Techniques for Investing in Bear Markets

With markets at multi-year lows in many countries, investors who use fundamental analysis to evaluate shares have become increasingly interested as markets have fallen further and further.

We know that Warren Buffett is investing much of his personal portfolio in US stocks and we know that other great investors like Seth Klarman are moving away from cash and into equities.

But how do you approach investing in a bear market? To be honest, the techniques used to invest in a bear market are not that different to the techniques used in any other market.

What follows are a few techniques that I have found useful in my investing and I think they have particular relevance for bear markets.

The Closed-End Fund Route

In a bear market some investors will get fearful about going out on a limb and selecting individual companies for investment (despite the fact that they think the prices are attractive).

One way to deal with this is to buy a long established, good quality listed closed-end fund at a discount to tangible book value (this will be the subject of an upcoming post). This avoids the need to select individual companies but still gets you into the market at low levels.

I believe this to be an excellent technique and a particularly valuable one for those who are not completely confident in their stock picking abilities. Even if you are confident in your stock picking abilities there is no shame in following this route. There is nothing stopping you from making individual stock picks and also putting some money in a closed-end fund.

There are some closed-end funds that have excellent records over long periods of time and those are the ones you want to be in and you want to be in at a discount to tangible book value.

Averaging

Another technique that you absolutely must use in a bear market is “averaging”. This involves initially buying only a fraction of the shares that you actually wish to buy.

For example, you may have decided that company XYZ is attractively priced and you want to buy 1,000 shares. What I do in this situation is normally buy 300-400 shares initially and then wait to see if the price moves down. If the price subsequently moves down by around 15% or so and I am still happy with my valuation of the company (i.e. there have been no adverse developments), I will buy another 300-400 shares and so on.

Now, some people will say that averaging down is a mistake. All I can say is that I have had success with this technique. Provided you have done your research properly, have patience and do not get emotional regarding weekly or monthly fluctuations, this can work very well (even more so in a bear market because prices tend to get cheaper and cheaper).

Being Very Selective

Another technique you can use is to be very selective regarding what you invest in (you should always be doing this). What I’m particularly looking for in a bear market is to buy into very high quality companies at prices which represent long-term historical lows in terms of price-to-book values, price-to-enterprise values, and price-to-earnings values and with the added advantage of a high dividend yield.

When I say “high quality”, I’m generally talking about large well established low debt companies that usually have some barriers to entry and have large market share – and I want them cheap.

When there is a general crisis, all companies will suffer. What you as an investor want to do is just pick off the very highest quality companies that have been adversely affected by what has been going on in sectors of the market that they are not involved in.

The 52 Week Low

You are unlikely to buy a company at its bear market low, you will usually enter either before (or after) it reaches its lowest price. That’s just the way it is and you have to accept that.

Once a bear market has been going for a year or more, you can start to look at the 52 week low prices for the companies you are interested in and attempt to buy close to those price lows. This gives you some idea of how low a price may go – it is definitely not fool-proof but can be used as a general guide. I know I’m bringing an element of charting into things here, but in this case it’s quite valid.

Have a look at what the analysts are saying

If you read my posts here regularly, you would know that I’m very skeptical regarding the forecasting of earnings, however, I will always look at what the analysts are estimating for the current year. Once we go beyond the current year’s estimate, we are getting into much more uncertain territory and I would place much less value on estimates 2-3 years out.

If the analysts are forecasting a material reduction in earnings, I will reassess my valuation accordingly. Analysts can and do get forecasts wrong. However, if 15 analysts follow a company and they are saying (on average) that earnings will decline by 30% for the current year, it would be foolish to ignore that.

Using all of these techniques should assist you in investing in bear markets and help limit downside risk.

Gems of Wisdom from Seth Klarman

Seth Klarman holds an MBA from Harvard University and was one of the founders of the Boston based Baupost Group. He has developed somewhat of a cult following amongst value investors because of his track record (he has achieved similar returns to those of Warren Buffett’s Berkshire Hathaway).

The Baupost Group remained heavily invested in cash during 2007 and into 2008. From all accounts the Group is now actively investing that cash in the market.

Klarman can legitimately be called a “great” investor and I thought I would provide some extracts from his book Margin of Safety (Harper Collins, 1991). Unfortunately this book is long out of print but I thought I would share some excerpts from it with you.

While Klarman is very cynical with respect to all encompassing stock valuation formulas, he does in fact use a Net Present Value methodology (discussed below) which is the same as the discounted cash flow (DCF) methodology.

