briefly suggest the elements to use in building a portfolio measurement approach.

Framing the Measurement   

Critical end dates and periods to measure and analyze choices:

12/31/21

11/10/22 (For US Taxpayers)

12/31/31

Retirement

Estate

Multi-Generation

Most important decision centers:

Capitol Cities – Washington, London, Beijing

Capital Cities – New York, London, Shanghai

Size of loss tolerance 

10%

25%

50%

100%

Cost (for long-term holdings)

Investment Policy or Critical Personnel Changes

What Yogi Might Observe Today

1. This week, the normally more speculative NASDAQ market is less “bullish” than the larger cap NYSE market in terms of the percent   of traded issues reaching new highs, 11.8% for the NASDAQ and 22.7% for the NYSE. Short position changes last month had the NASDAQ increasing +2% and the NYSE +1%. 
2. International Markets performed better than US: Taiwan (+19.5%) was the best performer, followed by South Africa, Canada, Singapore, France, and Hong Kong. The US followed Hong Kong with performance of +11.4%. South Africa and Canada are metals and energy driven.
3. T. Rowe Price’s target date funds reduced their commitment to US stocks due to lower expectations.
4. Robert Kaplan of the Dallas Fed thinks the Fed should recognize increased speculation by considering an increase in rates.
5. Some believe the real reason for increases in government spending is to increase the deficit, in order to raise taxes on the “wealthy.”
6. Hunter Lewis, developer of the “endowment” model at Cambridge Associates, believes it is outmoded since most academic endowments and  pension funds  use it and rely on important allocations of private equity and real estate.
7. Warren Buffett at the Berkshire Hathaway (*) annual meeting noted two things of general value: 
1. None of the 30 largest stocks by market capitalization from 30 years ago are on the list today.
2. Reports from their 60 plus affiliates indicate inflation in their costs.  
• (*) Owned in Private financial Services Fund and Personal accounts.
8. Medina Spirit led all the way to win The Kentucky Derby. The colt was purchased for $1,000 and was the 6th most favored horse in the race. It was Bob Baffert’s 7th Derby winner.

My interpretation of these observations is to be careful with short-term oriented accounts.

What do you think?

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2021/04/four-letter-words-to-sounder-investing.html

https://mikelipper.blogspot.com/2021/04/the-other-side-weekly-blog-677.html

https://mikelipper.blogspot.com/2021/04/mike-lippers-monday-morning-musings.html

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Turning Point or Bump? - Weekly Blog # 645

 

Mike Lipper’s Monday Morning Musings

Turning Point or Bump?

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

Investors can go to school on the lessons learned from September 2-5, 2020. Each day’s lessons can help determine the longer-term implications, suggesting either a turning point, a correction, or a bump. (As usual, my views focus on shepherding the assets of institutions and individual long-term investors.)

Record Index Highs of September 2nd 

All investors are captive to the media and pundits on their platforms. In this “sound-bite” world, the movement of “the market” is described by referencing one or more “popular indices”. If you believe them, the market achieved a high in terms of the recovery, year-to-date, or for all time. The reality is quite different. Using the Standard & Poor’s 500, a high point was reached. However, excluding the five tech-oriented winners and focusing on the investment performance of the other 495 stocks in the index, the average performance for 2020 was -2%.

Reaction to Tech Dominance - September 3rd 

The replacement of three stocks in the Dow Jones Industrial Average and the impact of Apple’s stock split highlighted that the index was becoming more captive to technology. For market historians, the emphasis on tech could follow past patterns of DJIA changes, which tended to occur late in their cycle of market leadership. The probable reaction in a low transaction volume market was to sell with “the market”, which at one point had the DJIA falling more than a thousand points before a wave of buying reduced the losses materially. However, this brought in another wave of selling which caused the DJIA to fall back toward its lows of the day.

The Battle on Friday, September 4th 

This preceded the three-day Labor Day holiday weekend and I suspect margin accounts, particularly those that were heavy users of options, were forced to put up more margin or sell out. Traditionally, margin calls are met by liquidating positions held by the owner or the source of the borrowed funds. I believe that what made this liquidation different was that some of the selling was done by new users of options, some of which were young, inexperienced electronic traders. In addition, there is a printed rumor of an Asian investor holding options on $50 Billion worth of securities. Market makers often take the other side of a derivative trade, which would have added to the volume on a low volume Friday. Few active market participants wished to carry large positions over this weekend.

