Graham and Dodd provide a template for investing

Zweig:

The first question I would like to ask you, Seth, concerns your work at Baupost. How have you followed Graham and Dodd, and how have you deviated from Graham and Dodd?

Klarman:

In the spirit of Graham and Dodd, our firm began with an orientation toward value investing. When I think of Graham and Dodd, however, it’s not just in terms of investing but also in terms of thinking about investing. In my mind,their work helps create a template for how to approach markets, how to think about volatility in markets as being in your favor rather than as a problem, and how to think about bargains and where they come from.  It is easy to be persuaded that buying bargains is better than buying over-priced instruments.The work of Graham and Dodd has really helped us think about the sourcing of opportunity as a major part of what we do—identifying where we are likely to find bargains. Time is scarce. We can’t look at everything.

Where we may have deviated a bit from Graham and Dodd is, first of all, investing in the instruments that didn’t exist when Graham and Dodd were publishing their work. Today, some of the biggest bargains are in the hairiest, strangest situations, such as financial distress and litigation, and so we drive our approach that way, into areas that Graham and Dodd probably couldn’t have imagined.  The world is different now than it was in the era of Graham and Dodd. In their time, business was probably less competitive. Consultants and“experts”  weren’t driving all businesses to focus on their business models and to maximize performance. The business climate is more volatile now. The chance that you buy very cheap and that it will revert to the mean, as Graham and Dodd might have expected, is probably lower today than in the past.  Also, the financial books of a company may not be as reliable as they once were. Don’t trust the numbers. Always look behind them. Graham and Dodd provide a template for investing, but not exactly a detailed road map.

Seth A. Klarman is president of The Baupost Group,LLC, Boston. Jason Zweig is a columnist for the Wall  Street Journal, New York City

http://www.scribd.com/doc/37358611/Seth-Klarman-CFA-Presentation

Do you regard commodities as investments? If an asset’s value is totally dependent on the amount a future buyer might pay, then its purchase is speculation.

Zweig:

In your book, Margin of Safety, you said as a general rule that commodities, with the possible exception of gold, are not investments because they don’t produce cash flow. Do you regard commodities as investments in today’s market?

Klarman:

No, I don’t. In the book, I was mostly singling out fine-arts partnerships and rare stamps—addressing the commodities that were trendy then. Buying anything that is a collectible, has no cash flow, and is based only on a future sale to a greater fool, if you will—even if that purchaser is not a fool—is speculating. The “investment” might work—owing to a limited supply of Monets, for example—but a commodity doesn’t have the same characteristics as a security, characteristics that allow for analysis. Other than a recent sale or appreciation due to inflation, analyzing the current or future worth of a commodity is nearly impossible.The line I draw in the sand is that if an asset has cash flow or the likelihood of cash flow in the near term and is not purely dependent on what a future buyer might pay, then it’s an investment. If an asset’s value is totally dependent on the amount a future buyer might pay, then its purchase is speculation. The hardest commodity-like asset to categorize is land, an asset that is valuable to a future buyer because it will deliver cash flow, not because it will be sold to a future speculator.  Gold is unique because it has the age-old aspect of being viewed as a store of value. Nevertheless, it’s still a commodity and has no tangible value, and so I would say that gold is a speculation.  But because of my fear about the potential debasing of paper money and about paper money not being a store of value, I want some exposure to gold.

Zweig:

Benjamin Graham drew a sharp and classic distinction between investment and speculation. I believe his exact words were, “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”  But Graham sometimes speculated over the course of his career. So, maybe regarding commodities as speculative doesn’t  preclude you from owning them, right?

Klarman:

I would say that a commodity’s speculative nature is not what precludes investment. When Graham was talking about safety of principal, he was not referring to currency.  He wasn’t really considering that the currency might be destroyed, but we know that can happen, and has happened, many times in the 20th century.  The investing game has historically been closer to checkers, but now it is more like chess—almost in three dimensions. The possibility that the dollars you make could be worth much less in the future leads an investor to think, How can I protect myself?  Should I be shorting the dollar against another currency, and if so, which one?

Our goal is to do everything to protect client purchasing power

Zweig:

How are you protecting your clients against unanticipated inflation and a decline in the dollar?

Klarman:

Our goal is not necessarily to make money so much as to do everything we can to protect client purchasing power and to offset, as much as possible, a large decline in market value in the event of another severe global financial crisis.We not only care about the intrinsic underlying value of our clients’ investments, but we also want to avoid the psychological problem of being down 30 or 40 percent and then being paralyzed.