Klarman on valuation formulas and forecasting

Many investors greedily persist in the investment world's version of a search for the holy-grail: the attempt to find a successful investment formula. It is human nature to seek simple solutions to problems, however complex. Given the complexities of the investment process, it is perhaps natural for people to feel that only a formula could lead to investment success.

Regardless of the market environment, many investors seek a formula for success. The unfortunate reality is that investment success cannot be captured in a mathematical equation or a computer program.

Like most eighth grade algebra students, some investors memorize a few formulas or rules and superficially appear competent but do not really understand what they are doing. To achieve long-term success over many financial market and economic cycles, observing a few rules is not enough. Too many things change too quickly in the investment world for that approach to succeed. It is necessary instead to understand the rationale behind the rules in order to appreciate why they work when they do and don't when they don't.

Many investors insist on affixing exact values to their investments, seeking precision in an imprecise world, but business value cannot be precisely determined. You cannot

appraise the value of your home to the nearest thousand dollars. Why would it be any easier to place a value on vast and complex businesses?

Any attempt to value businesses with precision will yield values that are precisely inaccurate. The problem is that it is easy to confuse the capability to make precise forecasts with the ability to make accurate ones.

The advent of the computerized spreadsheet has exacerbated this problem, creating the illusion of extensive and thoughtful analysis, even for the most haphazard of efforts. Typically, investors place a great deal of importance on the output, even though they pay little attention to the assumptions.

Although some businesses are more stable than others and therefore more predictable, estimating future cash flow for a business is usually a guessing game.

Forecasting sales or profits many years into the future is considerably more imprecise, and a great many factors can derail any business forecast.

Stocks do not have the firm mathematical tether afforded by the contractual nature of the cash flows of a high-grade bond.

Stocks, for example, have no maturity date or price. Moreover, while the value of a stock is ultimately tied to the performance of the underlying business, the potential profit from owning a stock is much more ambiguous. Specifically, the owner of a stock does not receive the cash flows from a business; he or she profits from appreciation in the share price, presumably as the market incorporates fundamental business developments into that price. Investors thus tend to predict their returns from investing in equities by predicting future stock prices. Since stock prices do not appreciate in a predictable fashion but fluctuate unevenly over time, almost any forecast can be made and justified. It is thus possible to predict the achievement of any desired level of return simply by fiddling with one's estimate of future share prices.

Just as many generals persist in fighting the last war, most investment formulas project the recent past into the future.

The financial markets are far too complex to be incorporated into a formula. Moreover, if any successful investment formula could be devised, it would be exploited by those who possessed it until competition eliminated the excess profits. The quest for a formula that worked would then begin anew.

Investors would be much better off to redirect the time and effort committed to devising formulas into fundamental analysis of specific investment opportunities.

Klarman on methods of valuing a business

While a great many methods of business valuation exist, there are only three that I find useful.

Net Present Value

The first is an analysis of going-concern value, known as net present value (NPV) analysis. NPV is the discounted value of all future cash flows that a business is expected to generate.

When future cash flows are reasonably predictable and an appropriate discount rate can be chosen, NPV analysis is one of the most accurate and precise methods of valuation.

Unfortunately future cash flows are usually uncertain, often highly so. Moreover, the choice of a discount rate can be somewhat arbitrary. These factors together typically make present value analysis an imprecise and difficult task.

A perfect business in terms of the simplicity of valuation would be an annuity; an annuity generates an annual stream of cash that either remains constant or grows at a steady rate every year. Real businesses, even the best ones, are unfortunately not annuities.

Few businesses occupy impenetrable market niches and generate consistently high returns, and most are subject to intense competition. Small changes in either revenues or expenses cause far greater percentage changes in profits. The number of things that can go wrong greatly exceeds the number that can go right. Responding to business uncertainty is the job of corporate management. However, controlling or preventing uncertainty is generally beyond management's ability and should not be expected by investors.

A recurring theme in this book is that the future is not predictable, except within fairly wide boundaries.

Will Coca-Cola sell soda next year? Of course. Will it sell more than this year? Pretty definitely, since it has done so every year since 1980. How much more is not so clear. How much the company will earn from selling it is even less clear; factors such as pricing, the sensitivity of demand to changes in price, competitors' actions, and changes in corporate tax rates all may affect profitability. Forecasting sales or profits many years into the future is considerably more imprecise, and a great many factors can derail any business forecast.

There are many investors who make decisions solely on the basis of their own forecasts of future growth. After all, the faster the earnings or cash flow of a business is growing, the greater that business's present value. Yet several difficulties confront growth-oriented investors.