September 5th - Kentucky Derby Lessons

Long-term readers of these blogs recognize that I’ve learned more about investing at the New York racetracks while at college, than sitting in a New York classroom. With only thirty minutes between races, one learns quickly. Thus, reading about The Kentucky Derby today, I see investment lessons.

• The single most important factor in making an investment decision is guessing the magnitude of the potential return. The known denominator for the racetrack bettor is the approximate quoted odds for a fist place finish. (The odds for second and third can be calculated by hand, with a little bit of work.) The smallest odds are for the horse that the weight of money believes will win. Favorites only win about 1/3rd of the time and extreme favorites require the bettor to put up more money in addition to the wagered amount. These so-called odds-on favorites only win about ½ of the time. The favorite for this Derby was going off at 3 to 5, which means that a bet of $5 would win $3 in addition to the return of the original wager. To me these are normally bad bets, as “things happen”, or if you prefer “racing luck”. It is like investing in the most valued stock in terms of the highest price/earnings ratio or similar measures. As I expected, the odds-on favorite ran a good come from behind race to finish second, but the slightly less raced winner paid off substantially more.
• Present conditions are rarely the same as those in the past and they sometimes dictate the result. In this case, as with most Kentucky Derbies, there were probably twice the number of horses racing than usual. Passing tiring horses requires the effort and skill that some horses and jockeys don’t have. Furthermore, for the favorite in the race, it was run with a shorter home stretch than the race immediately preceding it. This favored the horse leading at the beginning, as the race to finish from the last turn makes it harder for the oncoming horses. With publicly traded stocks, the different conditions can be subtle but meaningful accounting differences, as well as the dates of their announcement. As the US stock market is institutionally driven, large market forces are the only buyers able to move highly popular stocks. (Generally, I prefer under owned stocks and funds that own them. Recently, this has been the exact wrong strategy due to the high concentration of ownership in a limited number of companies.)
• The team behind a horse can be very important. The winning team for this Derby had a trainer who has now won the most Kentucky Derbies of those still training and runs a very people-oriented operation. He and their connections were cheering for the winner in the name of an assistant trainer who had just broken his arm when one of their entries fell on him. Among the owners are a syndicate of 4,600 investors, giving them access to substantial capital if needed. 
• The trainer instructed the jockey, a previous multiple Derby winner, to use the whip on the left side to keep his young, fractious colt from getting too close to the rail. The rough equivalent I use in picking mutual funds for our clients is applying the decision processes to both a particular fund and its management as a whole. I pay particular attention to the level of specific knowledge portfolio managers and their supporting analysts have on individual issues.
• Finally, there are horses that do better at particular tracks and distances. Today, many managers are primarily focused on near-term performance years.  Some believe we are in the last phase of an investment cycle and are delaying the sale of principal positions until they reach an expected peak in 2021. There is also one large brokerage firm advisor who thinks that the “new normal” will usher in a new, long cycle. Our job is to select the appropriate length of the current market for each account based on their needs and internal policies.

Question of the week: 

Do you think last week was a turning point or just a bump in the road as we move higher to a new event or stimulus? 

     

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2020/08/caution-ahead-emotional-turns-likely.html

https://mikelipper.blogspot.com/2020/08/mike-lippers-monday-morning-musings_23.html

https://mikelipper.blogspot.com/2020/08/mike-lippers-monday-morning-musings.html

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2nd of May’s Good Lessons - Weekly Blog # 575

Mike Lipper’s Monday Morning Musings

2nd of May’s Good Lessons

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

The inestimable Charlie Munger has labeled Warren Buffett a learning machine, someone who is always learning from his own and other’s mistakes. This is a good model to follow. The first couple days of May provided some good classrooms, the Berkshire Hathaway annual meeting and The Kentucky Derby, both on Saturday, May 4th.

