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Month: May 2012

Don’t Use These 377 Words Unless You Like Being Spied On And Tailed By Unmarked Cars (#policestate, #ThreatLevelMidnight, #nsa, #dhs)

Don’t Use These 377 Words Unless You Like Being Spied On And Tailed By Unmarked Cars (#policestate, #ThreatLevelMidnight, #nsa, #dhs)

Want to end up on the Department of Homeland Security’s watchlist, or the watchlist of other federal “law enforcement” and “security” agencies?

Then simply put any of the following 377 words and phrases in your communications, public or private (don’t worry, they’re monitoring both), via SovereignMan.com:

Department of Homeland Security (DHS)
Federal Emergency Management Agency (FEMA)
Coast Guard (USCG)
Customs and Border Protection (CBP)
Border Patrol
Secret Service (USSS)
National Operations Center (NOC)
Homeland Defense
Immigration Customs Enforcement (ICE)
Agent
Task Force
Central Intelligence Agency (CIA)
Fusion Center
Drug Enforcement Agency (DEA)
Secure Border Initiative (SBI)
Federal Bureau of Investigation (FBI)
Alcohol Tobacco and Firearms (ATF)
U.S. Citizenship and Immigration Services (CIS)
Federal Air Marshal Service (FAMS)
Transportation Security Administration (TSA)
Air Marshal
Federal Aviation Administration (FAA)
National Guard
Red Cross
United Nations (UN)
Assassination
Attack
Domestic security
Drill
Exercise
Cops
Law enforcement
Authorities
Disaster assistance
Disaster management
DNDO (Domestic Nuclear Detection Office)
National preparedness
Mitigation
Prevention
Response
Recovery
Dirty bomb
Domestic nuclear detection
Emergency management
Emergency response
First responder
Homeland security
Maritime domain awareness (MDA)
National preparedness initiative
Militia Shooting
Shots fired
Evacuation
Deaths
Hostage
Explosion (explosive)
Police
Disaster medical assistance team (DMAT)
Organized crime
Gangs
National security
State of emergency
Security
Breach
Threat
Standoff
SWAT
Screening
Lockdown
Bomb (squad or threat)
Crash
Looting
Riot
Emergency
Landing
Pipe bomb
Incident
Facility
Hazmat
Nuclear
Chemical spill
Suspicious package/device
Toxic
National laboratory
Nuclear facility
Nuclear threat
Cloud
Plume
Radiation
Radioactive
Leak
Biological infection (or event)
Chemical
Chemical burn
Biological
Epidemic
Hazardous
Hazardous material incident
Industrial spill
Infection
Powder (white)
Gas
Spillover
Anthrax
Blister agent
Chemical agent
Exposure
Burn
Nerve agent
Ricin
Sarin
North Korea
Outbreak
Contamination
Exposure
Virus
Evacuation
Bacteria
Recall
Ebola
Food Poisoning
Foot and Mouth (FMD)
H5N1
Avian
Flu
Salmonella
Small Pox
Plague
Human to human
Human to Animal
Influenza
Center for Disease Control (CDC)
Drug Administration (FDA)
Public Health
Toxic Agro
Terror Tuberculosis (TB)
Agriculture
Listeria
Symptoms
Mutation
Resistant
Antiviral
Wave
Pandemic
Infection
Water/air borne
Sick
Swine
Pork
Strain
Quarantine
H1N1
Vaccine
Tamiflu
Norvo Virus
Epidemic
World Health Organization (WHO) (and components)
Viral Hemorrhagic Fever
E. Coli
Infrastructure security
Airport
CIKR (Critical Infrastructure & Key Resources)
AMTRAK
Collapse
Computer infrastructure
Communications infrastructure
Telecommunications
Critical infrastructure
National infrastructure
Metro
WMATA
Airplane (and derivatives)
Chemical fire
Subway
BART
MARTA
Port Authority
NBIC (National Biosurveillance Integration Center)
Transportation security
Grid
Power
Smart
Body scanner
Electric
Failure or outage
Black out
Brown out
Port
Dock
Bridge
Cancelled
Delays
Service disruption
Power lines
Drug cartel
Violence
Gang
Drug
Narcotics
Cocaine
Marijuana
Heroin
Border
Mexico
Cartel
Southwest
Juarez
Sinaloa
Tijuana
Torreon
Yuma
Tucson
Decapitated
U.S. Consulate
Consular
El Paso
Fort Hancock
San Diego
Ciudad Juarez
Nogales
Sonora
Colombia
Mara salvatrucha
MS13 or MS-13
Drug war
Mexican army
Methamphetamine
Cartel de Golfo
Gulf Cartel
La Familia
Reynosa
Nuevo Leon
Narcos
Narco banners (Spanish equivalents)
Los Zetas
Shootout
Execution
Gunfight
Trafficking
Kidnap
Calderon
Reyosa
Bust
Tamaulipas
Meth Lab
Drug trade
Illegal immigrants
Smuggling (smugglers)
Matamoros
Michoacana
Guzman
Arellano-Felix
Beltran-Leyva
Barrio Azteca
Artistic Assassins
Mexicles
New Federation
Terrorism
Al Qaeda (all spellings)
Terror
Attack
Iraq
Afghanistan
Iran
Pakistan
Agro
Environmental terrorist
Eco terrorism
Conventional weapon
Target
Weapons grade
Dirty bomb
Enriched
Nuclear
Chemical weapon
Biological weapon
Ammonium nitrate
Improvised explosive device
IED (Improvised Explosive Device)
Abu Sayyaf
Hamas
FARC (Armed Revolutionary Forces Colombia)
IRA (Irish Republican Army)
ETA (Euskadi ta Askatasuna)
Basque Separatists
Hezbollah
Tamil Tigers
PLF (Palestine Liberation Front)
PLO (Palestine Liberation Organization
Car bomb
Jihad
Taliban
Weapons cache
Suicide bomber
Suicide attack
Suspicious substance
AQAP (AL Qaeda Arabian Peninsula)
AQIM (Al Qaeda in the Islamic Maghreb)
TTP (Tehrik-i-Taliban Pakistan)
Yemen
Pirates
Extremism
Somalia
Nigeria
Radicals
Al-Shabaab
Home grown
Plot
Nationalist
Recruitment
Fundamentalism
Islamist
Emergency
Hurricane
Tornado
Twister
Tsunami
Earthquake
Tremor
Flood
Storm
Crest
Temblor
Extreme weather
Forest fire
Brush fire
Ice
Stranded/Stuck
Help
Hail
Wildfire
Tsunami Warning Center
Magnitude
Avalanche
Typhoon
Shelter-in-place
Disaster
Snow
Blizzard
Sleet
Mud slide or Mudslide
Erosion
Power outage
Brown out
Warning
Watch
Lightening
Aid
Relief
Closure
Interstate
Burst
Emergency Broadcast System
Cyber security
Botnet
DDOS (dedicated denial of service)
Denial of service
Malware
Virus
Trojan
Keylogger
Cyber Command
2600
Spammer
Phishing
Rootkit
Phreaking
Cain and abel
Brute forcing
Mysql injection
Cyber attack
Cyber terror
Hacker
China
Conficker
Worm
Scammers
Social media

Sometimes it’s hard to know if one should laugh or cry.

The True Principle Of Modern Education Exposed: To Make Us A Means To Others’ Ends (#education, #government, #preschool, #egoism)

The True Principle Of Modern Education Exposed: To Make Us A Means To Others’ Ends (#education, #government, #preschool, #egoism)

What is the true purpose of public education?

According to a new research study reported in the WSJ, it appears to be all about career-prep:

Can finger-painting, cup-stacking and learning to share set you up for a stellar career?

Research says yes, according to Dr. Celia Ayala, chief executive officer of Los Angeles Universal Preschool, a nonprofit that funds 325 schools in Los Angeles County, Calif., using money from tobacco taxes.

“When they enter kindergarten ready to thrive with all the social, emotional and cognitive skills, they perform at grade level or above,” she said. “When they don’t, that’s where that achievement gap starts.”

Note: don’t ask why money from tobacco taxes is being used to fund preschool research nonprofits.

There’s a lot at stake here– not only does pre-school appear to grant an advantage, but NOT doing appears to confer disadvantages such as increasing the likelihood of becoming a “special needs” student:

Kids without that early boost have been shown to be more likely to get special-needs services, be held back a grade or two, get in trouble with the law and become teen parents. Preschool alumni have a better chance, she said.

Today, a child’s life ends before it even begins:

“Those who go to preschool will go on to university, will have a graduate education, and their income level will radically improve,” she said.

Implication: don’t go to preschool, don’t go to university, don’t get a graduate education, watch your income level stagnate or decline, eventually you’ll probably kill yourself through obesity or suicide in a depressed state of lifetime unaccomplishment.

The article goes on the explain that preschool could hold “the key to job success in adult life” and warns of the sorrows of children who don’t receive an education in preschool because they’re spending time with “parents or caregivers.” Yes, there is nothing being learned there, apparently. Nothing valuable, at least.

But valuable to whom? And for what?

Why, valuable to society, for the purpose of making the child a good little worker! The definition of success is one who works productively for others. The purpose of education is not to develop a society of individuals, but a society of workers.

Or, as one French director of an “ecole maternelle” put it, the object is to give them social skills “to be students and citizens,” a “citizen” being one who obediently does what others ask of him.

Meanwhile, policymakers in the US are big on preschool:

Policymakers in the U.S. are most concerned about eliminating the gap between kids who do well in school, going on to college and successful careers, and those who fall behind. Preschool, say policymakers, offers educators the best shot for getting children of varying backgrounds on equal footing.

There’s a codeword in there– “equal”. Equal means same. Same means, “not different.” But wait, individuals ARE different. They have different likes and dislikes, different skills and aptitudes. How can beings who are inherently different, ever be equal? And why would policymakers care? How does being “equal” help one succeed at living ONE’S OWN life?

Answer– it doesn’t. It isn’t about living one’s life. Sameness, equality, is being sought to create an army of interchangeable cogs to go on society’s wheel. Then, the elites spin the wheel. And round go all the equal people, never asking why.

Don’t worry, though. Policymakers at Department of Education won’t let anyone fail to be equal. They’re “equal” to the task:

“We’re really focusing on the cradle-to-career continuum,” said Steven Hicks, special assistant for early learning at the federal Department of Education, where there has been a recent shift as officials realize “we need to start earlier.”

Once people are in the work force, the Social Security Administration is responsible for the “career-to-grave continuum”. Which means no matter what point in the continuum you’re at during your life, the State is there to help you out, with kid gloves, of course.

Although most education funding happens at the state level, the federal government has been trying to fuel a preschool wave with a half-billion dollars in challenge grants funded in January. The next five states in line will share $133 million in preschool money this year. Call it a pre-job-training program.

Are you starting to get the picture here? You’re being trained from the moment you develop the mental, emotional and conceptual faculties to see yourself as a differentiated “other” in the world, to prepare to work for someone else. This is scary stuff. And it’s all coming in the innocuous guise of “equality” for all.

Most teachers and parents would agree that early-childhood education matters to a child’s trajectory in life. But with budgets stretched around the country, a lack of money is forcing some states to make choices about scarce education dollars. Too bad, the DoE thinks.

“Secretary Duncan says there are smart investments and some things you can do that are not so smart, and one of those is cutting early childhood education,” Hicks said.

To calculating socialists running short on Other People’s Money, future worker bees are like hot dogs from the corner stand– “Get ’em while they’re young!”

This article, intentionally or not, is coincidentally the most timely and blatantly obvious confirmation of Stirner’s false principle of education. Nobody in this article is aiming at an educational system which produces “self-developed” individuals. The name of the game is forming human clay into pre-determined molds appropriate to other people’s ends.

It is distinctly anti-individual. It’s a quiet and brutal form of slavery-as-virtue.

Notes – David Merkel On Corporate Bonds (@alephblog, #bonds)

Notes – David Merkel On Corporate Bonds (@alephblog, #bonds)

David Merkel, author of the AlephBlog, has an extensive background on Wall Street and is something of a value investor when it comes to his money management principles. There is a lot of good content on his site in various disciplines within the investment analysis and money management domains so this will likely be the beginning of a multi-part digest series. This one deals with his lessons about the corporate bond market. To read the entire original discussion, please click the title heading of each section.

The Education of a Corporate Bond Manager, Part I

How I learned the basics, and survived 9/11.

  • “Bond swap”– trading away an older bond of a company for a new issue
  • New deals almost always came cheap
  • Think about bonds as a put option on the equity
  • When selling a bond, look at what investment banks ran the books of the deal
  • Never make it look like there are two sellers (by working with two banks) or bids will vanish; bad etiquette to employ two banks without telling them they’re in competition with one another

The Education of a Corporate Bond Manager, Part II

How I learned to trade bonds, and engage in intelligent price discovery.

  • If you want to buy a bond not presently offered, find out who brought the deal and made a market in the bond issue
  • Price discovery toolkit:
    • Comparable bonds in the same industry
    • Credit spreads across rating categories
    • Credit spreads across the maturity spectrum within rating categories
    • Spreads on CDS on the same name
    • Value of scarcity vs cost of liquidity
    • Proper spread tradeoffs on premium vs discount bonds
    • Calculate spread on last few trades
  • There is a price to gain liquidity that the issuer pays
  • “One-minute drill” creditworthiness check on Bloomberg:
    • GPO, how has the stock price moved over the last year?
    • HIVG, how have option implied volatilities moved of late?
    • CH6, how is operating cash flow?
    • DES, what industry is it in?
    • DES3, major financial ratios of the company
    • CH2 or ERN, earnings declining?
    • CRPR, credit ratings?
  • If these tests are passed, odds of company doing badly while waiting for a credit analyst’s opinion are slim

The Education of a Corporate Bond Manager, Part III

What is the new issue bond allocation process like, and what games get played around it?

  • Speed of decision process when buying new bond issuance based upon:
    • complexity of deal
    • creditworthiness of issuer
    • speculative nature of market
  • When market runs hot, odds rise that the syndicate will overprice a deal and deliver losses to those asking for overly large allocations
  • Dealing in the gray market has taint, you don’t want to be seen doing it lest your allocations be reduced
  • Syndicates want to place bonds entirely with long term holders if they can, implies they priced it right, leaving little money for speculators

The Education of a Corporate Bond Manager, Part IV

On the games that can be played in dealing with brokers.

  • Poker aspects of the bond market:
    • be honest, keep your word on trades, don’t weasel out once you say “done”
    • have a fair reputation, that you don’t try to pull fast ones on the broker community
    • reputation for fairness should be reinforced by other actions
      • if ibank quotes price/spread out of market context, let them know what you know; only trade against them if they insist they’re right
      • if risk control desk comes to you with a trade to cover a short and you own the bonds, help them; make them pay a little more than the ask but don’t gouge, then they might offer you the long cross-hedge bond at a nice price
    • have an “openness policy”; reveal 80% and conceal 20%, the most critical 20%
    • your broker at the ibank is proud of his best clients; he doesn’t want to lose you if you’re bright, trade a lot, run a big account
    • never tell your whole story to any broker; break up your business among many brokers, with no overlap
    • it’s good to have a reputation for being bright, or at least not a pushover
  • It’s freeing to not think about whether a particular trade will generate a gain or a loss but rather how the portfolio can be improved

The Education of a Corporate Bond Manager, Part V

On selling hot sectors, and dealing with the dirty details of unusual bonds.