At this juncture, there are just too many scenarios to enumerate. We have thought about scenarios in which the dollar remains the reserve currency and those in which it doesn’t; those in which gold goes berserk on the upside and those in which it stays flat and then falls, because gold is currently at a record high. All scenarios are worth contemplating. This type of analysis is really very much art and not science

Price is the essential determinant in every investment equation.

Zweig:

How does Baupost define a value company, and what is your average holding period?

Klarman:

With the exception of an arbitrage or a necessarily short-term investment, we enter every trade with the idea that we are going to hold to maturity in the case of a bond and for a really long time, potentially forever, in the case of a stock.  Again, if you don’t do that, you are speculating and not investing. We may, however, turn over positions more often.  If we buy a bond at 50 and think it’s worth par in three years but it goes to 90 the year we bought it, we will sell it because the upside/downside has totally changed. The remaining return is not attractive compared with the risk of continuing to hold.  In our view, there is no such thing as a value company. Price is the essential determinant in every investment equation. At some price, every company is a buy; at some price, every company is a hold; and at a still higher price, every company is a sell. We do not really recognize the concept of a value company.

Investors need to pick their poison.

Investors need to pick their poison:  Either make more money when times are good and have a really ugly year every so often, or protect on the downside and don't be at the party so long when things are good.

Seth Klarman:  At Baupost, we are all clearly in the same camp.  We have all our own money invested in the firm, and so we are very conservative.  We have picked our poison.  We would rather underperform in a huge bull market than get clobbered in a really bad bear market.


http://www.scribd.com/doc/37358611/Seth-Klarman-CFA-Presentation

Warren Buffett on Phil Fisher

http://investinginknowledge.com/info/2010/10/warren-buffett-on-phil-fisher/

Confessions of a bargain hunter (Seth Klarman)

June 23, 2012
By Nathan Bell
Read more: http://www.smh.com.au/money/confessions-of-a-bargain-hunter-20120622-20tap.html#ixzz1ypcBDriW
In the offices of an unmarked high-rise building in Boston sits Seth Klarman, surrounded by stacks of papers and books, which, by his own admission, are at risk of toppling over and crushing him at any instant.

Klarman is the founder and president of the phenomenally successful Baupost Group, a $29 billion ”deep value” hedge fund. It has produced 19 per cent annual returns, and every $10,000 given to Klarman at inception in 1982 is worth about $1.85 million today – and this was achieved while carrying extremely high levels of cash (more than 50 per cent at times) and using minimal leverage.

So how did he do it?

Know your seller
The financial markets are fiercely competitive, with millions of investors, traders and speculators around the world trying to outwit one another. Klarman concluded that since prices are set by the forces of supply and demand, rather than buy something and wait for someone to demand it at a higher price, why not wait for an irrational supplier to sell it to you for any price? Hence, Klarman looks for assets that people are being forced to sell or avoid, often as a result of fear or institutional constraints.

You can apply this principle by looking at heavily sold or avoided opportunities closer to home.

For example, stocks at the bottom of the S&P/ASX 200 are kicked out and replaced on a regular basis and, since index funds can hold stocks only over a certain size, newly removed stocks from the S&P/ASX 200 are sometimes driven down in price because of the selling pressure from such funds.
To make matters better, owing to regulation many super funds often cannot invest in smaller companies and such stocks are rarely followed by analysts. Servcorp resides on Intelligent Investor’s buy list and falls into this category.

Some institutions are also forced to ignore debt instruments unless they achieve a certain credit rating, even though they might offer an attractive risk-reward profile. You can take advantage of this by investing in income securities in a downturn, when large price falls create great opportunities such as those in 2009, for example, the Goodman PLUS, Dexus RENTS and Southern Cross SKIES hybrid securities.

Tax-loss selling (in Australia, this tends to occur in June, at the end of the financial year) can cause irrational mispricing in already beaten-down stocks. Cheap blue chips that could be this group next week include Computershare, QBE Insurance and Macquarie Group.

Competitive advantage
The difference between great investors and mediocre ones is only a few percentage points in terms of judging things correctly. Klarman realised he would have to bring something different to the game to win: a ”competitive advantage”.

”I will buy what other people are selling,” Klarman says. ”What is out of favour, what is loathed and despised, where there is financial distress, litigation – basically, where there is trouble.”

An inexperienced individual will have little success using such a tactic. After all, how many of us have four years to spend analysing Enron’s accounts? Instead, look for inefficiencies you can exploit.

Most market participants have a narrow, short-term view and are driven by fear and greed. So your edge is having a longer-term perspective and controlling your emotions. These two advantages will help you pile on the performance points over the professionals. Both have been invaluable to Klarman.

Cash is a weapon
Holding cash is perhaps Klarman’s most famed characteristic.