The Annual Meeting/ Investment School

While many attended the meeting to gather bits of information to help guide their views as to Berkshire’s earnings and/or near-term stock price, I view it as an opportunity to learn about the art of investing. For me this is a linear progression from my Introduction to Securities Analysis course under Professor David Dodd at Columbia University. Dave Dodd was both a teaching and investment partner with Ben Graham, Warren Buffett’s first mentor. The following are the nuggets gathered from the meeting which can be applied to investing in general:

1. Paying too much makes it very tough to make money on an investment. (They did for Kraft.)
2. Intrinsic value is a range not a specific point. This range could be 10% plus or minus. (This is the fulcrum point for their buybacks.)
3. Individual Investors are their preferred owners rather than bureaucratic institutions.
4. They have a desire that their heirs hold onto their shares long after Charlie and Warren are gone. That is why they are developing the next tier of management, which will be different and better.
5. A large opportunity reserve has two values, it cushions periodic declines and creates bargain opportunities.
6. The allocation of resources allows them to shift capital to where it is most productive long-term.

The Kentucky Derby 

I have written about “racing luck” or surprises in the past. At this year’s running of “The Derby” we witnessed a classic example of “racing luck”. With far too many horses on a rain-soaked track there was at least one bumping incident, which the three racing stewards felt impacted the order of the finish. After reviewing many films of the race and a call to the two leading jockeys, they disqualified the winner and gave the victory to the horse that came in second. The level of surprise can be gleaned from the betting odds. The first horse to finish was the second favorite at $9 to $2. The declared winner was a $63 to $1 long-shot. This is the first time in the history of this race that they have disqualified the winner for an on-track violation.

The investment lesson from this experience is to avoid putting too much faith in the “inevitable conclusions”. Surprises do happen, even those that are the first in more than one hundred years.

The Mixed Current Picture

Change Signs?

1. While the NASDAQ composite has gained the most since its January low, +26% compared to +17% for the Dow Jones Industrial Average and +20% for the S&P 500, this past week the 420 new highs on the NYSE exceeded the 305 new highs on the NASDAQ. Have traders shifted their focus to more industrial and  seasoned companies from growth and tech?
2. Of the 72 price indicators tracked by the WSJ covering securities, commodities and currencies, only 30 are rising, Recently, the number of gainers were in the majority.
3. Both High quality bonds and intermediate quality bonds gained in price, showing some shift in demand away from stocks. 

Did you miss my past few blogs? Click one of the links below to read.

https://mikelipper.blogspot.com/2019/04/value-investing-will-be-superior-but-it.html

https://mikelipper.blogspot.com/2019/04/contrarian-observations-not-predictions.html 

https://mikelipper.blogspot.com/2019/04/not-yet-peak-luck-lessons-weekly-blog.html

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Justify Wins, Buffett Looks for New Commitment - Weekly Blog # 522

Introduction

On Saturday there were two useful omens for long-term investors. For the ninth time, one of my sons and I attended the Berkshire Hathaway celebratory annual meeting. I also watched Justify win the Kentucky Derby on television. I detected messages or inputs from both to aid in making long-term investment decisions. Both have already received substantial press reviews. As many of our regular subscribers have come to expect, I see or perceive things differently than most others. I will mix in additional thoughts from my current readings.


Berkshire Hathaway Annual Celebration (Annual Meeting)

For the past nine years we have gone to Omaha to learn more about Berkshire, get general investment lessons from Charlie Munger and Warren Buffett, gain insights into specific areas of the economy, and see many of the great value-oriented managers from around the world.

One of the lessons that I’ve learned from my racetrack handicapping experience is that the way one handles one’s money is in the long run even more valuable than individual selection of specific bets. One of the big advantages that Warren Buffett has is that he is in a position to make selectively big bets through his securities investment accounts and in his insurance risk facilities. In terms of the latter he is willing to accept unusual concentrated risks that could total $400 Billion in aggregate to cover severe storms and extreme crypto risks. His expectation of individual risks is limited to perhaps 3% of global underwritten risks.

Berkshire’s current float is $116 Billion, which is part of the over $325 Billion in its investment accounts. This suggests that if an opportunity appears, Buffet could commit over $200 Billion. He has not totally given up his “cigar butts” training from Ben Graham and is likely to become more aggressive if lower prices or better values appear. However, he does recognize that Ben Graham lived long enough to see many of his views invalidated.