First, such investors frequently demonstrate higher confidence in their ability to predict the future than is warranted.

Second, for fast-growing businesses even small differences in one's estimate of annual growth rates can have a tremendous impact on valuation. Moreover, with so many investors attempting to buy stock in growth companies, the prices of the consensus choices may reach levels unsupported by fundamentals. Since entry to the "Business Hall of Fame" is frequently through a revolving door, investors may at times be lured into making overly optimistic projections based on temporarily robust results, thereby causing them to overpay for mediocre businesses.

When growth is anticipated and therefore already discounted in securities prices, shortfalls will disappoint investors and result in share price declines. As Warren Buffett has said, “For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments.”

Another difficulty with investing based on growth is that while investors tend to oversimplify growth into a single number, growth is, in fact, comprised of numerous moving parts which vary in their predictability. For any particular business, for example, earnings growth can stem from increased unit sales related to predictable increases in the general population, to increased usage of a product by consumers, to increased market share, to greater penetration of a product into the population, or to price increases.

Specifically, a brewer might expect to sell more beer as the drinking-age population grows but would aspire to selling more beer per capita as well. Budweiser would hope to increase market share relative to Miller. The brewing industry might wish to convert whiskey drinkers into beer drinkers or reach the abstemious segment of the population with a brand of non-alcoholic beer. Over time companies would seek to increase price to the extent that it would be expected to result in increased profits.

Some of these sources of earnings growth are more predictable than others. Growth tied to population increases is considerably more certain than growth stemming from changes in consumer behavior, such as the conversion of whiskey drinkers to beer. The reaction of customers to price increases is always uncertain. On the whole it is far easier to identify the possible sources of growth for a business than to forecast how much growth will actually materialize and how it will affect profits.

How do value investors deal with the analytical necessity to predict the unpredictable? The only answer is conservatism. Since all projections are subject to error, optimistic ones tend to place investors on a precarious limb. Virtually everything must go right, or losses may be sustained. Conservative forecasts can be more easily met or even exceeded. Investors are well advised to make only conservative projections and then invest only at a substantial discount from the valuations derived therefrom.

Liquidation Value

The second method of business valuation analyzes liquidation value, the expected proceeds if a company were to be dismantled and the assets sold off. Breakup value, one variant of liquidation analysis, considers each of the components of a business at its highest valuation, whether as part of a going concern or not.

Stock Scribe Note: This method has been used to great effect by multi-millionaire investor Sir Ron Brierley. However, it often requires gaining control of a company (or at least board seats) to achieve a successful outcome.

Stock Market Value (for unlisted companies)

The third method of valuation, stock market value, is an estimate of the price at which a company, or its subsidiaries considered separately, would trade in the stock market. Less reliable than the other two, this method is only occasionally useful as a yardstick of value.

Just when you thought it was safe: The financial crisis continues

The effective collapse of the Royal Bank of Scotland (RBS) has ushered in another phase of the financial crisis.

Just when things were starting to look a little better and investors were starting to think about re-entering the markets, good old RBS comes along with a result that must have put the fear of God into British Government officials.

The RBS result has reverberated around the world and caused renewed selling in banking stocks.

The British economy is in a precarious state – the result of having a disproportionate component of that economy dedicated to financial services, services that many people no longer have a use for. There is going to be a lot of pain this time around.

One thing that Governments everywhere should understand is that the cycle will run its course regardless of what they do. You can attempt to mitigate the worst effects of what is happening but it’s like standing in front of a freight train with a stop sign.

In Australia we have Prime Minister Kevin Rudd attempting all sorts of rather foolish things in order to stop the economy entering recession – he will fail.

He gave away $10 billion dollars of tax payers’ money so that certain Australians could enjoy a pre-Christmas spending spree – in effect firing a significant amount of his ammunition before the war had even started.

He placed an essentially unlimited guarantee on bank deposits (something his Government would not be able to honour if one of the big four banks were to collapse, the Government doesn’t have the financial resources needed, it’s all just a confidence game).

He now wants to assist commercial property developers with $2 billion of taxpayers’ money. That’s right – commercial property developers, many of whom took on massive levels of debt and completely mismanaged their affairs and now we the taxpayers are being asked to assist them (and the banks that lent to them) – if this wasn’t true it would be very amusing indeed.

The Reserve Bank of Australia is hell bent on reducing interest rates to almost nothing in order to “stimulate economic activity”. Note to the Reserve Bank – it hasn’t worked in Japan, the United States or the UK – it won’t work in Australia either.