However, contrary to what you might expect, Klarman holds cash so it can be used in a concentrated manner when the right opportunity arises. This is because while value investing outperforms in the long run, Klarman quips that ”you have to be around for the long run … [you have to make sure] you don’t get out and you are a buyer”.

Despite the complexity of some of his investments, Klarman’s underlying approach is not complicated, although that is far from saying it is easy.

He says Baupost has outperformed ”by always buying at a significant discount to underlying business value, by replacing current holdings as better bargains come along, by selling when the market value comes to reflect its underlying value, and by holding cash … until other attractive investments become available”.

Nathan Bell is the research director at Intelligent Investor, intelligent investor.com.au. This article contains general investment advice only (under AFSL 282288).
Read more: http://www.smh.com.au/money/confessions-of-a-bargain-hunter-20120622-20tap.html#ixzz1ypcBDriW

http://investinginknowledge.com/

The Legacy of Benjamin Graham

The below video provides video footage from his Columbia College, Security Analysis course. Enjoy



@ 8 min Benjamin Graham vs Buffett

http://investinginknowledge.com/

Stock valuation. Why does the value of a share of stocks depend on dividends?

Does the value of stocks depend on dividends or earnings?

Management determines its dividend policy by evaluating many factors, including:

• the tax differences between dividend income and capital gains,
• the need to generate internal funds to retire debt or invest, and,
• the desire to keep dividends relatively constant in the face of fluctuating earnings.

Since the price of a stock depends primarily on the present discounted value of all expected future dividends, it appers that dividend policy is crucial to determining the value of the stock.

However, this is not generally true. It does not matter how much is paid as dividends and how much is reinvested AS LONG AS the firm earns the same return on its retained earnings that shareholders demand on its stock. The reason for this is that dividends not paid today are reinvested by the firm and paid as even larger dividends in the future.

Dividend Payout Ratio

Management's choice of dividend payout ratio, which is the ratio of cash dividends to total earnings, does influence the timing of the dividend payments. 

The lower the dividend payout ratio (that is more earnings are retained), the smaller the dividends will be in the near future. Over time, however, dividends will rise and eventually will exceed the dividend path associated with a higher payout ratio.

Moreover, assuming that the firm earns the same rate on investment as the investors require from its equity (for example, ROE of 15%), the present value of these dividend streams will be identical no matter what payout ratio is chosen.

How to value Stocks?

Note that the price of the stock is always equal to the present value of ALL FUTURE DIVIDENDS and not the present value of future earnings. 

Earnings not paid to investors can have value only if they are paid as dividends or other cash disbursements at a later date. Valuing stock as the present discounted value of future earnings is manifestly wrong and greatly overstates the value of a firm. (Note: Firms that pay no dividends, such as Warren Buffett's Berkshire Hathaway, have value because their assets, which earn cash returns, can be liquidated and disbursed to shareholders in the future.)

John Burr Williams, one of the greatest investment analysts of the early part of the centrury and author of the classic The Theory of Investment Value, argued this point persuasively in 1938. He wrote: 

"Most people will object at once to the foregoing formula for valuing stocks by saying that it should use the present worth of future earnings, not future dividends. But should not earnings and dividends both give the same answer under the implicit assumptions of our critics? If earnings not paid out in dividends aree all successfully reinvested at compound interest for the benefit of the stockholder, as the critics imply, then these earnings should produce dividends later; if not, then they are money lost. Earnings are only a means to an end, and the means should not be mistaken for the end."


Ref: Stock for the Long Run, by Jeremy Siegel

http://myinvestingnotes.blogspot.com/2009/05/does-value-of-stocks-depend-on.html

Using PEG ratio: Not all growth is created equal.

As the risk increases, the PEG ratio of a firm decreases. When comparing the PEG ratios of firms with different risk levels, even within the same sector, the riskier firms should have lower PEG ratios than safer firms.

Not all growth is created equal. A firm that is able to grow at 20% a year, while paying out 50% of its earnings to stockholders, has higher quality growth than another firm with the same growth rate that reinvests all of its earnings back. Thus, the PEG ratio should increase as the payout ratio increases, for any given growth rate.

As with the PE ratio, the PEG ratio is used to compare the valuations of firms that are in the same business.  The PEG ratio is a function of:

• the risk,
• growth potential and
• the payout ratio of a firm.

http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf

http://myinvestingnotes.blogspot.com/2009/11/using-peg-ratio-not-all-growth-is.html

Defining Value Investing in ONE sentence

Value investing consists of analyzing businesses within one's circle of competence to find those whose return on incremental capital is high, compared to what capital costs, and then investing in those that can be bought most cheaply.  