The same occurrence happened to that great Nobel Prize winning scientist Stephen Hawking. This week I read that at his death he no longer believed the universe had no boundaries. He previously believed there were no boundaries.

These realizations are critical for us investors who believe in the immutable power of various investment theories. Charlie Munger’s approach to buying good companies at a fair price produces better results than buying at only cheap prices.

On an operating basis he is encouraging GEICO to expand its share of market, expecting significant initial losses to later translate into substantial profits. In a similar approach, in the near term Buffett does not expect dividend growth to result from growing earnings at the utility operations of the parent company. He also expects to grow their life reinsurance business on a regular basis and the casualty reinsurance business only if he sees favorable prices.

Both the stock market and the global economy are structurally changing. One of the points that Warren Buffett made at the meeting was that the five largest market value companies in the S&P500 are not capital-intensive businesses. At this stage of its development Berkshire-Hathaway does not need external capital. Thus to some degree it has escaped the discipline of the market place. To my mind this makes the policy of indexing into the S&P500 more risky than active portfolio management.

Justify Winning “The Derby” Lessons

During a driving rain storm dropping 3 inches of rain on the track, Justify ran away from the other 19 horses in the race. Justify was the favorite, which proves that occasionally favorites do win, suggesting that current market leaders (as is often the case) won’t disappoint.

From a tactical standpoint there were many horses that were in the second phalanx which could not catch the winner in the homestretch, proving that positioning does not always work well. The winner was unusual in a number of respects. First, Justify did not race as a two year old, which was unusual. From an investment standpoint the most significant factor is was that the winner was bought for $500,000 by a Chinese syndicate. Interestingly, the only foreign language translated at the Berkshire meeting was Mandarin. In addition, there were a large number of Chinese at the meeting and they asked a significant number of questions. This is not so surprising. For sometime, Charlie Munger has felt that there are more opportunities for sound investing in China than in America. Mr. Buffett echoed those thoughts.

Next week’s blog will continue the topic of Investment in China and will come to you via Hong Kong where I am chairing a meeting of the International Stock Exchange Executives Emeriti).

__________
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Money Management Lessons

Introduction

Successful money managers do much more than select winning stocks. They use weighting of their selections, timing of their transactions, partial trading actions and timely admitting of mistakes.

Lessons from Berkshire Hathaway

On Friday the investment press was full of stories from the latest release of Berkshire Hathaway’s transactions for the quarter. All of these reports focused exclusively on the names of the stocks that were bought and sold and none on the structure of the overall equity portfolio. Thus, their readers missed the opportunity to learn how the portfolio is managed.

The company has at least eleven equity reporting elements excluding the investments in their retirement accounts. Many equate the company to an open end mutual fund, which is a mistake for in all of my work on US and foreign registered funds I have never seen a portfolio that truly operates on the same basis.

First, Berkshire’s equity portfolio is part of a complex series of holding companies which include fixed income securities, liabilities, and substantial float of “temporary” money that can be invested. Second, with rare exception there is no pressure to liquidate assets to meet immediate redemption orders. Third, one of the great assets the company has is its brand. In times of financial distress on the part of others, the company can demand very high returns for the use of its money to prop up the market value of large, high quality companies which may be viewed as in distress. Fourth, the company can be extremely patient and at the same time make very rapid decisions without the need for committee or board actions. (These are some of the reasons that I am happy to be a long-term shareholder for a fund I manage and personal accounts.) In my mind these attributes are worth a premium over book value or if it were a fund, net asset value.

Regular readers of these posts have learned that I count the lessons that I learned at the race track as important guides to my professional investment practice. Let me define a winning day at the track, which is an enjoyable day in a pleasant surrounding and walking away from the track with more money than I had before I got to the track. As Yogi Berra is reported to have said, “You can see a lot by observing.” I have seen numerous “horse players” that have cashed winning tickets, but at the end of the day they are not qualified for my definition of having a winning day because they go home poorer. Their mistake was not in failing to pick winners, but in handling their money poorly. Often they made too many bets, spent too much in meals and other entertainment, increased the size of their bets to obtain break even and accepting of low odds by backing favorites.