It won’t work because once banks decide to tighten lending criteria (as they have done globally), it doesn’t matter what the interest rate is – if they won’t lend to you, they won’t lend to you!

[The Australian residential property market that has stood up remarkably well to date is now showing definite early signs of weakness. I think things on this front may be very interesting in a year or so.]

Of course it was the artificial suppression of interest rates for an extended period by that now maligned central banker Alan Greenspan (and his unthinking global clones) that created the ideal environment for this crisis to take place. How do we solve the crisis? Do the exact same thing that caused it in the first place!

The inauguration of Barack Obama made people around the world feel good, but the market was not so impressed. The novelty value of an African-American president won’t last long if President Obama doesn’t deliver and deliver soon. He is a very intelligent and incredibly articulate person and he has the best wishes of all of us. Let’s hope he can pull a rabbit out of the hat, he is going to have to. The problems he faces are momentous.

The Stock Market as a Parimutuel System

I read an article some years ago in which Charlie Munger (the Vice Chairman of Berkshire Hathaway) likened the stock market to a parimutuel betting system (referred to in some countries as a totalizer betting system).

This aroused my interest and the more I thought about it, the more I thought that Munger was absolutely correct.

A parimutuel or totalizer betting system is where people wishing to bet on a particular event (let’s say a horse race or a sporting event) place their bet with an organisation that pools all the money wagered and then sets the odds for each outcome based on the amount of money bet (after taking a set percentage off the top, I believe the percentage is around 17% in the US).

For example, Team A is playing Team B in some sporting event. Those betting on the outcome of this event have bet $800,000 in total. Of this $800,000, $600,000 has been bet on Team A and $200,000 has been bet on Team B.

The organisation running the parimutuel system will take off the top a certain amount, let’s say 17%. Therefore, $136,000 of the amount wagered goes straight to the betting organisation. So $664,000 is left to distribute in winnings.

Because $600,000 was wagered on Team A and those making that bet can only be paid $664,000, the payment for a $1 bet is close to $1.11 ($664,000/$600,000). The payout for Team B is $3.32 ($664,000/$200,000). We are assuming that a draw cannot happen in this example (and yes, I have simplified the calculations).

The organisation running the parimutuel system doesn’t care who actually wins or loses – they take their cut right up front. In the parimutuel system, bets on opposite sides of a wager are competing against each other and the odds are set based on how much each side is prepared to bet on a particular outcome. The winners share the entire pool of money and the losers get nothing.

In the betting world, all of the really large horse racing syndicates operate in Hong Kong because it has the largest betting market in the world.

These syndicates use extremely sophisticated software to calculate odds. This software usually cost upwards of $1 million to develop and many of the people involved in these syndicates come from an actuarial background.

It can be highly lucrative. The late Alan Woods (an Australian) died in 2008 with an estimated fortune of $670 million, all of which was derived from gambling.

Now, as Charlie Munger observed, the stock market is very similar to the parimutuel system. Individuals in the stock market submit buy and sell orders (rather than bets) and market prices (like the odds) are determined by the number of buyers and sellers on each side.

In the stock market, the buyer of company XYZ’s shares is in effect “betting” against the seller of company XYZ’s shares that company XYZ’s share price will rise.

A really good horse will have low odds in a race and a really good company will generally sell at a high price in the market.

As Munger has stated, the two huge advantages that the stock market has over the parimutuel system are:

1. The stock broker takes far less off the top than the betting organisation;

2. Prices of shares can occasionally completely disengage from the fundamentals. This is far less likely to happen when setting the odds in a parimutuel system.

Obviously the share market is not a zero sum game like the parimutuel system (that’s if we exclude derivatives). It’s highly unlikely that you will lose all your money in the stock market if you have a sufficiently diversified portfolio. But just like the parimutuel system, if you don’t really know what you are doing, you will lose some money overtime, it’s just a slower process in the share market.

So what implications do Munger’s observations have?

1. It’s extremely important to keep brokers’ costs as low as possible to maximise the potential gain. This is one of the reasons why sophisticated share market investors rarely use full service brokers;

2. Research pays off. Just like those syndicates in Hong Kong, use of statistics and research can aid in finding an incorrectly priced “bet”. But remember, this research is not always the kind of thing that you can just find out from a broker or read in a newspaper;

3. Professional gamblers only bet when the odds are incorrectly set in their favour (based on significant research). Most of the time the odds will in fact be accurate, just like the prices of shares in the stock market will be and when this is the case the professional will not “bet”. Fortunately however, this is not always the case – bear markets and bull markets offer real rewards to the patient investor;

4. Most novices would not seriously think that they could make money betting on horses but many share market novices think they can beat the market (I’m sure that 2008 probably changed that attitude for many of these people).