  • It takes time and effort to farm, but financial products can be whipped up in any season
  • If I am underweight, someone else must be overweight versus the index; someone has to absorb all the paper of a hot sector, don’t let that be you
  • Credit analysts understand the creditworthiness of bonds; what do PMs understand?
    • portfolio composition vs needs of the client
    • trading dynamics of the marketplace, whether good bonds might temporarily be mispriced
    • dirty details of the bond; covenants, terms, etc.
  • A lot of value is added by document review; in a time of panic, those insights are golden because other managers toss out illiquid bonds they don’t fully understand

The Education of a Corporate Bond Manager, Part VI

On dealing with ignorant clients, and taking out-of-consensus risks.

  • Optimal strategy for life insurers: interest spread enhancement with loss mitigation
  • Defaults are a fact of life; if you run with such a thin capital base that you can’t survive a few modest defaults, you’re running your insurance company wrong

The Education of a Corporate Bond Manager, Part VII

On the value of credit analysts.

  • Credit analysts are a corp bond mgrs best friend
  • Provide a necessary check on a PM trying to play “cowboy” and be a yield hog
  • Native tendency is to reach for yield:
    • a portfolio with more yield earns more
    • a higher yielding credit will rally, due to mean-reversion
  • The second is true about 50% of time, but rewards are assymetric; gains are small, losses are large– it doesn’t pay to be a yield hog
  • All analysts have biases; to overcome, give them a list of spreads for companies they cover and ask them to rank the credits in that sector
  • For Mr. Yes, ask him about risk factors; for Ms. No, ask what are the best names she’d invest in
  • Every investment shop tends to create a monoculture modeled off the PM at the top; to avoid bias:
    • have multiple analysts look at a conviction idea
    • have PM take it home and analyze it
    • look at Street research to find bears, and circulate the opinion to the team

The Education of a Corporate Bond Manager, Part VIII

On price discovery in dealer markets, and auctions gone wrong.  I never knew that I could haggle so well.

  • There may be 7000 actively traded stocks in the US but there are nearly 1,000,000 bonds, the last trade of which may have been a week or a month ago
  • After adjusting for default risk, the number one predictor of portfolio return is yield
  • Default risks are lower after the bust phase of the credit cycle, rise as the credit cycle gets long in the tooth
  • David does a trade: “But how to come to the right price/yield/spread?  I had a few trades, but they were dated.  I knew the spreads then, and used the spreads of more liquid similar credits to adjust it to a likely yield spread today.  I put in a fudge factor because illiquid bonds are higher beta, and then studied which of my brokers might have a bead on the bonds in question.  I would ask them their opinion, and if they were in my ballpark, I would back up my bid some, and bid for $1 or $2 million of the bonds.  The response would come back, and I would have a trade, or nothing, but maybe some color on where they would be willing to sell.  If a trade, I would back up my bid a little more, and offer to buy more.  If no trade, I would offer 50-70% of the distance between our bid/offer, and see what they would do.”
  • How to have a successful auction of bonds you own:
    • limit auction to dealers who have most interest
    • say you’re just raising cash, eliminates information risk, makes them willing to bid
    • cover level is the second place bid
    • can’t come back begging for love
    • ties are fine; no love, both brokers get half
    • not enough bids, cancel it
  • Limits to haggling: when you’re already getting an unreasonable deal, smile, say thanks and move on; it’s more important to be invited back
  • Bid/offer fewer bonds than wanted by the seller/buyer at the level, and ask for better terms at their size; makes them more willing to deal
  • Always pay your brokers, it makes them more loyal to you
  • Trading is an amplified version of character; try to be fair everywhere you can while still making money for the client
  • Playing for the last nickel costs 95 cents in the long run

The Education of a Corporate Bond Manager, Part IX

On the vagaries of bulge-bracket brokers, and how a good reputation helps on Wall Street.

  • You aren’t supposed to act like a market-maker; if it’s known you aspire to risk-free profits, they might use their power to hurt you:
    • lower allocations on new deals
    • tougher in haggling
  • Reputation matters
  • Gravitate secondary trading business to those who “walk the walk”

The Education of a Corporate Bond Manager, Part X

On how we almost did a CDO, and how it fell apart.  Also, how to make money in the bond market when you reach the risk limits.

  • You can only do deal #2 if you’ve done deal #1
  • Macro theme: stability usually triumphs over discontinuity

The Education of a Corporate Bond Manager, Part XI

On my biggest mistakes in managing bonds.  Also, on aggressive life insurance managements.

  • Bonds are assymetric
  • Paid to be cautious regarding failure
  • When in doubt, sell
  • Don’t always take your broker at face value

The Education of a Corporate Bond Manager, Part XII (The End)

On bond technical analysis, and how to deal with a rapidly growing client.   Also, the end of my time as a bond manager, and the parties that came as a result.   Oh, and putting your subordinates first.

  • On timing purchases and sales:
    • the large brokers generally know who is doing what
    • be nice to sales coverage, you’d be amazed what they’ll tell you
    • keeping the VIX on screen helped accelerate or slow down purchases and sales in a given day; yield spreads lag behind option volatility
  • On time horizons:
    • Three horizons
      • daily
      • weekly-monthly
      • credit cycle
  • On scaling:
    • moving in and out of positions slowly, as market conditions warranted, is useful
    • “Never demand liquidity unless it is an emergency and you meet the strenuous test that you know something everyone else does not. But, make others pay up for liquidity where possible. You are doing them a service.”
Notes – Gary North On Inflation, Deflation And Japan (@DrGaryNorth, #inflation, #deflation, #japan, #money)

Notes – Gary North On Inflation, Deflation And Japan (@DrGaryNorth, #inflation, #deflation, #japan, #money)

The following notes cover Austrian economist Gary North’s views on the chances of inflation and deflation in the US and Japanese monetary systems, derived from a 5-part article series on the subject found at LewRockwell.com:

Why Deflation Is Not Inevitable (Sadly), Part 1: John Exeter’s Mistake

  • Fed will attempt to stabilize money supply before hyperinflation; “mass inflation, yes; hyperinflation, no. Then deflation.”
  • Deflation will not take place unless the CB stops making new money
  • When prices fall, you are richer, but you pay no income tax on your profits (deflation is good)
  • Not-money: if you pay a commission to exchange, the asset is not truly liquid
  • Gold is a mass inflation hedge, not a deflation hedge
  • According to Exter/deflationists, gold is supposedly both an inflation hedge and a deflation hedge– the only asset possessing this virtue
  • We have never been able to test Exter’s theory of gold as a hedge against price deflation because there has never been a single year in which CPI has fallen (Q: what did gold price of Yen do in 2009 Japanese CPI decrease?)
  • Consumer price indexes should be based upon goods and services that are rapidly consumed; not price of homes and other prices of “markets for dreams”
  • Central banks inflate, they do not deflate
  • “When housing is bought on the basis of ‘I’ll get rich,’ the market begins to resemble a stock market. When it is bought on the basis of ‘I can live here for what I can rent,’ it is more like the toilet paper market”
  • The skyrocketing price of housing under Greenspan was not reflected in the CPI; the collapsing price of housing under Bernanke was not reflected in the CPI
  • Consumer prices did not fall during the 2008-09 crisis because the money supply did not fall; if the money supply shrinks, there will be price deflation; watch the monetary statistics

Why Deflation Is Not Inevitable (Sadly), Part 2: The Deflationists’ Myth of Japan

  • The money supply shrank in the US 1930-33 (Q: Why did the Fed allow money supply to shrink? Does this weaken North’s argument that the Fed will always inflate rather than deflate going forward?)
  • The US and Japan had similar CB policies until late 2008, when the Fed “went berserk”
  • Japan’s M2 was mildly inflationary from 1992-2009; CPI was slightly deflationary over the same period of time but never worse than 1% in any 12mo period; prices rose 2% 1997 and 2008
  • There has been no systemic price deflation in Japan
  • Japan is more Chicago School than Austrian
  • Statistical conclusions about Japan:
    • CPI in Japan fell little 1992-2009, no more than 1% per annum
    • BoJ did not inflate the currency to overcome systemic price deflation, because it didn’t exist
    • Collapse of Japanese RE prices did not affect CPI
    • Collapse of Japanese stock market prices did not affect CPI

Why Deflation Is Not Inevitable (Sadly), Part 3: Why Currency Withdrawals Don’t Matter

  • The Japanese economy is starting to become price competitive; this will have ramifications higher up the corporate command chain
  • Estimates of US currency held outside the United States range from 50-70%
  • Rise of credit transactions such as credit cards have minimized the role paper currency plays in everyday transactions
  • Currency withdrawals from the banking system which are not later redeposited are deflationary due to the reserve ratio mechanism
  • Monetary deflation can occur as a result of deliberate Fed policy:
    • increase legal reserve requirement
    • sell assets
    • allow bank collapse to occur by not funding FDIC with new money to offset withdrawals

Why Deflation Is Not Inevitable (Sadly), Part 4: High Bid Wins

  • All economics systems are governed by principles of:
    • supply and demand
    • high bid wins
  • The increase in the Fed’s balance sheet (monetary base) has been offset by increase in excess reserves held at banks; thus, no price increases
  • Deflationists’ claim: “Commercial banks will not start lending until the recovery is clear. The recovery is a myth. So, banks will not start lending, no matter what the FED does. The largest banks remain over-leveraged. They will not be able to find borrowers at any rate of interest, so the capital markets will collapse (except gold), and then consumer prices will fall.”
  • North’s response: “the largest banks are making money hand over fist. It is the local banks that are failing. The FED has done what it was set up to do in 1913: protect the largest banks.”
  • Inflationists’ claim: “Commercial banks will start lending when the recovery is clear. The FED will probably not contract the monetary base all the way back to August 2008, because this would bring on another crisis comparable to September 2008. The FED will not risk bankrupting the still highly leveraged megabanks. It will therefore not fully offset the decrease in excess reserves. It will not “wind down” all the way, if at all. Bernanke fears 1930—33 more than anything else. So, the money supply will rise. Prices will follow.”
  • “The increase in excess reserves has been voluntary. The bankers are afraid to lend, even to the U.S. Treasury.” (Q: Why are bankers afraid to lend, even to the Treasury?)
  • “The FED is in complete control over excess reserves. It pays banks a pittance to maintain these reserves. It is legally authorized to impose fees.”
  • Why the Fed maintains its current policy:
    • doesn’t have to sell assets
    • doesn’t have to face rising long-term interest rates due to expanding money supply
    • doesn’t have to worry about collapsing housing market as interest rates go to 25-40%
    • doesn’t face a corporate bond market collapse
  • Monitoring money supply changes is key to predicting consumer price increases

Why Deflation Is Not Inevitable (Sadly), Part 5: Conclusion

  • J Irving Weiss and his son Martin, recommended 100% T-Bills since 1967; it takes $6400 to buy what $1000 bought in 1967
  • Deflationists confuse asset prices with consumer prices
  • Deflationists believe low interest rates lead to debt build up but lower ones won’t stabilize; cost of capital can fall to zero and no one will borrow
  • This is John Maynard Keynes theory, who therefore recommended the government should borrow and spend to avoid this fate
  • There is not a shortage of borrowers today, corporate bond rates are around 6%, not 0%, implying there are people looking to borrow at positive rates of interest
  • Capital markets — markets for dreams, priced accordingly
  • Consumer prices rise comparably to increases in M1 in the US and M2 in Japan
  • Deflationists confuse money (in a bank account) with dreams (imputed asset prices in capital markets)
  • At the supermarket, prices are slowly rising in the US and slowly falling in Japan
Notes – There’s Always Something To Do (#valueinvesting, #patience, #contrarian)

Notes – There’s Always Something To Do (#valueinvesting, #patience, #contrarian)

There’s Always Something To Do: The Peter Cundill Investment Approach

by Christopher Risso-Gill, Peter Cundill, published 2011

The Peter Cundill approach to value investing

The following note outline was rescued from my personal document archive. The outline consists of a summary of Christopher Risso-Gills’ recent biographical investment profile of Canadian value investor Peter Cundill, There’s Always Something To Do. The notes are in summary form of the most critical aspects to Cundill’s value investment perspective and analytical process.