Growth or the lack of it, is integral to a valuation exercise

The value of a business, a share of stock or any other productive asset is the present value of its future cash flows.

However, value is easier to define than to measure (easier said than done).

Valuing a business (or any productive asset) requires estimating its future performance and discounting the results to present value.  The probable future performance includes whatever GROWTH (or SHRINKAGE) is ASSUMED.

SO GROWTH (OR LACK OF IT) IS INTEGRAL TO A VALUATION EXERCISE.

This supports the point that the phrase value investing is redundant.  Investing is the deliberate determination that one pays a price lower than the value being obtained.  Only speculators pay a price hoping that through growth the value  rises above it.

Growth doesn't equate directly with value either.  

Growing earnings can mean growing value.  But growing earnings can also mean growing expenses, and sometimes expenses growing faster than revenues.  Growth adds value only when the payoff from growth is greater than the cost of growth.

A company reinvesting a dollar of earnings to grow by 99 cents is not helping its shareholders and is not a value stock, though it may be a growth stock.

Value investing is conventionally defined as buying companies bearing low ratios of price-to-earnings, price-to-book value, or high dividend yields.  But these metrics do not by themselves make a company a value investment.  It isn't that simple.  Nor does the absence of such metrics prevent an investment from bearing a sufficient margin of safety and qualitative virtues to justify its inclusion in a value investor's portfolio.

So how would you value the REIT's business?

1. Book Value
The book value or net asset may not also fully value the REIT as a business operating to maximise the stream of rental and other forms of income derived from the property.  So one should not entirely simply rely on the book value.  Value investors however often would be reluctant to pay for a REIT at a price higher than the NAV unless there is immediate prospect of the NAV being re-valued# once a new valuation is conducted.

Book Value = Value of each of the properties + Value of its other assets (cash, inventory and receivables) - Liabilities

2. Property Yield
The property yield shows the earning power of the properties within each of the REIT's portfolio.

Property Yield = Net Property Income / Property valuation x 100

3. Distribution Yield
Distribution yield gives an indication of how much return you would expect from the REIT on an annual basis from the distribution.

Distribution Yield = Distribution per Unit / Price paid for Unit  x 100.


[#The REIT owns the various properties which would be valued by professional valuers at least once annually. Valuers will often provide a value of each property on the basis that the REIT is a going concern i.e. that the business of the REIT is functioning normally and is not forced by distress to sell the property.]


APPROACH TO REIT VALUATION

Why would you want to invest in a REIT?
You want to accumulate a string of properties with your money and allow them to be managed by a professional manager.

What would you want from your portfolio of properties?
1.  You want to enjoy capital appreciation from the property.  You can achieve this easily by owning the properties.
2.  You want the revenue that the properties might generate.  This revenue is necessary to pay all the property expenses including the mortgage and also to provide for you some return to compensate you for the use of your capital that you have ploughed into the properties. For this, you have to calculate the Property Yield and the Distribution Yield.

What further information do you need to make an intelligent decision?
The Distribution Yield tells you your return if the tenants continue to occupy the premises and pay their rent and rental rates stay the same.
1.  What happens if this happy scenario is affected by economic turmoil?
2.  If the property vacancy increases or rental rates drop, can the mortgage still be serviced by the earnings?

Be rational, stay focus on the business of the company and not its share price

What Kills the Amateurs

Nothing is more fatal to amateur investors than thinking that a stock trading near a 52-week low is a good buy. They based this logic on the notion "what goes down must eventually comes up".

Suppose we have 2 companies
i. Co. A had recently gone down from $5 to $1. 
ii Co. B had recently gone up from $1 to $5.

Believe it or not, all things being equal, a majority of amateur investors will choose Co.A because they believe that it will eventually make it back up to those levels again. On the other hand amateur investors will think that chasing after Co.B is almost suicidal because the music will end soon. 

The point is that the stock price is a reflection of the company. If a great firm is run by excellent managers, there is no reason the stock won't keep on going up, vice versa.

Therefore dun said the falling knives killed you when actually you have performed hara-kiri yourselves.