In general Warren Buffett, Charlie Munger, and their two investment managers are guilty of these mistakes in managing the Berkshire stock portfolios. As of June 30, 2015 the reported total of the stock portfolio was $ 107.2 Billion. Only four stocks represent 62.38% of the total, and another eleven stocks represent 27.01%. This last group of eleven individual holdings were each 1-5% of the portfolio. There was another 11.61% spread through 31 names. While for some purposes I like concentrated mutual fund portfolios, I can find very few that would be this concentrated and they would have redemption problems where Berkshire does not.

In looking at their recent trading history one sees that many of the positions are traded somewhat actively; enlarging and contracting the size of the position and often changing the tax cost basis of the holding. These are done for investment purposes not to accommodate flows which is often the case with funds. While Berkshire is a prodigious net cash generator, I do not expect that there will be a large flow into the current equity portfolios as the latest 100% acquisition absorbs a good bit of the company’s preferred cash cushion or strategic reserve which can be deployed within 24 hours on a potentially highly profitable rescue mission. Perhaps most importantly, after due consideration, Berkshire will liquidate a holding at a considerable loss and admit that they did faulty analysis rather than blame external events.

If I were to recommend a Berkshire-type strategy for a managed account today, it would have a sufficient opportunity reserve to be able to take advantage of rapidly attractive situations when others are fearful. Further, I would use investment judgment in weighting my portfolio, something my older brother has been saying for some time. I would be selective in my diversification by only one or a few stocks in a sector, typically the best of breed. I might have some very small explorative positions with a sense of how long I would be willing to hold them. Most importantly I would try to be disciplined to admit analytical mistakes and discard losers regardless of costs.

Another valuable lesson from the Racetrack

On Friday there was a long and glowing obituary for John Nerud who died at 102 after saddling over 1,000 winners as a trainer or farm manager. He was the best and worked for a great and generous owner. The lesson is that one can get the horse wonderfully prepared to win the Kentucky Derby, employ one of the best jockeys and give him good instructions. In this case when Willie Shoemaker was leading with Gallant Man, the jockey mistook the finish line and stood up briefly in his stirrups and let another horse win the Derby. A few weeks later Gallant Man won the much more significant Belmont Stakes proving that he was best three year old in the country. The lesson is that bad things unexpectedly happen and we should not expect perfection in our choices, even when they are eventually proven to be correct.

Another Numbers Lesson

Many value managers make their case on the basis that their holdings are selling at low multiplies of stated book value.  While I am a believer in buying something at a discount from what a knowledgeable buyer would pay for the asset, I have little confidence in the book value calculation. Book value is derived from the balance sheet of the enterprise. These are largely based on historic costs on periodic impairment decisions by the company on the advice of their auditors. Rarely are assets written up, declines in market share are not recorded, contingent liabilities are not deducted, the value of expiring patents is not noted, etc. The auditors prepare balance sheets for creditors not equity owners. Too many investors equate book value with the total net asset value of funds. They understand that when they redeem their open end mutual funds they will be paid out on the basis of the current net asset value.

However, they fail to look at the way the market values net asset values of closed end funds. Open end and closed end funds use the same calculations and auditors. Because investors, through their brokerage firms, must find a ready buyer for their closed end sales, the market functions to bring buyer and seller together at an agreed price and time. Currently the discount on closed end funds to their net asset value is approximately 10%,  my friends at my old firm Lipper, Inc., tell me. Thus my starting point in looking at book value for companies before I reconstruct is to assume a 10% discount from stated value. After reconstruction of an updated appraisal of what a knowledgeable buyer would pay for the company my estimated book value is very likely to be higher or lower of stated book value. To me this is the proper approach for so-called value investors as distinct from “quants” who don’t see beyond the published financial statements.

Question of the week:
What circumstances would lead you to sell or to buy Berkshire Hathaway? 

__________   

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Comment or email me a question to MikeLipper@Gmail.com .

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Copyright © 2008 - 2015

A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.

Picking Winners at the Track and Market

Introduction

The skills required to pick winning horses and selecting successful funds are very similar. As I have indicated numerous times, despite my degree from Columbia University, my two real institutions of useful learning were the US Marine Corps and the racetrack.