There’s Always Something to Do: The Peter Cundill Investment Approach

  • “I think that intelligent forecasting should not seek to predict what will in fact happen in the future. Its purpose ought to be to illuminate the road, to point out obstacles and potential pitfalls and so assist management to tailor events and to bend them in a desired direction.”
  • He made a habit of visiting whichever country had the worst performing stock market in the past 11 months.
  • “In a macro sense, it may be more useful to spend time analyzing industries instead of national or international economies.”
  • “It must be essential to develop and specify a precise investment policy that investors can understand and rely on the portfolio manager to implement.”
  • A few investment principles:
    • never use inside information, “All you get from inside information is a whiff of bad breath.”
    • economic facts and company values always win out in the end
    • don’t try to be too clever about the purchase price
    • isolate what the real assets are
    • never forget to examine the franchise to do business
  • Insider buying is not always well-informed– Peter once scooped up shares of J. Walter Thompson (JWT) at a perceived discount and faced a hostile and confused president who was selling stock from the companies pension fund and couldn’t figure out why Cundill was buying (pg. 29), which demonstrates that there are informational disadvantages and ambiguities that keen analysts can take advantage of, even over company insiders; insider buy/sell ratios and actions should be considered thoughtfully and fully “discounted”, not taken as authoritative proof of anything by themselves
  • “Very few people really do their homework properly, so now I always check for myself.”
  • Look for hidden gems on the balance sheet
  • Investing globally:
    • if you find one foreign stock that is trading at a significant discount, snoop around because there may be other bargains in the foreign industry or market
    • There was nothing “ad hoc” about the way Peter addressed the process of international value investment. In every instance it had to be firmly based on a clear understanding of local accounting practices and how those might differ from accepted standards in North America. The fact that it was different, less transparent, or deliberately opaque was never a reason for ignoring or excluding a market or security. Peter’s attitude was “vive la difference”; if a balance sheet was hard to penetrate it was not just a challenge but an opportunity because the difficulties actually represented a “barrier to entry” even for the experienced professional investor and undoubtedly excluded all but the most sophisticated private investors.
    • The other aspect, which Peter considered to be a vital component of a successful international strategy, was building carefully constructed networks of locally based professionals who had a thorough understanding of value investment principles and would instinctively recognize a security that would potentially fit the Cundill Value Fund’s investment criteria.
  • “THE MOST IMPORTANT ATTRIBUTE FOR SUCCESS IN VALUE INVESTING IS PATIENCE, PATIENCE AND MORE PATIENCE. THE MAJORITY OF VALUE INVESTORS DO NOT POSSESS THIS CHARACTERISTIC.”
  • “It is also dangerous to rely on a single strategy in a doctrinaire fashion. Strategies and disciplines ought always to be tempered by intelligence and intuition.”
  • Personal margin note: Peter did not succeed in isolation but cultivated and utilized networks of knowledgeable and influential people (investors, political activists and politicians, business people); he also had several mentors
  • Peter was impressed by a group of corporate socialites he had dinner with, “They maintain that having a hangover is a waste of a day.”; personal margin note: respect the value of time, the ultimate scarce resource, always
  • Peter organized a prestigious investment conference, the Cundill Conference, where he both talked and exchanged ideas on investing with other friends and gurus, as well as heard from invited guest expert speakers who spoke on a range of topics totally unrelated to investing, to promote cross-disciplinary rigor and creative spark
  • “The boards of charitable foundations are convenient meeting places for influential people. Their ostensible purpose is intimately bound up with the social and commercial ones.”
  • Peter relocated to London from Toronto to better pursue his global value investment approach, seeing London as the center of capital and the business crossroads of the world at the time; personal margin note: where is today’s London, or tomorrow’s?
  • On flying across the Atlantic routinely on the Concorde:
    • “It is a remarkable sounding board, especially in my world of matters financial.”
    • “One becomes even more keenly aware that there is never just one factor determining events, there are many of them interwoven and acting simultaneously.”
    • “I always need to discipline myself to be aware of the world generally, rather than trying to be specific. I only need to be specific about the numbers.”
  • Selling stocks which near or surpass their intrinsic value often acts as an “inbuilt safety valve” for the value investor in markets which are in a bubble or overpriced generally
  • Peter channels Horace’s Ars Poetica via Graham in a journal entry prior to the 1987 Crash: “Many shall be restored that now are fallen, and many shall fall that are now held in honor.”
  • “Sooner or later the market will do what it has to do to prove the majority wrong.”
  • Cundill, via Oscar Wilde, on an approach to stocks: “Saints always have a past and sinners always have a future.”
  • “Being out on a limb, alone and appearing to be wrong is just part of the territory of value investment.”
  • Cundill on overvalued markets: “it can tempt one to compromise standards on the buy side and it may lure one into selling things far too early.”
  • Cundill’s value approach gently evolves: “Discounts to asst value are not enough, in the long run you need earnings to be able to sustain and nurture these corporate values. We now, as a matter of course, ask ourselves hard questions as to where we expect each business to be in the future and, as well, make a judgment on the quality of management.”
  • Cundill defines shorting based off of his ‘antithesis of value’: “identifying a market where values are so stretched and extreme that they are clearly unsustainable. They have passed far beyond the realms of any measure of statistical common sense.”
  • “The great records are the product of individuals, perhaps working together, but always within a clearly defined framework.”
  • “In reality outstanding records are made by dictators, hopefully benevolent, but nonetheless dictators.”
  • On avoiding the temptation to sell an eventual winner: “What we ought to do is go off to Bali or some such place and sit in the sun to avoid the temptation to sell too early.”
  • Cundill on his shock related to 1968 sentiment toward the shoddy accounting of the conglomeration movement: “Nobody cared; accounting is a bear market phenomenon!”
  • “Every company ought to have an escape valve: inventory that can readily be reduced, a division that can be sold, a marketable investment portfolio, an ability to shed staff quickly.”
  • “We always look for the margin of safety in the balance sheet and then worry about the business.”
  • “If there’s no natural skeptic on an investment maybe it would be wise to appoint one of the team to play Devil’s Advocate.”
  • More on investing overseas in developing markets: What was required was an asset-based margin of safety significantly greater than would be considered adequate in the more developed markets. It was also fairly obvious that in these less developed markets tangible fixed assets were superior to cash, which had a nasty habit of evaporating.
  • Cundill on retirement: “Retirement is a death warrant.”
  • Poetic Cundill: “No fortunes are made in prosperity, Ours is a marathon without end: Enjoy the passing moments.”
  • Cundill’s wit and wisdom on what makes for a great investor:
    • “Curiosity is the engine of civilization”, he advises to have serious conversations with people that result in an exchange of thoughts and to keep one’s reading broad.
    • “Patience, patience and more patience.”
    • “Always read the notes to a set of accounts very carefully… seeing the patterns will develop your investment insights, your instincts — your sense of smell. Eventually it will give you the agility to stay ahead of the game, making quick, reasoned decisions, especially in crisis.”
    • “Holding on to a heavily discounted stock that the market dislikes for a period of five or ten years is not risk free. As each year passes the required end reward to justify the investment becomes higher, irrespective of the original margin of safety.”
    • “An ability to see the funny side of oneself as it is seen by others is a strong antidote to hubris.”
    • Routines: “They are the roadmap that guides the pursuit of excellence for its own sake.”
    • Via Peter Robertson, “always change a winning game.”
    • “An investment framework ought to include a liberal dose of skepticism both in terms of markets and of company accounts.”
    • Personal responsibility: “If you lose money it isn’t the market’s fault… it is in fact the direct result of your own decisions. This reality sets you free to learn from your mistakes.”
    • Suggested reading list:
      • Extraordinary Popular Delusions and the Madness of Crowds
      • The Crowd: A Study of the Popular Mind
      • Buffett: The Making of an American Capitalist
      • The Money Masters
      • The Templeton Touch
      • The Alchemy of Finance
    • Cundill’s Corrolary to Murphy’s Law: “When things get so bad that you’re really scared, that’s the time to buy.”
    • Global investing: “Given the dearth of bargains today, it pays to search for them everywhere.”
    • On independence, via Ross Southam, “You have to be willing to wear bellbottoms when everyone else is wearing stovepipes.”
    • “If it is cheap enough, we don’t care what it is.”
    • “I would say that the problem with big businesses that have moats around them is they tend to over-expand.”
    • “IPOs for the most part are dreams engendered by the hope that pro forma estimates will be met. We deal to a certain extent in nightmares that everyone knows about.”
  • Three parts to Cundill’s investment strategy:
    • NAV
    • sum of the parts analysis
    • future NAV estimation
  • “Sometimes nothing is more misleading than personal experience.”
  • Investments held by Peter Cundill, managed by others, a potential place to search for ideas or gain more insight, pgs. 223 and 224

Notes – Distressed Debt Analysis (#debt, #capitalstructure, #bankruptcy)

Notes – Distressed Debt Analysis (#debt, #capitalstructure, #bankruptcy)

Distressed Debt Investing: Strategies For Speculative Investors

by Stephen G. Moyer, published 2004

Distressed debt: a true contrarian investment strategy

The following note outline was rescued from my personal document archive. The outline consists of a summary of Stephen G. Moyer’s integral handbook on distressed debt dynamics, Distressed Debt Analysis. The notes currently cover chapters 1-4. They are incomplete at present. I will likely not revise these notes and instead plan to release a new series of notes on this book in the future when I re-read it.

Distressed Debt Analysis

  1. Chapter 1 – Introduction
    1. What is “distressed debt”
      1. Some define based off of credit ratings, which lacks rigor because:
        1. credit ratings lag fundamental credit developments
        2. credit ratings essentially only handicap the risk of default, they say nothing of whether the price is appropriate for the risk
      2. Martin Fridson advocates defining debt as distressed when it trades with a yield to maturity greater than 1000 basis points more than the comparable underlying treasury security
      3. Moyer suggests the following:
        1. equity value is diminimus (eg, under $1/share)
        2. all or some portion of unsecured debt trading at a market discount of more than 40%
        3. this pattern implies a balance sheet restructuring, resulting in creditors owning a significant portion of equity, or else a sale of assets and subsequent liquidation
    2. Distressed debt investing is not for everybody
      1. significant risk of loss
      2. often an informational advantage for professional participants
      3. markets are often illiquid, significantly increasing transaction costs
      4. average trading size is sufficiently large to rule out the average investor
    3. Potential restructuring events introduce significant levels of complexity
      1. Will restructuring occur within or outside of a bankruptcy context?
      2. What is the risk of a loss of economic value due to loss of key customers, suppliers or employees?
      3. How much economic value might be gained via bankruptcy?
      4. If balance sheet is restructured, what will new components look like and who will win and lose?
      5. What are the tax consequences?
      6. Any investors with “controlling” stake allowing them to unfairly influence the process at the expense of others?
    4. Common considerations of a distressed investment:
      1. What is the cause of distress?
      2. How will the distress be resolved?
      3. What are the implications of that resolution on the value of the business or particular securities?
      4. What actions on the part of bondholders are being assumed to realize a particular outcome?
      5. Will the price of the instrument in question go up or will it be exchanged into other securities requiring a new analysis?
  2. Chapter 2 – The Distress Debt Investing Opportunity
    1. investment grade bonds
      1. BBB or higher – investment grade
      2. lower than BBB – speculative grade
      3. fallen angel – a company that goes from investment grade to speculative grade
      4. bonds that go from BBB to BB or lower may result in forced selling for fund managers who by law must hold BBB or higher, creating an opportunity for distressed debt investors
      5. alternately, fallen angels may force speculative grade fund managers into “forced buying” when they are added to an index, creating another opportunity
      6. PRECURSORS TO DEFAULT
        1. economic performance- economic softness generally gives rise to falling revenues and cash flows, putting many companies into distressed situations
        2. relative quantity of low-rated bonds
          1. low-rated bonds tend to default more often
          2. downgrades and new issuance can increase the number of low-rated bonds
        3. capital markets liquidity- highly leveraged companies are often more dependent on capital markets for on-going financing
          1. the appearance of a recession can restrain a levered companies ability to float more debt
          2. general risk aversion or investor disinterest with the junk bond market can increase financing challenges for companies
          3. a bear market in stocks can shut off another source of funding for these companies
      7. MARKET CONDITIONS THAT PERMIT SUPERIOR RETURNS
        1. equal access to information
          1. hundreds of high-yield issuers have no analyst coverage
          2. many transactions are done OTC
          3. many high-yield issuers have no public equity and thus do not fill out SEC reports
          4. when companies file for bankruptcy, they often delay or totally fail to file SEC reports
          5. two levels of information in bankruptcy proceedings: restricted nonpublic info; publicly available info
          6. the seller of heavily discounted bonds may know something you do not
        2. rational behavior- absence of “free will”, “coerced” sales:
          1. sales by banks to maintain portfolio quality standards often not based on “fair value”
          2. institutional investors may have earnings goals and sell an asset for less than they deem it is worth but still more than its carrying cost, satisfying the goal
          3. high yield, open ended mutual fund managers may be forced to liquidate holdings to meet investor demands for redemption following a swift change in sentiment about their asset class
        3. low transaction costs
          1. settlement fee, including commission to broker- generally nominal, but indeed higher than large-cap equity or other mainstream transactions
          2. “unwind” fee, represents bid-ask spread in the market
            1. this fee can often be a point or more
            2. on highly speculative bonds it can often consist of several % of the total value of the trade
            3. this reduces potential liquidity and volume of exchange in the markets
  3. Chapter 3 – Conceptual Overview of Financial Distress and the Restructuring Process
    1. the value of assets is typically uncertain and subjective
    2. EMT theory suggests the market can be relied upon to accurately asses the value of assets and thus one can infer the value of a firm’s securities
    3. in reality, the market makes dramatic reassessments of securities, positive and negative, often with very few fundamental changes in the business
    4. declines in asset value can be handled fairly flexibly when the capital structure is composed of equity; when the capital structure is composed of large amounts of debt this becomes tricky (due to debt covenants)
    5. two solutions
      1. increase the value of the company (unlikely possibility or management would’ve done it)
      2. resize the capital structure
    6. resizing is accomplished via the restructuring process, a combined legal and financial operation
  4. Chapter 4 – Legal OverView of Distressed Debt Restructurings
    1. OUT OF COURT RESTRUCTURINGS: THE PREFFERED OPTION WHEN EFFECTIVE AND FEASIBLE
      1. The Financial Effects of an Out-of-Court Restructuring
        1. Firm and its most significant creditors negotiate a change in the terms of obligations or a voluntary exchange of financial interests
        2. debt for equity or reduced debt for new debt and equity are typical arrangements
        3. the postreorganization capital structure is fairly “arbitrary”; the company may eventually flourish under a number of different capital structures
        4. because it is not handled in court, this settlement can not change or negate the interest of other claimants not participating in the restructuring
        5. the restructuring can involve payments of cash instead of exchanges of securities
      2. The Out-of-Court Restructuring Process
        1. Parties Involved
          1. With bank debt, the negotiating agent is usually self-evident and is often a previously chosen “agent” of a loan syndicate specified in the loan agreement
          2. With bonds, typically represented by a small group of significant bondholders who form an informal bondholder committee, in practice >=25% of all bonds
          3. There are often agendas involved; commonly people are united around the cause of achieving the most economic value from their claims as possible, but opportunists might see a way to cheaply “acquire” equity which might be profitable in the future
          4. The view of the “job” of forming a bondholder committee is subjective; a hedge fund may see it as an intended part of the investment; a mutual fund or insurance company might consider it to be an embarrassing but necessary evil
          5. The bondholder committe has no legal authority to bind either member or nonmember bondholders
        2. Strategic Considerations in Participating on the Bondholder Committee
          1. If the objective is to invest so as to participate in the bondholder committee, one must be prepared to accumulate a significant quantity of the bonds
          2. an investor may be forced to sign a “confi” (confidentiality agreement); the investor gains the best material information available but must make disclosures of possession of such information (but not the info itself) when trading, which could make trading more difficult
          3. restriction begins at the receipt of material non-public info and ends when the information becomes non-material or is publically disclosed via an 8-K, 10-Q or 10-K
          4. counter-parties which have become restricted must execute a “big-boy letter”
            1. an acknowledgement by the nonrestricted party that they are aware the counter-party has material non-public info
            2. a waiver of claims the nonrestricted party might otherwise have under securities law
            3. typically executed by a broker-dealer to maintain anonymity
        3. Beginning the Process
          1. when the debt is bank debt, usually begins because the borrower is in or approaching technical default of some provision of the loan
          2. when the debt is bonds and there is no or little bank debt, an investment bank or other restructuring specialist is often hired on retainer for advice
          3. if out-of-court looks like an option, the firm can
            1. invite creditors to organize a bondholders committee
            2. propose a restructuring without prior consultation
        4. Implementing the Restructuring
          1. with bank debt, usually involves an amendment to the loan agreement
          2. with bonds and a bondholder committee, usually a relatively simple private exchange
        5. Feasability: The Holdout Problem
          1. those not participating in the restructuring may be better off than those who do, but if nobody participates, all will be worse off
          2. with too many holdouts, the company’s only option is bankruptcy, which often just adds legal costs and reduces everyone’s final recovery
          3. holdouts may be managed via:
            1. moral sanction– the distressed debt market is small and the big players are well known so most deals happen within a context of familiarity and consideration for the future of relationships
            2. coercive structural devices– use of tender offers to strip out covenants on the holdouts, forcing them to participate
    2. IN-COURT RESTRUCTURINGS: AN OVERVIEW OF THE BANKRUPTCY PROCESS
      1. Intro
        1. it is hardly ever a surprise when a firm files for bankruptcy
          1. market prices have typically adjusted prior to the filing to represent the fear and uncertainty
        2. many firms send signals and warnings to the market before doing so
          1. distressed debt situations are often illiquid and you can not wait for the “bottom” to accumulate a position
        3. some or all of the creditors will usually incur some financial loss
        4. the key is not to buy at the bottom but to buy for less than things are worth
      2. Declaring Bankruptcy
        1. begins with a petition filed at a bankruptcy court, filed by the debtor and known as a “voluntary petition”
        2. in a few cases, three or more creditors may have grounds for filing an “involuntary petition”
        3. Chapter 11 contemplates allowing the existing management to reorganize the debtor as a going concern
        4. Chapter 7 anticipates that a court-appointed trustee will supervise the liquidation of the debtor’s assets
        5. Jurisdiction of Filing
          1. if a prepackaged plan has been put together, a jurisdiction with a reputation for expediting the process may be chosen
          2. if management anticipates a fight with creditors, it might choose a more “debtor” or “home-town” friendly jurisdiction
          3. DDI need to consider the relative level of bankruptcy planning that has occurred or may be possible, the probable jurisdiction of filing and what this implies for the timing of the resolution and the potential effect on the treatment of various claims
        6. Timing of Filing
          1. debtor will typically choose to file before it is in material breach of an agreement, which would allow creditors to make an involuntary filing
          2. the debtor will often try to conserve or charge up liquidity prior to the filing by stretching payment to vendors and creditors and utilizing revolving lines of credit
          3. everything that occurs before filing is considered “prepetition” and everything afterward is “postpetition”, which are senior to “prepetition” claims
          4. when the management of the debtor continues to operate the business postpetition, it does so as fiduciary of the creditors, known as “debtor in possession”
            1. tasked with managing day-to-day operation of biz
            2. anything outside the scope of ordinary business, such as sale of a major asset, requires approval of the bankruptcy court
          5. chapter 11, creation of “official committee of unsecured creditors”
            1. appointed by U.S. Trustee under the Bankruptcy Code
            2. supposed to consist of the seven largest creditors willing to serve
          6. equity holders are allowed to participate in the process and vote on acceptance of the plan for reorganization in certain cases
      3. The Goal: The Plan of Reorganization
        1. Intro
          1. plan of reorganization is a legal document that discusses what will happen to the debtor, its assets and all constituent liabilities, including equity interests, upon the debtor’s exit from bankruptcy
          2. confirmation of the plan is a pivotal legal event which instantaneously alters, with significent uncompensated loss in most cases, preexisting legal relationships such as lending agreements, leases and other contracts
        2. The Role of Exclusivity and Prefiling Coordination
          1. in cases of significant cooperation, management and creditors may work out a tentative plan and have it readied for a vote before the bankruptcy petition, called “prenegotiated” chapter 11 filing
          2. opposite end of the spectrum, an abrupt filing or one lacking consensus is called “free-fall” chapter 11
            1. often a warning sign that the bankruptcy process may be especially lengthy (1-3yrs) and expensive
            2. may signal the reorganization will involve a change of management, introducing a new element of risk
        3. Content and Structure of the Plan
          1. identifies claimaints and assigns them to classes for purposes of voting and priority
          2. class usually determined by commonality of interest
          3. similarity involves similar priorirty against the debtor
          4. provides for what, if anything, each class will receive in the reorganization
          5. all claims grouped within a class must be treated similarly
      4. Operating Under Chapter 11
        1. Stabilizing Operations
          1. automatic stay freezes all creditors in their prepetition state
          2. grants debtor some “breathing room” and financial flexibility
          3. debtor-in-possession allows a super-priority interest against assets to be granted to postpetition lenders
          4. rollup, conversion of a prepetition claim into a postpetition claim through an offer to become a DIP lender
          5. critical vendor motion occurs when the bankruptcy court allows the debtor to pay critical vendors to allow for the continuance of business
          6. KERP, key employee retention plans are often negotiated
        2. Developing a Going-Forward Business Plan
          1. downsizing the labor force, closing unprofitable facilities, selling noncore lines of business or assets and renegotiating various contracts are typical
          2. making a new acquisition is not common although not technically prevented by the law
        3. Determining the Assets and Liabilities
          1. assets
            1. voidable preferences are transactions and distributions that occurred before bankruptcy filing which need to be unwound
            2. fraudulent conveyance, occurs when a debtor did not receive fair value in the transaction in question and at the time or as a result of the transaction was insolvent
            3. debtor may be seeking assets through ongoing legal actions and complaints
          2. laibilities
            1. executory contract rejection and expunging of unexpired leases
        4. Determining the Valuation and the New Capital Structure
          1. “best interests test”, no creditor should come out with less in a reorganization than they would under a liquidation
      5. Voting on and Confirming a Plan of Reorganization
        1. a solicitation package is approved by the creditors and then sent to all holders of impaired claims and interests
        2. for acceptance, 50% in number of claims representing 66 ⅔% of the amount must vote in favor
      6. Summary
        1. chapter 11 is the result of a failure to reach a consensual restructuring
        2. bankruptcy proceedings are complicated and involve substantial negotiation and gamesmanship
        3. the DDI must gain an appreciation for the other participants and their leverage
        4. secured claims will have greater assurance of recovery but lower return potential
  5. Chapter 5 – Overview of the Valuation Process