Ref:
http://www.investlah.com/forum/index.php/topic,49773.msg972601.html#msg972601

Berkshire Hathaway's Shareholdings

No.	Shareholder Name	Share Held	Shares Held (%)	Company Name	Exchange
1	Berkshire Hathaway Inc.	0	0	Bank of America Corporation	NYSE
2	Berkshire Hathaway Inc.	1,740,231	0.76	Gannett Co., Inc.	NYSE
3	Berkshire Hathaway Inc.	37,275,400	6.67	DIRECTV	NasdaqGS
4	Berkshire Hathaway Inc.	7,052,750	0.4	Mondelez International, Inc.	NasdaqGS
5	Berkshire Hathaway Inc.	7,484,300	1.75	National Oilwell Varco, Inc.	NYSE
6	Berkshire Hathaway Inc.	52,793,078	1.93	Procter & Gamble Co.	NYSE
7	Berkshire Hathaway Inc.	49,247,235	1.5	Wal-Mart Stores Inc.	NYSE
8	Berkshire Hathaway Inc.	18,939,115	1.63	The Bank of New York Mellon Corporation	NYSE
9	Berkshire Hathaway Inc.	68,121,984	6.14	International Business Machines Corporation	NYSE
10	Berkshire Hathaway Inc.	1,563,434	0.93	Verisk Analytics, Inc.	NasdaqGS
11	Berkshire Hathaway Inc.	400,000,000	8.98	The Coca-Cola Company	NYSE
12	Berkshire Hathaway Inc.	24,922,178	11.18	Moody's Corp.	NYSE
13	Berkshire Hathaway Inc.	588,900	0.01	General Electric Company	NYSE
14	Berkshire Hathaway Inc.	327,100	0.01	Johnson & Johnson	NYSE
15	Berkshire Hathaway Inc.	59,400	0.01	United Parcel Service, Inc.	NYSE
16	Berkshire Hathaway Inc.	14,973,906	14.15	DaVita HealthCare Partners Inc.	NYSE
17	Berkshire Hathaway Inc.	17,072,192	15.73	USG Corporation	NYSE
18	Berkshire Hathaway Inc.	8,174,100	5.42	VeriSign, Inc.	NasdaqGS
19	Berkshire Hathaway Inc.	5,956,600	0.9	Archer Daniels Midland Company	NYSE
20	Berkshire Hathaway Inc.	1,727,765	23.28	The Washington Post Company	NYSE

No.	Shareholder Name	Share Held	Shares Held (%)	Company Name	Exchange
21	Berkshire Hathaway Inc.	151,610,700	13.8	American Express Company	NYSE
22	Berkshire Hathaway Inc.	4,333,363	0.99	Costco Wholesale Corporation	NasdaqGS
23	Berkshire Hathaway Inc.	405,000	0.33	Mastercard Incorporated	NYSE
24	Berkshire Hathaway Inc.	0	0	The Goldman Sachs Group, Inc.	NYSE
25	Berkshire Hathaway Inc.	3,978,767	1.03	Deere & Company	NYSE
26	Berkshire Hathaway Inc.	3,877,122	1.1	General Dynamics Corp.	NYSE
27	Berkshire Hathaway Inc.	5,622,340	null	Liberty Capital Group	NasdaqGS
28	Berkshire Hathaway Inc.	88,863	0.17	Lee Enterprises, Incorporated	NYSE
29	Berkshire Hathaway Inc.	4,646,220	16.68	Media General, Inc.	NYSE
30	Berkshire Hathaway Inc.	484,722,523	9.15	Wells Fargo & Company	NYSE
31	Berkshire Hathaway Inc.	24,123,911	1.97	ConocoPhillips	NYSE
32	Berkshire Hathaway Inc.	1,977,336	1.35	Precision Castparts Corp.	NYSE
33	Berkshire Hathaway Inc.	61,458,101	3.32	U.S. Bancorp	NYSE
34	Berkshire Hathaway Inc.	4,235,818	4.58	Torchmark Corporation	NYSE
35	Berkshire Hathaway Inc.	1,555,459	0.24	Visa Inc.	NYSE
36	Berkshire Hathaway Inc.	7,607,200	1.57	Viacom, Inc.	NasdaqGS
37	Berkshire Hathaway Inc.	5,382,040	4.17	M&T Bank Corporation	NYSE
38	Berkshire Hathaway Inc.	4,076,325	6.53	WABCO Holdings Inc.	NYSE
39	Berkshire Hathaway Inc.	25,000,000	1.82	General Motors Company	NYSE
40	Berkshire Hathaway Inc.	5,622,340	4.67	Liberty Media Corporation	NasdaqGS

No.	Shareholder Name	Share Held	Shares Held (%)	Company Name	Exchange
41	Berkshire Hathaway Inc.	27,163,918	4.39	Phillips 66	NYSE
42	Berkshire Hathaway Inc.	1,602,061	0.27	Kraft Foods Group, Inc.	NasdaqGS
43	Berkshire Hathaway Inc.	6,508,600	6.08	Chicago Bridge & Iron Company N.V.	NYSE
44	Berkshire Hathaway Inc.	5,622,340	4.65	Starz	NasdaqGS