The Belmont Stakes

For those handicappers, or if you prefer, racing analysts, the Belmont takes on great importance. This race is the longest race for American three year old thoroughbred horses. Most US races on the flat surface are give or take a mile, with the Kentucky Derby a mile and a quarter. The Belmont is a mile and a half with a very long home stretch. Few of each year’s crop of young three year olds have the stamina to compete.

Even though in theory the Belmont is the truest race for these young horses, the results are not often as expected. The same is true in picking funds, but I have an advantage. At the track all the attention is on picking the winner, while often one can make the same money (and take less risk) by being correct on the second place finisher. For our accounts the winning selection is beating the average of the competitors.

Ten factors plus one “kicker”

This year’s Belmont provides me with an opportunity to identify the Ten Factors plus One “Kicker” that can be used in selecting the most probable winner. Each factor is followed by a description of how I also apply these items to my fund selection responsibilities.

Breeding (DNA) Does the portfolio manager come from a background of striving and demonstrates discipline?

Training What are the current demonstrations of personal analytical and portfolio skills?

Raced or trained at Belmont How long has the portfolio and analytical teams worked together?

Weather (this year’s starting time was late, did the angle of the sun matter?)What are the fund's characteristics in up and down markets, not just performance but concrete actions taken?
 

Soil (composition and slope) Within the organization is there a big advantage to good early performance? What is the tolerance of the entire organization for a “come from behind” performance?

Jockey Is this particular portfolio manager critical to the fund’s success and if so what are his/her strengths and weaknesses?

Trainer As all of us are the product of our learning, who were the critical teachers and what did they teach?

Post position (in the starting gate) Most of the time we are not dealing with a brand new fund. What are the carry-forward implications about sources of cash flows and tax considerations?

Likely early fractions of the lead horse What are the critical time periods for the investors as distinct from gate-keepers and marketing people?

Skill of the ride What is the history of making organizational changes of portfolio managers, key analysts, trading people + trading systems, and marketing people?

Kicker:  The kicker is “racing luck”- unexpected things that no one is ready for. For instance: How does the ecosystem around the portfolio handle both good and bad luck?

Good luck on your choices in the race and picking winning funds

The bond side

Any careful reader of these posts will quickly spot that my mind focuses primarily on equities and equity funds. For a long period of time I have been attempting to get balanced accounts to shed long-term fixed income securities and funds. In 2014 this was a mistake as long-term bonds in general performed better than stocks and stock funds.

2015 is different

My old shop now known as Lipper, Inc., has been estimating for almost all of this year that mutual fund investors have been adding to their long-term Corporate Bond funds both of high quality and high yield types. At the same time they have been redeeming their Domestic Equity funds. What is curious is that the total return of all Domestic Bond funds for the year to date through June 4^th is +1.62%. While total return measurements are normally the single best measurement of relative investment performance, in this case it may be misleading to the bulk of individual investors that own or recently purchased bond funds. I suspect the +1.62% is largely the interest paid and often spent. The price value of the bonds and bond funds is probably close to or completely negative. In addition if one takes into consideration taxes and over 1% inflation that the Federal Reserve uses in its calculations, bonds have been a loser.

One of the things that I have learned from handicapping is to ask after a race what was it that I mis-analyzed or didn’t even see? Thus, before condemning the public investor for being dumb, one should look at what would make them seem quite bright. Perhaps, the public is more worried about a renewed recession caused at least in part by future US Fed policy.

Lesson from the winner

American Pharoah won and led the Belmont from beginning to end. He did all he had to get home first with a large lead. The handicapper in me noted that the fractions at the quarter mile and six furlongs were acceptable, but not a record (neither was the final time itself, but it was good). The analyst in me noted that the place or second horse, Frosted,  paid the same as the winner did for winning and was a better money bet than the winner due to less risk taken.

In terms of picking funds the lesson may be enjoy the leader, but there is a safer bet with less risk of an unpleasant surprise (always remember luck). 

Question of the week:

Are you ready for a renewed recession?

__________   

Did you miss my blog last week?  Click here to read.

Comment or email me a question to MikeLipper@Gmail.com .

Did someone forward you this Blog?  To receive Mike Lipper’s Blog each Monday, please subscribe using the email or RSS feed buttons in the left column of MikeLipper.Blogspot.com 

Copyright © 2008 - 2015

A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.