Notes – Dying Of Money (#hyperinflation, #crisis, #money, #economics)

Notes – Dying Of Money (#hyperinflation, #crisis, #money, #economics)

Dying Of Money

by Jens O. Parsson, published 1974, 2011

The collapse of a monetary regime

The following note outline was rescued from my personal document archive. The outline consists of a summary of Jen O. Parsson’s classic tale of monetary woe, Dying Of Money. Parrson catalogued two mass inflation events in modern Western history– the German post-war hyperinflation and the US monetary boom of the 1960s and 70s which culminated in the abrogation of the gold-exchange mechanism by Nixon in 1971; both are instructive for different reasons.

Dying Of Money

  1. Prologue: The German Inflation of 1914-1923
    1. The Ascent
      1. “Disastrous prosperity”
        1. old mark had been worth 23 US cents; written off at 1T old marks to one new mark at end of inflation
        2. all the marks in the world in summer of 1922 (190 billion) were not enough to buy a newspaper or tram ticket in November 1923
        3. first 90% of Reichsmark’s real value had been lost before the middle of 1922
        4. inflation cycle: gestation of 8 years, collapse of 1 year
      2. The beginning
        1. summer of 1914, Germany leaves gold standard, runs up debt, prints money in anticipation of WWI
        2. war financed through issuance of new debt (war loans) paid for with newly printed currency
        3. domestic prices slightly more than doubled by the end of the war in 1918, even though money supply increased more than 9x
        4. 1919, Germany sees violent price increases of 17x prewar level
        5. other nations, including WWI victors, stop spending and suffer recession 1920-1921; Germany continues printing and experiences a boom while prices stabilize for fifteen months between 1920 and 1921, money supply doubles again
      3. Benefits of the inflationary boom
        1. Exports thriving
        2. Hordes of foreign tourists
        3. New fortunes minted overnight
        4. Berlin becomes one of the brightest capitals in the world
        5. Great mansions of the new rich in abundance
        6. City life took on a wanton, careless manner
        7. Frugality absent as no one took time to search for real value
      4. Losers of the inflationary boom
        1. Crime rate soared
        2. Unionized workers kept up with inflation while non-unionized fell behind
        3. Salaried and white-color workers lose purchasing power even as unemployment virtually disappears
        4. Total production rose
      5. Paradoxical wealth and poverty
        1. much employment in “spurious and unproductive” pursuits
        2. paperwork and paperworkers abounded
        3. government employment grew, heavy restraints against layoffs and discharges kept redundant employees on payroll
        4. incessant labor disputes and collective bargaining consumed time and effort
        5. business failures and bankruptcies were few
        6. almost any kind of business could make money
      6. Speculative fever
        1. speculation became one of the largest activities
        2. fever to buy and sell paper titles to wealth was enormous
        3. volumes on Berlin Bourse were so high that, even with bloated back-office staff, Bourse was closed several days a week to work off the backlog
        4. capital goods and industrial construction industry experience a boom, many new factories built all while neighboring countries continued using old equipment
        5. M&A, takeovers and proxy fights in vogue
        6. massive conglomerations of non-integrated businesses took place; these businesses and the “kings of inflation” disappeared after the collapse
    2. The Descent
      1. Price increases catch-up with money printing
        1. From July 1921, prices double in next four months and increase 10x through summer of 1922
        2. consumers put on “buyer’s strikes” that are fruitless
        3. interest rates soar as lenders attempt to anticipate inflation
        4. businessmen transact in gold or constant-value clauses or foreign currency
        5. government’s budget deficits close to balance; nonetheless, government is only able to refinance existing debt through money printing
      2. Final moments
        1. July 1922, prices rise 10x in four months, 200x in 11 months
        2. near end in 1923, prices nearly quadrupling each week
        3. prices raced so far ahead of printing that the total real value of all Reichsmarks in the world was smaller than ever
      3. The end of the inflation
        1. August 1923, government of Wilhelm Cuno falls; October 1923, Gustav Streseman made chancellor, given dictatorial powers, hires Dr. Hjalmar Schacht as commissioner of new Rentenmark (“investment mark”)
        2. Rentenmark placed in circulation beside mark with the avowal that Rentenmark’s would not be inflated
        3. Germans believed it, and Rentenmarks supply was held constant
        4. November 15, 1923: final exchange rate, 1T mark: 1 Rentenmark
        5. Government budget balanced by finance minister Dr. Hans Luther
      4. The fallout of the collapse
        1. Schacht orders end of credit from Reichsbank April 7, 1924; credit squeeze ensues; price increases halt
        2. Savings destroyed
        3. Inflationary boom businesses go bankrupt
        4. Credit nearly impossible to get
        5. Unemployment temporarily skyrockets
        6. Govt spending slashed, govt workers dismissed, taxes raised
        7. Working hours increase, wages cut
        8. Millions of voters join Communist and Nazi parties in the “inflation Reichstag” of May 1924
      5. Economic recovery
        1. New elections in December 1924 erase extremist party gains
        2. business recovery based upon foreign loans due to German credit tightening; world depression of 1929 knocks debtor Germany down
    3. Gains and Losses
      1. Debtors: winners
        1. every contract or debt fixed in marks was paid off in worthless marks
        2. Germany’s total prewar mortgage indebtedness, equal to 40 billion marks or 1/6th of total German wealth, worth less than one American cent after the inflation
        3. Savers and owners of mark wealth (bank accounts, savings, insurance, bonds, notes) lose out big
        4. those who borrowed up until the last minute to buy assets turned out to be winners
      2. German Govt: winner
        1. Largest debtor
        2. Entirely relieved of crushing war debt, representing cost of war, reconstruction, reparations and deficit-financed boom
        3. beware being a creditor when the government is a huge debtor
      3. Farmers: winners
        1. always had food
        2. farms were constant values
        3. mortgages were forgiven outright
      4. Foreign owners of marks and other losers
        1. Germany made a profit of 15 billion gold marks, or 40% of annual national product, on sale of paper marks to foreigners, after deduction of reparation payments
        2. Trustees, forced by law to own fixed obligations, lost
        3. Wealthy Germans invested in marks lost
        4. Great charitable institutions wiped out
        5. Banks and insurance companies were weakened but not destroyed (they are both lenders and borrowers)
        6. Sound business survived, but in a weakened state, boom businesses wiped out
      5. Industrial stocks
        1. height of the boom, astronomical P/E ratios
        2. dividends cancelled
        3. stock prices increase 4x from February 1920-November 1921
        4. Stock market crash of December 1, 1921, in the middle of inflation
          1. prices fell by 25% and hovered for 6 mos while other prices were soaring
        5. real value of stocks decline because their prices lagged behind the price of tangible goods
          1. Entire stock of Mercedes-Benz valued at price of 327 cars
        6. near end of 1923, stocks skyrocket again as investors realize that stocks have value even when bonds do not and have a claim to underlying real value
    4. Roots of the inflation
      1. Prices contained by faith
        1. Germans and foreign investors, until 1922 and the brink of collapse, absorbed the Reichsmark
        2. faith was in the idea that an economic giant like Germany could not fail
        3. willingness to save marks kept them from being dumped immediately back into the markets
        4. realization that Germany would not back the money was the moment the dam let loose
      2. Balance of payments
        1. More cheap Reichs flowed out than hard money came in
        2. This despite constantly rising exports and constantly falling imports
        3. payment deficit actually muted price increases by keeping Reichs outside of German markets
        4. Reversal of payments deficits marked the proximity of the end
        5. in collapsing stages, Germany ran a huge payments surplus
      3. Foreign exchange rate
        1. unlike era after WWII, free and uncontrolled “float” of forex
        2. German mark almost always falling and almost always had a lower forex value than its purchasing power within Germany
        3. Thus, forex rate proved a quicker and more sensitive measure of inflation than internal prices
        4. German exports were abnormally competitive on world markets due to forex vs. internal purchasing power discrepancies
        5. Germany lost 10 billion gold marks, or 25% of a year’s national product, on underpriced exports due to inflation
    5. The Great Prosperity of 1920-1921
      1. March 1920-December 1921
        1. prices stable
        2. businesses and stock market booming
        3. exchange rate of mark against $ and other currencies rose for a time, was momentarily strongest in the world
        4. ROW enduring severe recession; Germany envy of the world
      2. Reign of finance minister Matthias Erzberger, June 1919
        1. Raised taxes on capital; real tax yield of 1920 highest of any year from beginning of war to end of inflation
        2. tight money induced for an extended period in late 1919; only time money supply stopped rising for more than a month or so
        3. March 1920, price level was 17x prices of 1914, roughly equal to increases in money supply, new equilibrium reached
        4. Price increases halted for nearly a year, real burden of war debt had been cut by 5/6ths as a result of price increases of 1919
        5. March 12, 1920, Erzeberger exits govt, disgraced after a libel suit, and his pro-inflationary rivals take over
        6. March 1920 is the month prices stop rising, but with Erzeberger’s exit, the boom prosperity begins
          1. prices remain passive
          2. exchange value of Reichsmark rises
          3. stock market rises 3x before crashing in December 1921
          4. Reichsbank doubles over next year into summer of 1921 when price increases catch up
    6. The Lessons
      1. Unrealized depreciation
        1. built upon faith in the German economy to recover
        2. built upon faith in German government to make good on debts
      2. Booms
        1. built upon increasing rates of inflation
      3. Hitler and extremists thrive in wild, inflationary conditions
        1. Hitler’s putsch was in the last and worst month of the inflation
        2. totally eclipsed when economic conditions improved
        3. took power through elections during another economic period of trouble
        4. middle class voters wiped out in the inflation moved to the extremes in polling, bolstering Hitler and others
  2. ACT ONE: The Rise of the great American Inflation
    1. The War
      1. Dollar lost 70% of its value from 1939-1973, prices rose 3.5x
      2. Seven years of WWII, Federal debt increased to $269B
        1. 1/4th greater than the annual gross product of the country at that time
        2. money supply grew by 3.5x between 1939 and 1947
        3. June of 1946, prices had increased by less than half from 1939
          1. price controls
          2. new money was absorbed by the issuance of war debt rather than bidding for consumer goods
          3. many saved money during the war for “safety” rather than spent it
          4. low money velocity resulted
        4. real value of dollar at the end of the war was 2/3rd what it had been at start of war
        5. government stopped inflating, allowed price increases to reach new equilibrium
      3. Prices controls end 1946
        1. prices double from levels in 1939 in two years
      4. Money supply held stable 1947-1950; prices remain stable as well
        1. economic recession 1949
      5. Comparisons: German war inflation vs. US war inflation
        1. American war debt of $269B, about 1.25x annual national product; Germany 153B marks, about 1.5x annual national product
        2. American monetary inflation, 3.5x; German 25x
        3. American price inflation 2x; German 17x
        4. Ratio of monetary to price increases about the same, 60%
    2. Grappling with Stability
      1. Korean War, 1950
        1. Federal budget did not run a deficit fighting the war
        2. money supply increases by 16%; prices increased 13%
      2. Eisenhower administration
        1. money supply increased 1% per year on average from 1953-1962; wholesale prices never vaired +/-1% from 1958-1964
        2. “monetary oscillations”
          1. 1953-1954, money growth <1%, recession
          2. 1954-1956, money growth 3.9%pa, boom and price inflation
          3. 1957, money supply contracts, followed by recession
          4. 1958-1959, inflation
          5. 1959-1960, contraction
          6. 1961, inflation
          7. 1962, contraction
    3. The Great Prosperity of 1962-1968
      1. intense monetary inflation beginning 1962
        1. 4.6% per annum for 43 months (through April 1966)
        2. 7.2% per annum for 27 months (January 1967-April 1969)
        3. total inflation over seven years was 38%, interrupted only by the 9month period of no expansion in 1966, accompanied by stock market collapse and economic recession by no effect on prices
        4. combined with an investment tax credit of 7% for businesses to spend on new capital assets, leading to exaggerated investment boom
        5. prices did not keep up, leading to “unrealized price inflation”, despite rising at nearly 5% per annum for the seven year period
    4. The Inflationary Syndrome
      1. economic effects from 1962-1968
        1. gross national product increased $360B, or 7% per annum, compared to 4.8% per annum during Eisenhower years of 1955-1960
        2. unemployment continually decreased
        3. stock market was almost constantly rising for more than 6 years
      2. speculative effects
        1. high stock market volumes, huge capital gains appreciation, large paper profit generation
        2. conglomeration and merger of big business
        3. most wage growth in the speculative class of paper-pushers
        4. overinvestment in capital goods
        5. IBM, Xerox (back-office service/goods companies) were the investment darlings of the era
        6. overproduction and stimulation of the growth of educational and legal industries
      3. foreign exchange and the balance of international payments
        1. current account deficits are a symptom of inflation
          1. when there is excess money in one country it flows out to other countries
          2. the currency in the inflationary country is overpriced relative to world markets, so it goes out and buys imports
        2. current account deficits reduce price inflation in the inflationary country because the currency bids up prices in foreign rather than domestic markets
        3. dollars held by foreigners returning to the US at the point that the current account turns to a surplus, would result in price inflation in the US
  3. INTERLUDE: The General Theory of Inflation
    1. Prices
      1. prices in aggregate are determined by total amount of money availble for spending in a given period of time, in relation to total supply of all values available for purchase with money in that period of time
      2. money supply defined as that which people use to buy things of value with, but which is not a thing of value itself (dollars, coins, checking account deposits)
      3. money available per unit of time, aka money velocity, also a factor, but it is hard to measure or determine
      4. price level = money quantity x money velocity / supply of all real values
      5. this is the quantity theory of money
    2. Real Values
      1. in an inflation, there are many “spurious values” which disguise and conceal the inflation of prices of real values
      2. real wealth consists of land, resources, productive plant, durable goods and people
      3. paper wealth is not real wealth; money wealth is debt, including money contracts such as bonds, mortgages, debentures, notes, loans, dposits, life insurance and pension obligations
      4. debt does not represent the direct ownership of any real assets but rather subdivision of interests in real assets with the direct owners of the assets
        1. for ex, a man is not part of the total supply of real capital as he can not be bought and sold
        2. however, if this man borrows money, he subdivides ownership of his future productive power and adds himself to the supply of capital assets
        3. if he borrowed from a bank which borrowed from a depositor, further subdivision has occured
        4. government debt represents a “lien” on the part of the productivity of all citizens
      5. this multiplication and stratification of paper wealth can be increased to many times the size of the real existing wealth
      6. paper wealth structure is all built on faith– issuance of new paper wealth does not result in an increase in real values by itself
    3. Government Debt
      1. issuance of government debt increases supply of paper wealth, meaning it is price deflationary
      2. when Fed wants to tighten money, sells govt debt into market, reducing prices
      3. large issues of government debt could not be marketed without a large increase in the supply of money beause they’d drive interest rates upward– precisely what govts don’t want; therefore, they’re almost always accompanied by money printing
      4. government surplus is price inflationary; if it is used to pay down debt, it reduces the supply of outstanding values and raises prices
      5. when faith in government debt fails, price inflationary effects will be amplified
    4. Interest
      1. lenders accepted negative real rates only because they didn’t realize what they were doing
      2. “the announced intention of Keynesian economics was to effect [the holder of money’s] extinction”
      3. the rich tend to be net debtors in an inflation
      4. inflation is paid for by the lower classes and the creditors
      5. an attack on interest results in a flight from debt to equity, from money wealth to equity/real values
    5. The Economics of Disaster
      1. occurs when the holders of money wealth revolt
      2. duller the holders of money are, the longer price inflation can be kept at bay by govt, though the greater will be the eventual breaking of the price dam
      3. desertion of money resembles a panic, sudden and unexpected
      4. people’s ability to discern real and spurious values suddenly becomes acute
      5. people flee paper assets and goods and services for known value like food and land
      6. no government causes collapse, “when at least it sees the choice, it has no choice”
  4. THE LAST ACTS: The American Prognosis
    1. Act Two, Scene One: President Nixon Begins
  1. Treasury reduces expenditures and attempts to balance budget, July 1969- June 1970
  2. Fed drops inflation rate in May of 1969 from 8%, 1yr later approx 3.8%
  3. Stock market prices fall by 14% within two months of May 1969, another year later down 31 percent; interest rates rise into spring 1970 credit crunch
  4. Approaching two year mark to next election, government begins pumping money again
    1. August 1970, budget deficit plungs to new peacetime lows
    2. money inflation of 6.5%
    3. interest rates plunge, stock market soars
  • Act Two, Scene Two: Price Controls and Other Follies
    1. worst inflation since the end of WW2 and before 1967
    2. economic boom into Nixon’s re-election in 1972
    3. boom quickly wears off
      1. stock market falls
      2. interest rates rise to surpass peaks of 1970
      3. price inflation worse than ever, around 4%
      4. cheap dollar floods world markets
    4. Nixon announces Phase I of price controls, August 15, 1971
      1. detaches dollar from gold
      2. 10% import surcharge
      3. excise taxes on automobiles removed
      4. wage and price controls
  • Self-Defense
    1. No sure safety, safety will change fluidly through an inflation
    2. Best hope is to lose as little as possible
    3. fixed money wealth/debt is the absolute worst investment in an inflation
    4. foreign money can be safe refuge only if the foreign government inflates less wildly than the domestic government
    5. the author shits on gold, but with no reason other than an arbitrary one because he is a Keynesian– gold may be overvalued during and even before and inflation but so long as people continue to think it is money, it can hold some value
    6. real estate provides a shelter for REAL value (useability/liveability/productivty of land) but could be harmed in terms of investment value in an inflation
      1. real estate held in high esteem by inflationary prosperity (luxury dwellings, overblown commercial developments) may lose more real value than other investments as they started out overpriced in the inflation
    7. farmland is a special category of real estate
      1. produces what people must have, inflation or no
      2. farmers thrive and farmland excels in dying throes of every inflation
      3. less prosperous in early stages of an inflation
    8. hoarding of useful goods is a possibility, but has large storage, distribution and opportunity costs prior to an inflation
  • Self-Defense Continued: The Stock Market
    1. stock shares are pieces of paper, but they are claims on real assets and real wealth
    2. stock market is incredibly liquid
    3. common stocks provide returns in first madness of an inflation, then fall into disrepute in middle stages of an inflation
    4. a booming stock market is not necessarily part of an economically healthy nation
      1. the opposite is truer: booming stock market is a signal of inflation
      2. falling stock market is a sign of returning to reality
    5. the stock market as a whole rises due to inflation and nothing more
    6. the stock market declines on a weakening of inflation
    7. general business conditions and price inflation operate on a lag; when money is first printed it has nowhere to “work” and goes into investment markets
      1. markets rise while business is still bad
      2. later, as money moves out of the market and into businesses, the market falls
      3. when business is worst, stock markets rise; when business is best, stock markets fall
      4. rising stock market signals nothing but fresh money inflation– it is the earliest and most sensitive signal
    8. stocks bought at any price above their real-value bottom are not a hedge against loss but a guaranteed loss
    9. conversely, stocks bought at real-value bottoms have a good chance of holding their values through an inflation
    10. American stock market’s deflated bottom in 1970 was 43% higher than deflated bottom in 1962, just as money supply in 1970 was about 43% higher than in 1962
    11. as other prices outpace stock market rises (or even stock market decreases), fear can take over that the businesses will not be worth anything; but faith will pay off with real value nearly the same at the end of an inflation
    12. stock markets can enjoy inflated gains if there are laws in place forbidding the inflationary money to bid up prices elsewhere or in foreign markets
    13. the stock market represents real value, but not every stock does
    14. inflationary times tend to reward the most valueless stocks; use a “post-inflationary eye” to have a look around at what might actually survive the inflation in terms of real value
    15. “Attempting to make profits from the stock market, or even to make sense of it, without completely understanding the universal determinant of inflation was like being at sea among uncharted rocks and shoals without so much as a tide table.”
  • A World of Nations
    1. Virtually all of the entire growth of Federal debt after 1967, $55B, was involuntarily financed and acquired by foreigners
    2. by 1973, foreigners’ holdings of liquid dollar debt had risen to $90B from $31B in 1966
    3. America exported inflation; other nations imported it– this is the balance of payments deficit
    4. natural consequence of an inflation, surplus money must flow outward looking for “cheap” items to buy abroad
    5. 100% beneficial to the deficit country
      1. import real value from abroad while exporting worthless paper
      2. price inflation domestically is partially contained
    6. central bankers began a game of printing up new local currency to exchange with the inflowing dollars, sending the dollars back to the US where they would be recycled and re-exported
    7. exchange rates operate on a time lag
      1. first, the internal price level is too low, so the new currency flows out to the rest of the world
      2. then, the internal price level rises, drawing in currency from the rest of the world
    8. the best defense against another country’s inflation, is inflation

Notes – One Up On Wall Street (#peterlynch, #gaarp, #tenbagger, #stocks)

Notes – One Up On Wall Street (#peterlynch, #gaarp, #tenbagger, #stocks)

One Up On Wall Street

by Peter Lynch, published 1989, 2000

The Final Checklist

The following note outline was rescued from my personal document archive. The outline consists of a summary of Peter Lynch’s classic contrarian/growth investing book, One Up On Wall Street. The notes are a series of checklists to go through when considering Peter Lynch’s various stock categories.

Stocks in General

  • The P/E ratio; is it high or low for this particular company and for similar companies in the same industry?
  • Institutional ownership percentage; the lower the better
  • Whether insiders are buying and whether the company itself is buying back its own shares. Both are positive signs.
  • The record of earnings growth to date and whether the earnings are sporadic or consistent
  • Whether the company has a strong balance sheet (debt to equity ratio) and how it’s rated for financial strength
  • The cash position; net cash per share can place a floor in the price of the stock

Slow Growers

  • Are dividends always paid and are they routinely raised?
  • Percentage of earnings paid out as dividend; a low number provides a cushion and protects the dividend in hard times

Stalwarts

  • These are big companies that aren’t likely to go out of business. The key issue is price, and the p/e ratio will tell you whether you are paying too much
  • Check for possible “deworsifications” that may reduce earnings in the future
  • Check the company’s long term growth rate, and whether it has kept up the same momentum in recent years
  • If you plan to hold forever, see how the company has fared during previous recessions and market drops

Cyclicals

  • Keep a close watch on inventories and the supply-demand relationship; watch for new entrants into the market which is usually a dangerous development
  • Anticipate a shrinking p/e multiple over time as business recovers and investors look ahead to the end of the cycle, when peak earnings are acheived

Fast Growers

  • Investigate whether the product that’s supposed to enrich the company is a major part of the company’s business
  • What the growth rate in earnings has been in recent years
  • That the company has duplicated its successes in more than one city or town, to prove that expansion will work
  • That the company still has room to grow
  • Whether the stock is selling at a p/e at or near the growth rate
  • Whether the expansion is speeding up or slowing down
  • That few institutions own the stock and only a few analysts are covering it

Turnarounds

  • Most important, can the company survive a raid by its creditors? How much cash does the company have? How much debt? What is the debt structure and how long can it operate in the red while working out its problems before going bankrupt?
  • If it’s bankrupt already, what’s left for the shareholders?
  • How is the company supposed to be turning around? Has it rid itself of unprofitable businesses?
  • Is business coming back?
  • Are costs being cut? If so, what will their effects be?

Asset Plays

  • What are the value of the assets? Are there any hidden assets?
  • How much debt is there to detract from these assets?
  • Is the company taking on new debt, making the assets less valuable?
  • Is there a raider in the wings to help shareholders reap the benefits of the assets?

Notes – The Aggressive Conservative Investor (#valueinvesting, #controlinvesting, #martywhitman)

Notes – The Aggressive Conservative Investor (#valueinvesting, #controlinvesting, #martywhitman)

The Aggressive Conservative Investor

by Marty Whitman, published 1979, 2005

A seeming contradiction in terms

The following note outline was rescued from my personal document archive. The outline consists of a summary of Marty Whitman’s classic value investing tome, The Aggressive Conservative Investor.

Chapter 1, An Overview

  1. Two main types of investors
    1. passive, outsider investors
      1. no control over the management of their investments
      2. no knowledge of the investment other than what is publicly disclosed
    2. activist, insider investors
      1. have control over the management of the investments
      2. privvy to non-public information and disclosures
  2. Two major types of businesses which require two different kinds of analysis
    1. strict, going-concern
      1. large, stable institutions which tend to sell the same product and finance the selling of it in similar ways over time
    2. asset-conversion firms
      1. merger/acquisitions
      2. the purchase and sale of assets in bulk
      3. major financial restructurings or recapitalizations
      4. sales of control or contests for control
      5. creation of tax shelter entities
  3. Key emphasis is placed upon financial position
    1. ability to create liquidity (from cash or from liquid assets)
    2. ability to borrow
    3. ability to generate surplus cash from operations
    4. ability to market new equity securities
  4. In contrast, conventional fundamental analysis focuses on primacy of earnings
    1. reported earnings are a fundamental determinant of stock price
    2. this primacy of earnings theory is emphasized only in special circumstances where the company is a strict going concern or when its securities are being studied via day to day share price fluctuations
    3. most securities holders are not stock traders
    4. most businesses are not strict going concerns
    5. financial position reveals itself to be a better long-run determinant of valuation because it more fully represents the character of the underlying business
  5. Concerned with fundamental rather than technical analysis
  6. What is a security?
    1. investment vehicle which allows the holder to benefit from an inactive creditor or owner role
    2. examples: common stocks, preferred stocks, bonds, leasehold interests, limited partnership participations, savings-bank deposits and commercial paper
    3. example of a non-security: fast food franchise agreement which requires the owner to participate as manager as part of the agreement
  7. Understanding the underlying business becomes increasingly important as larger amounts of funds or increasing proportions of the individual’s resources are invested in a security
  8. Additionally, understanding the business is increasingly important with diminishing seniority within the security hierarchy, which exposes the investor to increasing risk
  9. The book takes a broad perspective on the strategies and perspectives of numerous types of investors because understanding the motives of others can highlight specific opportunities and risks for the individual investor himself
  10. Emphasis is on “business internals” rather than market and economic externals
    1. most individuals have little ability to predict the latter
    2. keen awareness of the former can remove a lot of the risk from the equation and protect the investor from mistakes made about the latter
  11. Disagree with modern capital theorists
    1. most markets and common-stock prices are in disequilibrium
    2. careful and thorough perusal of publicly available documents can guard the individual from unsystematic risk
  12. Underlying conviction that the value of a business has no necessary relationship to the price of its stock
  13. The primary determinant of future earnings and common-stock prices is financial position; quality and quantity of a business’s resources
  14. “Magic formula” for investment success is not arithmetic but grows out of:
    1. experience
    2. insight
    3. maturity of judgment
  15. Three general topics covered by the book:
    1. educate outside investors about the way insiders and deal promoters tend to think
    2. help the outsider to gain familiarity with the uses and limitations of required disclosures of the SEC
    3. attempt to impart understanding about the roles of the various players in the financial community and how they each participate in the investment process
  16. Focus on four types of investments to be made in commercial paper, corporate bonds, certain leases, preferred stock, limited partnership interests and common stocks:
    1. trading investments
    2. investments in the securities of emerging companies or industries
    3. workout and special-situation investments
    4. cash-return investments

Chapter 2, The Financial-Integrity Approach to Equity Investment

  1. Successful investors-activists prioritize their concerns as the potential issuer of a loan would:
    1. First, how much can I lose?
    2. Second, how much can I make?
  2. Strong financial positions generally translate to:
    1. less risk
    2. greater ability to expand business
    3. more attractive candidate for asset-conversion activities
  3. Attractive equity investments for outsiders should have the following characteristics:
    1. strong financial position, measured not so much by presence of assets as by the absence of significant encumberances
    2. run by reasonably honest management and control groups that are aware of the interests of creditors and other security holders
    3. availability of a reasonable amount of relevant information, necessarily falling short of “full disclosure”
    4. price out to be below the investors reasonable estimate of net asset value
  4. Primary motivation for buying is that values are “good enough”, no search for bottoms in the short-run
  5. Shortcomings of the Financial-Integrity Approach
    1. requires an enormous amount of work; sifting through documents
    2. know-who is helpful and at times essential; special information discernible only from non-public relationships
    3. the most attractive securities uncovered by FIA tend to be in inactive markets, especially postarbitrage
    4. risk aversion results in a severely limited selection of attractive securities which might be fully enjoyed by the less risk-averse
    5. securities issued by those believed to be “predators” should be avoided
    6. FIA approach is mostly useless in areas where sufficient public disclosure can not be obtained
    7. insiders sometimes pose a risk to outsiders and because of their ability to force-out outsiders and independently appraise values, some attractive opportunities will be avoided by the FIA adherent
  6. FIA view of risk
    1. quality of the issuer
    2. price of the security
    3. financial position of the holder

Chapter 3, The Significance of Market Performance

  1. Stock market value should be weighted differently for different individuals
    1. traders; 100% because they are trading for capital appreciation
    2. investors seeking secure income; 0%, because they may want to acquire a larger position over time at lower prices
    3. vast majority of people; somewhere considerably more than 0 and considerably less than 100
  2. Investors who do not weight stock prices as 100% important:
    1. investors who would benefit from low market valuations for estate tax or personal-property tax purposes
    2. investors primarily interested in maximizing cash return and/or are continually creating cash for new investment from noninvestment sources
    3. investors seeking to accumulate large positions for control or to influence control shareholders
  3. One can not beat the market by trying to beat the market; instead, long-term performance comes from buying clear values and holding them in the absence of clear evidence that a mistake has been made
    1. evidence for this mistake comes in the results of the business, not the market’s valuation of the business
  4. Market performance is more important to a portfolio of fixed size or facing continued withdrawals of cash; less important to a portfolio which is a continual recipient of new cash and is thus a dollar-averager
    1. for the dollar averager, good market perf results in less attractive terms for continued investment, bad market perf leads to more attractive terms for continued investment
    2. dollar averaging diminishes the need to beat inflation because changes in the value of money, in the long-run, will be offset by changes in the return on securities
    3. example; a well-run fire and casualty insurance company, which receives continuous cash injections from underwriting department
  5. An outside investor holding a completely marketable security should give a weighting of close to zero to market perfomance when:
    1. he knows has reason to believe that the security’s real worth is not close to the market price
    2. he knows he will not need to liquidate in the near future
    3. he knows he will not need to use the security as collateral for borrowings
  6. Important to remember that stock market prices are not business or corporate values but a realization price that will likely not hold in the event of a merger or acquisition; market price is a value of only part of the total outstanding, not all outstanding stock
  7. Comparative measures of portfolio performance are imprecise; a company can beat its industry benchmark but still have performed poorly in an absolute sense, or vice versa
  8. Professional money managers and beating the market
    1. some economists believe that the goal of professional money mgrs is to beat the market and they have failed if they don’t
    2. many professional mgrs have other concerns than simply beating the market:
      1. maintenance of cash income
      2. maintenance of cash principal
    3. for example, is it important that a strongly capitalized insurance company outperform the market when its net investment income is increasing at 10% annualized?
  9. Investors seeking “bailouts” from their investments might weight market performance low
    1. control of a company can allow for control over cash bailouts through dividend policy, mgmt of salaries and fees
    2. control of a company can allow for nonmonetary bailouts via three P’s
      1. power
      2. prestige
      3. perquisites
  10. Three types of security holders who rate market performance highly, seeking “bailout” in the market:
    1. common stock holder with minority interest in which dividend income is insignificant or not part of the objectives
    2. control stockholder and company seeking to sell securities or issue them in merger and acquisition transactions
    3. holder without a strong financial position; someone who intends to borrow or has borrowed heavily to finance his portfolio

Chapter 4, Modern Capital Theory

  1. Description of MCT and efficient portfolios
    1. an individual knows how he reacts to risk and must choose from stocks, bonds and cash
    2. he evaluates each instrument accurately in terms of risk, expected return and relative valuation/price movement
    3. assuming all assumptions are accurate, the individual creates a portfolio that provides the largest expected return for a given level of risk
    4. this best describes the environment faced by the stock trader
    5. this theory failes to account for thin markets, price formation mechanisms, nonsymmetric information and general equilibrium considerations
    6. this theory is not sutiable for outside investors primarily interested in income, dollar averaging or special-situation investors who ignore timing considerations, as well as all activist investors
    7. MCT also assumes the avg outside investor and his adviser are capable and able to interpret information correctly; empirical evidence points to the opposite
  2. The computer and mathematical analysis
    1. the fatal flaw of mathematical analysis is the non-quantifiable variables or ugly facts that get left out of the models assumptions
  3. On systems for playing the market
    1. Chartist-approach
      1. Not necessarily irrational or illogical
      2. Movements of the market do represent aggregate behavior, however, to date no truly successful chartist model has been created
    2. Random-walk theorists
      1. at any instant, price changes follow no predictable pattern
      2. using only trading information, there is no predictability to prices
    3. filtering rules or formula-timing
      1. best that can be said is their mechanical application can save investors from getting suckered into go-go markets or being rushed out the exits by mass panic
  4. On arbitrage
    1. topic for a professional, requires plenty of calculation and minimization of trading costs (should be a member of an NYSE firm)
    2. Thorpe and Kassouf’s book is recommended
  5. Portfolio balancing
    1. “Beta” is the estimated market sensitivity of a stock, measured in terms of an expected incremental percentage return associated with a one percent change in return of the S&P500
    2. For the avg investor, problems occur far more often with security analysis than portfolio selection
    3. Most important for someone running many millions of dollars; for everyone else, this is over-rated; all the best portfolio-balancing in the world won’t save you from poor analysis
  6. Fundamental security analysis and corporate finance
    1. Good fundamental analysis involves perception, training, understanding and a high degree of abstraction in implicit or explicit model building– picking the right variables and causal relations
    2. There are far fewer skilled practitioners than there are opportunities to practice security analysis
    3. The idea that fundamental analysis is not necessary because markets are efficient is flawed because most analysts are incompetent, which prices ultimately reflect
  7. Calculation or evaluation
    1. The problem facing any serious analyst is what the figures mean, not what they happen to be
    2. For example, imagine a company carrying real estate on its books at $1.5M; the significance changes when we learn that they represent 100,000 acres of California coastal land carried at the 1880 purchase price
    3. Valuations change depending upon the context of valuation; estate planning, income taxes, obtaining a loan, etc. all produce different valuations of the same entity

Chapter 5, Risk and Uncertainty

  1. The outsider faces greater risks than the insider
    1. he cannot acquire complete knowledge of a company, no matter how many documents he studies
    2. he (and the insider) face the possibility that the analysis is wrong
    3. he may fail to properly appraise the quality and honesty of the management
    4. he may simply fall prey to the unpredictability of the future
    5. the market may fail to realise intrinsic value for extended periods of time, even if the analysis of those values is correct
  2. Assessing the investment odds: risk and reward
    1. conventional wisdom states that the key to investment risk is the quality of the issuer
    2. high quality issuers tend to be well-known, and this knowledge is reflected in asset prices
    3. therefore, the cliche, “You have to take chances if you want to make money”
    4. but financial position of the security holder and the price of the issue are also important factors in judging risk and reward
  3. Quality of the issuer
    1. A company can become high quality just because important people within the investment community say it is; they’re often proven wrong
    2. never buy when a high quality company is being touted because it is probably overpriced then
    3. if your investment matters to you, obtain at least a rudimentary knowledge of the company before investing
  4. Price of the issue
    1. Good investors focus on how much they can lose; “risk averse”
    2. higher price translates to higher risk, lower price, lower risk
    3. there can be considerably lower risk investing in a lower quality company at a lower price than at a higher quality company at a higher price
    4. an investor with more time and expertise to spend on his analysis should weigh price considerations more heavily; an investor with less time and less expertise should weigh quality considerations more heavily
  5. Financial position of the holder
    1. an investor who buys the best quality stock at a fraction of its overall value is taking a significant risk if he can’t afford the purchase
    2. investors on margin can turn high quality investments (such as USTs) into speculative gambles
    3. investors often take losses when they do not have enough funds to live on and are forced to liquidate at an inopportune time
    4. without the resources to ignore them, an investor has no guard against stock-price fluctuations
  6. Portfolio diversification versus securities concentration
    1. diversification is a way to reduce risk in situations where the investor lacks knowledge
    2. in situations where the investor enjoys enough knowledge, confidence and financial position to weather temporary setbacks, the risk-reward ratio may be tipped in favor of concentration
  7. Considering the consequences
    1. The astute investor examines consequences as well as odds
    2. The odds can be strongly in favor of appreciation/success, but the consequences of failure so severe (insolvency) that the risk-reward ratio is still not in favor of making an investment
  8. Risk and investment objectives
    1. The cash-return investor will base his investment decision on different factors in evaluating risk than the special-situation investor, even when using the same facts
    2. Risk-reward ratio will provide the investor with a guide to use in defining his investment objectives
    3. Cash-return investors with no opportunity to investigate carefully should focus primarily on quality of the issuer
      1. reference bond rating services
      2. reference the investors own independent conclusions
      3. any doubts, don’t invest; sell if owned
      4. should limit investments to debt securities in most instances
        1. debt securities have a legally enforceable right to be paid principal and interest
        2. higher up in the capital structure in the event of an insolvency
    4. workout- or special-situation investor should focus on price of the issue
      1. he finds safety in a low price
      2. place important emphasis on the four elements of the FIA

Chapter 6, Following the Paper Trail

  1. Principle documents of the paper trail:
    1. Form 10-K; official annual business and financial report
    2. Form 10-Q; quarterly financial report, includes disclosures of certain material and extraordinary events that occurred during the three-month period
    3. Form 8-K; filed within 15 days of a reportable event, unscheduled material events or corporate changes
    4. Annual reports; most important way most public companies communicate with shareholders
    5. Quarterly reports
    6. Annual-meeting proxy statements; used to solicit votes of shareholders
    7. Merger proxy statements; issued to shareholders to vote on an asset conversion-matter such as merger, consolidation, sale of assets or liquidation (S-14)
    8. Prospectuses; registration statements issued when securities are being offered publicly (S1 & S7)
    9. Cash tender offer circulars; sent when a publicly announced offer is made to buy shares for cash
    10. Encumberances are almost always spelled out in these documents and their footnotes
  2. The documents and how to read them
    1. Simply reading these documents will give you a good idea of whats contained within and what their use is
    2. If you can obtain copies of the preparation documents used to create the SEC officially regulated forms, you can get an idea of what the preparer has to consider in making disclosures
    3. Other important documents
      1. Forms 3 and 4; disclosure by insiders concerning their shareholdings and changes in holdings
      2. Form 144; filed by holders desiring to sell restricted stock under Rule 144
      3. Form 13F; filed by all managers with accounts of marketable equity securities greater than $100,000,000
      4. Schedules 13D; filed within ten days by persons who have acquired 5 percent or more of an outstanding security issue (or, who acquire an additional 2 percent within a 12 month period after already acquiring 5 percent)
      5. Schedules 14D; similar to 13D, filed prior to making a cash tender offer for more than 5% of shares outstanding
    4. What the paper trail doesn’t do
      1. does not provide company forecasts, company budgets and valuation appraisals of assets
      2. no real disclosure as to specifics of running the business, such as appropriate levels of capital expenditure, marketing, research and development, etc.
      3. might miss small acquisitions that do not require a shareholder vote

Chapter 7, Financial Accounting

  1. Types of accounting
    1. cost (or control or managerial)
      1. purpose is to tell a management what its costs are
      2. internal, essential to the operation of the business
    2. income-tax
      1. not supposed to measure economic reality, unlike cost-accounting
      2. designed to create an economic reality (tax bill) based on rigid set of principles (Internal Revenue Code)
      3. emphasis is on minimizing tax exposure
    3. financial
      1. sandwiched between cost accounting and income-tax accounting
      2. “primary purpose is to provide quantitative financial information about a business enterprise useful to owners and creditors”
      3. seeks to “fairly” represent the results of operations and the financial position of the company
  2. How to understand financial accounting, five major misconceptions:
    1. no need to distinguish between financial accounting versus income-tax and cost accounting
    2. financial accounting has much the same role in corporate analysis and in stock market analysis
      1. primary emphasis in corp analysis is on what numbers mean, not what they are
      2. in corp analysis, no rule that one accounting number is more important than any other; in stock market analysis, primary emphasis tends to be put on net income/earnings per share
      3. in corp analysis, profit is thought to come from the business factors themselves; stock market analysis, profit comes from what one thinks someone else will pay for the security later
      4. because stock market analysis doesn’t rely on deep understanding of the underlying business, value is sought elsewhere– in precise attainment of estimated numbers
    3. accounting can be made distortion-free an/or realistic and/or uniform
      1. financial accounting is based on Generally Accepted Accounting Principles
        1. an attempt is made to match revenues with costs on an accrual basis to the exclusion of matching cash inflow with cash outflow
        2. an attempt is made to view businesses on a going-concern basis
        3. financial-accounting is primarily based on exchange prices
        4. financial-accounting is primarily based on historical costs
        5. financial statements are designed to be general-purpose, “serve the common needs of a variety of groups”
      2. as a result, financial-accounting can not be distortion-free, realistic or uniform
      3. financial-accounting is more useful at measuring the economics results and values rather than the solvency of a business
        1. more useful for judging a strict going-concern
        2. less useful for a natural resource company, real estate or life insurance companies or companies engaged in mergers, acquisitions and imaginative financing and refinancing
        3. as an example, most high quality real estate that is well-maintained doesn’t depreciate over time, but it has to for tax and accounting purposes
    4. about the meanings of GAAP
      1. inter-industry distortions arise based upon calling similar circumstances “permanent differences” or “timing differences”
    5. about the shortcomings of the corporate audit function and the ethical standards of independent auditors in the US

Chapter 8, Generally Accepted Accounting Principles

  1. Myths and realities about the meaning of GAAP
    1. Myth #1; GAAP tends to, or ought to, be rigidly codified with a series of well-articulated do’s and don’ts
    2. Myth #2; GAAP is all-encompassing and is, or should be, designed to measure all sorts of corporate events and phenomena
    3. Myth #3; GAAP should tell the Truth, that somehow it can be made more realistic for average investors while still becoming more informative and more useful for all of its users
  2. Eleven underlying assumptions of GAAP which provide insights into its uses and limitations:
    1. ownership of, that is, title to, tangible assets is the basis of value and the means of creating income
      1. ignores the value of intangible assets, such as lack of debt or ability to create new debt, advantageous debt terms, price at which new equity can be raised, etc.
      2. some other intangibles:
        1. long-term, favorable (or unfavorable) contracts with key employees, customers and vendors
        2. trade names and patents
        3. distribution channels, such as dealer organizations
        4. manufacturing know-how
        5. licenses to do business
        6. tax-loss carry-backs (worth cash) and tax-loss carry-forwards
      3. GAAP becomes increasingly less descriptive when intangibles play a larger role in creating value and income
        1. GAAP provides good benchmarks to value the output of a steel mill, for example
        2. GAAP does not provide good bench marks for valuing the worth of a medical degree
    2. corporate asset items have independent values unmodified by their inclusion as but one small part of a going concern
      1. as a practical matter, few assets of a going concern have value that is independent of the going concern
      2. independent values exist only in asset-conversion
      3. passivity and liquidity are highly interrelated; more liquidity means less responsibility in administering the asset
    3. changes in accounting rules should not be disruptive of important existing practices unless there is conflict among establishment members
      1. GAAP is an establishment tool and its basic purpose is to aid, not to fight or alter, an existing economic system
      2. changes should be expected to be evolutionary, not revolutionary or radical
    4. a puritan work ethic is desirable; hence achievement through going-concern operations are far more desireable than achievements through asset conversions– mergers and acquisitions, reorganizations or refinancings
      1. profit should be created from going-concern operations, not capital appreciation through asset arbitrage
    5. the medium is the message
      1. immediate stock market impact is what financial statements are directed to
    6. precise definitions are a desireable goal
      1. as much as possible, items should be defined as expense or income, liability or proprietorship
      2. except for insurance-company accounting, no recognization that many items (deferred income taxes, unexpired subscriptions, low-interest rate mortage loans, etc.) have elements of both expense and income, or liability and proprietorship
    7. GAAP is designed primarily to protect the cash buyer of securities
      1. great bulk of cash buyers of corporate securities are lending institutions– banks, insurance companies, pension trusts and finance companies
      2. GAAP tends to explain “how bad things are if you give up your cash for this security”
      3. GAAP is less suited to explain how a holder of equity securities will fare when asked to give them up for cash or other securities, such as in an acquisition or merger
    8. security holders tend to be monolithic: all have the same interests
      1. GAAP assumes all stockholders are interested in the price of the stock they own
    9. per-share market prices are per se important and are the single most significant indicator of the value of entire businesses
    10. in classifying assets or liabilities, physical substance and legal substance are deemed to be more important than economic substance
      1. often noncurrent, fixed assets are highly liquid due to their being subject to asset-conversation activities
      2. similarly, many current assets are locked up as part of the operation of the going-concern and are not liquid or marketable
    11. there is a basic identity of interests between a company and its various stockholder groups
      1. much more realistic to consider the relationships between company and stockholders and stockholders vs. stockholders as combinations of communities of interest and conflicts of interest
  3. Myths about the shortcomings of the corporate audit function and the ethical standards of the US independent audting profession
    1. most speculative bubbles have been in industries or issues where GAAP is either nonexistent or of little significance in appraising a business or stock

Chapter 9, Tax Shelter (TS), Other People’s Money (OPM), Accounting Fudge Factor (AFF) and Something Off the Top (SOTT)

  1. Tax shelters
    1. people try to avoid maximum rates
    2. people try to avoid being unable to control the timing of a tax liability
    3. people try to avoid transactions that produce a taxable event but not the cash to pay for it
  2. Other People’s Money
    1. OPM is different in different situations
      1. banks, it is depositors’ money
      2. AmEx, it is paid but not cashed traveler’s checks
      3. insurance company, it is premiums paid
    2. OPM can be used to enrich an opportunistic promoter at little to no cash cost to himself
    3. OPM is dangerous for common-stock investors
      1. hard to predict the short- to intermediate-term price activity
      2. danger of loss where there is a lack of positive cash-carry (cash income on investment exceeds cash interest costs of loan)
  3. Something Off The Top
    1. insiders view outsiders SOTT as having a free ride; enjoying the profits of a company without doing the work
    2. insiders themselves enjoy SOTT through special information access, nice offices, special opportunities through business relationships and contacts, opportunities to buy cheap stock and PPM (power, prestige, money)
    3. control can often be a negative in the event of a company being “sick”; in this case, being an outsider is SOTT
    4. a general rule for public investors is to avoid companies whose mgmts have general disdain for outsiders and try to claim SOTT at their expense
  4. Some preliminaries on the Accounting Fudge Factor (AFF)
    1. there is no “right” way to account for things
    2. are you a senior lender, a common stockholder or the president of the company, etc?
    3. are you interested in cash returns, the build-up of intrinsic value, the price of the stock or some combination of the three?

Chapter 10, Securities Analysis and Securities Markets

  1. Companies and securities can only be analyzed in context; what is good or bad in one context becomes bad or good in another
  2. Variables that can not be quantified as good or bad:
    1. profit margins
    2. size
    3. liberal accounting policies
    4. low net asset value
    5. Wall Street sponsorship
    6. the trading assumption versus the investment assumption
    7. convertible securities
    8. limitations of comparative analysis
  3. Reasons for acquiring and holding securities
    1. aggressive mgmts might fully utilize liquidity, thus creating a weak financial position
    2. high book value relative to market price when price-earnings ratios are high results in low return on investment
    3. companies with high profit margins, high stock prices and low book values attract comeptition
    4. companies that survive and prosper in highly cyclical, unprotected industries tend to be run by able mgmts
  4. Profit margins
    1. low profit margins can be a strong reason for purchasing a security if it is believed the margins will improve; small improvements in low margin situations can result in big, leveraged returns
    2. companies with consistently high profit margins tend to be popular and thus over-priced
    3. it often happens that companies with consistently high profit margins suddenly lose them overnight
  5. Size
    1. small companies should be chosen because of the appreciation potential inherent in their prospects for growing into giant businesses
    2. many small and medium sized companies are well financed and effective competitors, meaning they are high quality issuers even if not recognized as such
    3. large firms are best selected by investors with no ability or time to get to know their investments better
    4. in general, the smaller the business, the riskier, however, there are times when high prices can make large businesses riskier on a relative basis
  6. Liberal accounting policies
    1. a firm can use liberal accounting policies to gain market sponsorship through excitement about its strong earnings profile; this market sponsorship can be used to attract financing at extremely generous rates, improving the firm’s financial position
    2. if a stock goes up far enough and its management is astute, it can use the “Chinese dollar”, or puffed value, to buy economic value elsewhere at a discount
    3. The standard of investment behavior for passivists as well as activists should be, “Worry about the investments you made, that you shouldn’t have,” not, “Worry about the investments you should’ve made, but didn’t”
  7. Advantages of a low net asset value
    1. a company with a lower NAV might have a higher ROI
    2. all assets come with encumberances; sometimes having a lower NAV relative to a competitor with higher NAV can result in greater ROI because the higher NAV requires more maintenance and other costs to keep it current, even when not actively productive
  8. Wall Street sponsorship
    1. “sponsored security” is an issue that is recommended and/or purchased by people in the financial community who are able to lure or influence others to acquire that security
    2. important for those interested in immediate performance or timing or in owning a highly marketable, actively traded security
    3. buying poorly sponsored or unsponsored equity securities has its advantages for long term investors because this is typically where bargains are found
  9. The trading assumptions versus the investment assumptions
    1. Much advice about how to invest is given from the perspective that the market knows more than the individual investor, and thus should be heeded accordingly
  10. Convertible securities
    1. issuers of convertibles are frequently second-rank companies who include convertibility to “sweeten the deal”
  11. Limitations on comparative analysis
    1. the goal is not completeness, but “good enough”; time and knowledge are at a premium
    2. “good enough” is the standard for measuring market and business performance; no one can be best all the time or own all the resources in the world

Chapter 11, Finance and Business

  1. Heavy Debt Load
    1. high debt can be viewed as a reason to purchase a stock, especially in a bull market, because many equate it to aggressive mgmt
    2. another reason high debt can be an asset is if the debt was acquired at attractive terms and competitor firms are not able to replicate such financing
  2. Large cash positions
    1. can be a sign of unattractiveness when:
      1. entrenched, non-raidable mgmts refuse to make productive use of funds
      2. where mgmt refuses to use funds to undertake necessary expenditures
    2. watch out for companies that appear strong financially but operationally are weak because they have not invested properly in their businesses
  3. Diversification versus concentration
    1. some enterprises excel with a singular focus
    2. others benefit from diversification
    3. the jury is out
  4. Management incentives
    1. management expenses and salaries are paid before all other securities
    2. management looting is generally not a problem in larger firms, but it is widespread enough that no security holder should assume there is a community of interest between mgmt and security holders
  5. Advantages of highly cyclical companies in competitive industries
    1. the adversity and challenge of these industries tend to attract highly talented mgmt
    2. they also tend to be well financed and relatively liquid because they can’t afford not to be
  6. Going public and going private
    1. What a business is worth as a private enterprise is different from what it is worth as a public enterprise
    2. A private company can go public by selling its own equities, or it can sell out for cash to a company that is already public
    3. Many times a public company is worth far more private than public so it will go private by purchasing up shares for cash
      1. a company repurchasing stock is, in effect, going private when it does so
  7. Who runs most companies?
    1. Myth is that they’re run by their directors; day-to-day reality is they are run by their mgmt
  8. Consolidated versus consolidating financial statements
    1. Sometimes, due to cross-ownership of securities held within a senior organization, the common equity of a child company can take a “de facto” status as a senior security within the parent organization
  9. Negative values in owning assets
    1. “everything’s got a price”
    2. “I wouldn’t own that asset if you gave it to me”
    3. Because ownership of most assets entails obligations and expense, the second statement is typically truer than the first

Chapter 12, Net Asset Values

  1. The usefulness of book value in security analysis
    1. book value is an accounting number and it is limited in usefulness as any accounting number is
    2. by itself it means little; gains significance relative to other figures and information
    3. quantitative measure of assets; tells us “how much”
  2. Book value as one measure of resources
    1. the amount of resources a company has to create future earnings is a good indicator of future earnings power; book value measures available resources
    2. corporate buyers tend to focus on book value as an indicator of how they can redeploy newly acquired resources
    3. important in calculating ROI and ROE
  3. Book value as one measure of potential liquidity
    1. opportunities to create tax carry-backs can occur when a common stock is selling at a steep discount from brick-and-mortar book value and the business has been paying high tax rates
    2. useful when a profitable business is available for acquisition at a price well below net asset value as shown on the tax records
    3. IRS can end up providing a substantial amount of the cash needed to finance the acquisition
  4. Book value analysis as a competitive edge
    1. most stock traders focus on short-term earnings, which is reflected in market prices
    2. focusing on large high-quality asset values as an indicator of good future earnings could give an investor an edge as these will not be reflected in high market prices
    3. changes in earnings and P/E ratios can be sudden and violent; changes in book value, however, tend to be gradual
  5. Limitations of book value in security analyses
    1. does not, in and of itself, measure the quality of a company’s assets
      1. high-quality means approaching being down free and clear of encumberances
      2. high-quality means the business has a mix of assets and liabilities that appear likely to produce high levels of operating earnings and cash flows
      3. high-quality means assets tend to be salable at a price that can be estimated accurately

Chapter 13, Earnings

  1. Wealth or earnings?
    1. Generation of reported income is one way to create wealth
      1. another is creating unrealized appreciation
      2. another is realizing the appreciation that has been created
    2. Reported income generation is the least tax sheltered way to grow wealth; creates incentive for asset-conversion
    3. Private company mgmt tends to minimize reported income to minimize tax burden; public company mgmt tends to maximize to enjoy higher stock price
      1. allows investor to realize gains through selling and borrowing
      2. allows the company to issue stock for cash or to acquire other companies
  2. The long-term earnings record
    1. In fundamental analysis, special attention should be given to the importance of a favorable long-term earnings record
    2. The major component of NAV for most publicly owned businesses is retained earnings
    3. Earnings record is extremely important for a strict going-concern analysis
    4. Judging the quality of an issuer is another situation where a strong long-term earnings record is important to the analysis
  3. “Parsing” the income account
    1. The static-equilibrium approach
      1. looks at current earnings and the earnings record as principal factors in market price determination
      2. market prices within an industry tend toward equilibrium– a stock out of equilibrium could be a reason for buying or selling
      3. important in i-banking world, where new issues are commonly priced at lower than typical multiples as a marketing tool
    2. The dynamic-equilibrium model
      1. uses past and current record of current earnings as a base for estimating future earnings
      2. projected increase is then used for predicting a future stock price
    3. Various definitions of earnings
      1. what accountants using GAAP report them as
      2. what accountants using GAAP report them as, as measured by overall performance, including extraordinary items and discontinued operations
      3. the increase in value of a business (incl stockholder distributions) from one period to the next; ie, changes in NAV
      4. the increase in the ability to make stockholder distributions over and above actual stockholder distributions without reducing actual invested capital
      5. the increase in the ability to make payments to all security holders, not just equity holders, during a period
      6. the increase in ability to improve future sales, accounting profits and/or cash flow during a period
    4. use caution when an expanding business’ earnings are not “real” because they can not finance their own growth without being acquired, ex, Parliament brand cigarettes from small private company Benson and Hedges
    5. may make sense to stress “earning power” (wealth creation) versus “earnings” (reported accounting earnings)

Chapter 14, Roles of Cash Dividends in Securities Analysis and Portfolio Management

  1. The three conventional theories
    1. John Burr Williams
      1. common stock is worth the sum of all the dividends expected to be paid out on it in the future, each discounted to its present worth
      2. criticism: only apply in a tax-free world where the reason for owning stocks is to receive dividends and the reason for all corp activities was to pay dividends
      3. instead, more realistic to say that common stock held by noncontrol stockholders is worth the sum of all the net after-tax cash expected to be realizable in the future from ownership of the common stock, with such net cash coming in the form of cash disbursements from within the company (dividends, liquidations) or from without (stock purchasers, lenders accepting stock on margin)
    2. Modigliani and Miller
      1. as long as mgmt is thought to be working in the best interests of the shareholder, retained earnings should be regarded as equivalent to a fully subscrubed, preemptive issue of common stock, and therefore that dividend pay-out is not material in the valuations of a common stock
      2. criticism: no evidence that mgmts share a “community of interest” with stockholders
      3. mgmt, if they are responsive to stockholders, tend to focus on the interests of holders that will bring the best benefits to mgmt
    3. Graham and Dodd
      1. in the vast majority of companies, higher common-stock prices will prevail when earnings are paid out in dividends rather than retained in a business
      2. criticism: emphasis should be on which stock — low dividend payer or high dividend payer — is more attractive to which type of investor
  2. Cash dividends as a factor in market performance
    1. ceteris paribus, a low dividend payer is better for an investor seeking market appreciation rather than cash-casrry
    2. lower dividend companies tend to sell at lower prices, thus they tend to be more attractive buys
    3. a company whose common stock is available at a lower price will have more room to increase its dividend; dividend increase record is important for some in valuing stocks
    4. lower dividends translates to higher retained earnings and thus improved financial position over time
    5. countervailing argument: high-dividend payers tend to be better buys because a high payout ratio means mgmt is more attuned to the desires of most outside stockholders
    6. stockholders can be hurt by companies paying out high dividends long after it is wise for them to do so
    7. Graham and Dodd view is valid in the short-run but seems to make less sense in the long-run
  3. The placebo effect of cash dividends
    1. dividends increase in importance for securities holders insofar as they lack confidence in their outlook or mgmt or in the reliability of disclosures
    2. dividends are a hedge against being wrong
  4. Cash dividends and portfolio management
    1. Dividends increase in importance with the shareholder’s need for immediate cash income from his portfolio
    2. didivends become a negative factor when the shareholder wants a tax shelter or has no need for income and has confidence mgmt will successfully reinvest retained earnings
    3. securities with a high cash return can be attractive due to positive cash-carry
  5. Cash dividends and legal lists
    1. cash dividend income is a legal or quasi-legal necessity for many securities holders
  6. Cash dividends and bailouts
    1. the ability to convert assets to cash is a key consideration for many buyers for control purposes; always key for outside investors
    2. assuming an investor has no control over a company whose common stock he has invested in, eventually he will want the opportunity to convert into cash
  7. The goals of security holders
    1. most owners of senior securities are interested solely in cash income
    2. in contrast, some equity holders can be interested in cash return (dividends or cash sale of shares) but many are interested in earnings return

Chapter 15, Shareholder Distributions, Primarily from the Company Point of View

  1. Cash dividends or retained earnings
    1. “proper” dividend payout policy should be made from the point of view of the corporation, not the stockholder
    2. dividend payouts are a residual use of corporate cash and company requirements for cash in other areas have primacy
    3. dividend policy should be dictated by company needs for funds for expansion as well as for margin of safety
    4. companies should retain earnings whenever they have profitable ways to deploy it– this is not determined by the price of their stock as proclaimed by the stock market
    5. high dividends can be used by mgmt to create a higher stock price and thus protect the mgmt from raids
  2. Distributions of assets other than cash
    1. can create a taxable event with no cash to pay it
  3. Liquidation
    1. any payment by a corporation to its shareholders is a form of liquidation
    2. in truth, there is no such thing as liquidation in any meaningful sense, but rather asset-conversion
  4. Stock repurchases
    1. receipts of cash are taxed on a capital-gains rate only
    2. benefits:
      1. corporation benefits because cash requirements on future dividends are reduced
      2. EPS, BVS and corp reality value per share may be enhanced
      3. can promote strong stock market price, thus increasing the companies future financial position and financing opportunities
    3. disadvantages:
      1. if buy-ins are of massive size, investors may be forced out of the company at a price much lower than corp reality, even if at a substantial premium to market prices
      2. possible conflicts with insiders who might want to purchase shares, appearance of payoffs to insiders who want to sell

Chapter 16, Losses and Loss Companies

  1. Quality considerations and tax-loss companies
    1. an organization suffering economic losses can be attractive from the POV of asset-conversion acquisitions if:
      1. the resources employed by the company can be put to another use so losses are stemmed
      2. the business lacks overwhelming amounts of indebtedness
      3. it has available to it tax benefits growing out of the former losses
  2. On accounting and income
    1. tax benefits, for accounting purposes, are treated as extraordinary items
    2. however, these benefits have very real cash consequences and can generate substantial future earnings when reinvested, regardless of how they are accounted for
  3. Be wary of acquiring equity securities of the encumbered firm
    1. the danger in investing in loss corporations is that they have become so encumbered that there is no practical way to invest safely and profitably
    2. “big-bath” writedowns should be viewed as nonrecurring from the standpoint of judging the stewardship of the mgmt
  4. Commercial banks’ portfolio losses
    1. principal earnings assets of banks are investments in loans to customers and investments in securities, notably UST and munis
    2. when interest rates rise, the banks’ loan book falls in value, so they purposefully take losses to reinvest in higher yielding securities
  5. The “turned the corner” theory
    1. many times people will invest in small, losing companies with no record of profitability with the belief that when they “turn the corner” the market will substantially appreciate their new growth records
    2. risky
      1. hard to predict the future of uncertain businesses
      2. new issues normally not priced on bargain bases relative to corporate reality
    3. these securities rarely prove attractive from the FIA

Chapter 17, A Short Primer on Asset-Conversion Investing: Prearbitrage and Postarbitrage

  1. prices paid for common stocks for investment purposes are different from prices paid for control of businesses
  2. Four types of “do-able” asset-conversion activities that might be spotted with the FIA
    1. more aggressive employment of existing assets
    2. merger and acquisition activities
    3. corporate contests for control
      1. incorporated and domiciled in states where there are no strong anti-takeover statutes
      2. share ownership is widespread or blocks are locked up in private transactions
      3. possible low will of mgmt to resist a takeover
      4. absence of impediments to takeover, such as being in a regulated industry
      5. no antitrust problems
      6. there do not appear to be important people or institutions, such as customers, employees or suppliers, who could harm the takeover target by terminating relationships
    4. going private
  3. Postarbitrage
    1. occur after an asset-conversion event when securities owned by public shareholders remain outstanding
    2. sometimes when an offer to acquire securities is announced and less than all the shares tendered are accepted, arbitragers tend to dispose of masses of stock they have accumulated shortly afterward, depressing market prices
    3. important to avoid mgmts that have a predatory predilection
    4. postarbitrage securities tend to be relatively unmarketable or not marketable at all
    5. one important rule of thumb: acquire shares at prices two thirds or less than control shareholders paid in the recent past to obtain control

Notes – A Compilation Of Ideas On Investing (@geoffgannon, #ncav, #netnet, #valueinvesting)

Notes – A Compilation Of Ideas On Investing (@geoffgannon, #ncav, #netnet, #valueinvesting)

Is Negative Book Value Bad?

  • Negative equity itself is meaningless (could be good or bad)
  • Compare net financial obligations to EBITDA
  • Think of borrowed money as the price of time; ask yourself if you’d rather they borrow money or spend time
  • Stocks in Geoff’s portfolio tend to:
    • have positive FCF
    • have unusually high ratios of FCF to reported earnings
    • buy back shares
    • pay dividends
    • have excess cash after the above
  • “I have found I do not make good decisions when I have to juggle 10 or more opportunities in my head at once”
  • “I don’t believe in taking a risk where I think if everything goes perfectly the upside is still going to be in the single digits”
  • How much debt is too much debt is a separate issue from whether the debt is being used productively
  • When soaring over the market trying to find bargains, these are useful as screening tools:
    • tangible book value
    • EV/EBITDA
  • If an entire country’s market has a low P/TBV or EV/EBITDA, this is important to know; you can buy indexes on this info alone
  • However, ultimately the following matter more:
    • liquidation value
    • market value
    • replacement value
    • Owner Earnings
  • Move beyond being a record keeper — an accountant — and become an appraiser
  • The assets that matter most on the balance sheet:
    • cash
    • investments
    • land
    • intellectual property
    • tax savings
    • legal claims
  • Cash flow protection is much better than asset protection
  • Businesses with special assets that are not separable from the operating business are most likely to not be reflected on the balance sheet and present hidden value
  • Being in a strong, safe liquidating position does not necessarily mean you are in a strong, safe operating position
  • Working capital needs and capital spending needs are part of the DNA of a business; “you can’t turn a railroad into an ad agency”
  • Negative equity itself is not a risk; poor interest coverage is
  • Non-aggressive long-run return assumptions:
    • stocks – 8%
    • bonds – 4%
  • When looking at companies with negative equity and stock buybacks, ask yourself the following:
    • Earnings yield of stock buybacks > interest rate on borrowed money?
    • Need to adjust financial obligations (such as unfunded pension liability) to determine true extent of liabilities?
    • Are net financial obligations (debt and pensions minus cash) a low enough multiple of their EBITDA?
    • How many years of FCF would it take to pay off all financial liabilities?
    • Is the price of the entire company in terms of EV/EBITDA low enough to justify investment?
    • How reliable is EBITDA, FCF, etc?
  • Common concerns in these situations:
    • Moat not wide enough
    • High risk of technological obsolescence
    • No pricing power/cost cutting potential to support margins
  • The right company can have negative equity and be investable if it is a wide moat business with almost no need for tangible investment:
    • Negative working capital
    • Minimal PP&E
    • A wide moat

Is It Ever Okay For A Company To Have No Free Cash Flow?

  • Four cash flow measures:
    • Owner’s Earnings (most important)
    • EBITDA
    • CFO
    • FCF
  • You can get a hint where a company is tripping up in delivering cash to shareholders (FCF) when:
    • EBITDA is positive
    • CFO is positive
    • Net income is positive
  • EBITDA measures the capitalization independent cash flow of the business; it doesn’t take into account spending today for benefits that won’t be realized until tomorrow; also misses working capital changes
  • Look for companies that are growing quickly in an industry that is not
  • Avoid companies that are fast growing in a fast growing industry; it will face more competition every year
  • To judge the future ROI of FCF reinvestment with a company that has no FCF, look at:
    • Will they be competitive?
    • Will competitors over expand?
    • Do they have a moat?
  • When a company spends so much on growth for so long, you really are betting on what the ROI will be way out in the future
  • “There isn’t necessarily a prize for being the last one to succumb to the inevitable. It’s usually more of a moral victory than an economic one”
  • Don’t short a great brand; if you want to short something, short a company:
    • with a product with inherently poor economics
    • a bad balance sheet
    • with deteriorating competitiveness
    • preferably in an industry with a high morality rate
  • When a company reinvests everything, you need to worry about what they’ll earn on their capital many years out

Value Investor Improvement Tip #1: Settle For Cheap Enough

  • A lot of people look for:
    • lowest P/Es
    • lowest P/Bs
    • highest div yields
    • new lows
  • This creates lists of companies that are quantitative outliers, instead of companies you know something about
  • You should feel comfortable throwing out 7/10 names found on a screen
  • Better to cast a wider net and then focus on companies you can learn a lot about by reading 10-Ks
  • Try a screen that combines (Ben Graham-style):
    • above average div yield
    • below average P/E
    • below average P/B
    • fewest unprofitable years in their past
  • Start with the company that sounds simplest, then move out slowly and carefully to those you understand less well; stop when you find something cheap that you know you can hold as long as it takes
  • Another screen:
    • EV/EBITDA < 8
    • ROI > 10%
    • 10 straight years of operating profits
  • You need a good reason for picking stocks that don’t meet this criteria
  • It’s hard to figure out companies with a lot of losses in their past; so don’t try
  • Familiarize yourself with a few stocks; what insiders have is familiarity
  • You want to find companies where you can think more like an insider
  • For long-term investing health, it’s better to find a slightly less cheap — but still cheap enough — stock you can get familiar with than a super cheap one that is a mystery
  • Anything less than NCAV is cheap enough
  • “Some of value investing is in the buying; most of value investing is in the holding; almost none of value investing is in the selling”