Just to pick up on that last point - you may be an average investor with a small portfolio and limited knowledge, the person on the other side of your buy or sell order may have vast knowledge and may have made millions in the market. You are unlikely to outsmart such people, just as novices won’t outsmart professional gamblers or bookmakers.

It worries me when I see people who know almost nothing about share market investing jumping into the market (sometimes with borrowed money). These people need to educate themselves before making any investments – read, read and then read more. If someone wants to invest in the market but doesn’t want to bother with research, they can always buy a good quality listed investment company (this will be the subject of an upcoming post).

Blackmores and Campbell Brothers: Why I like them

Two companies that I have admired for a long time are Blackmores (BKL) and Campbell Brothers (CPB). Both companies have been listed on the ASX for many years and have excellent track records.

Blackmores is a manufacturer of high quality dietary supplements and Campbell Brothers derives most of its profits from the provision of consulting and analytical laboratory services.

Let’s look at some financial statistics:

Statistic	Blackmores	Campbell Brothers
Average 10 year Return on Equity	31.7%	13.5%
Average 10 year Price-Earnings Ratio	16.8	15.1
Current Price-Earnings ratio*	11.7	10.0
Price-earnings ratio based on forecast 08-09 earnings	11.7	7.8
Average compound growth in earnings**	16.6%	17.2%
Debt-to-equity ratio (as at last reporting date)	75%	73%
Current dividend yield*	6.5%	6.02%
Current dividend payout ratio (07-08 year)	69%	76%
Current share price*	$13.85	$18.27
Approximate market capitalization*	$224m	$961m

* As at 9 January 2009.

** 30 June 1999 to 30 June 2008.

A number of interesting things are apparent from the above table:

1. Both companies have exceptional growth rates over the nine year period;

2. Both companies have maintained exceptional growth rates while also maintaining a high dividend payout ratio;

3. The current dividend yields are attractive compared to bank interest rates (note that CPB’s dividend is 50% franked);

4. The current price-earnings ratios are well below historical averages;

5. Debt is a bit on the high side for both companies (but appears manageable);

6. Blackmores has maintained an outstanding return on equity over the 10 year period (although that is likely to be because its equity is understated, i.e. it has not valued brand names etc that clearly have significant value).

Campbell Brothers has forecast huge earnings growth of 70% for 2008-09 (when so many other companies are forecasting earnings declines). Blackmores’ earnings are likely to be flat for 2008-09.

Neither of these companies were included in The Stock Scribe portfolio because they would not have passed one or two of the filters specified by Benjamin Graham. But this is ok. Investors do need to use a degree of judgment in what they do. I’m willing to be somewhat flexible with companies that have very long and successful track records.

While it would be imprudent to expect that the growth rates achieved for both companies over the last decade or so will be repeated over the next decade, it would be reasonable to assume that some level of growth will take place. The multiples that these companies are currently selling at imply that there will be little or no growth and this seems unlikely based on each company’s past record.

Whenever you are contemplating an investment always ask yourself: “What can go wrong?”

One thing that you should be aware of with companies that manufacture food products or drugs is that they always carry a special risk – the possibility that if there is a scare associated with a “bad” batch of a particular product it has the potential to destroy the business. I would definitely not expect that any such thing would happen with Blackmores, but it is something the investor needs to be cognisant of.

Something else to note is that Campbell Brothers has significant intangible assets on its balance sheet. If we were to calculate the debt-to-equity ratio using only tangible assets it would be 220% - very high. Given Campbell Brothers very long history and reputation, it is likely that those intangibles are valued appropriately (although we can’t say that for sure).

Both companies trade low volumes of shares - something which investors need to be mindful of.

So what are these two companies worth?

I will say that in my opinion (and it’s my opinion only), Blackmores is worth approximately $18 and Campbell Brothers is worth approximately $23. That makes for an interesting situation at prices prevailing in early January 2009.

Note: None of the above constitutes financial advice. You need to do your own research and consult appropriately qualified people for advice (where necessary).

Snowball: Things you never knew about Warren Buffett

There are 11 books sitting on my book shelves that are about Warren Buffett – some of them I bought, others were given to me.

Sometimes I have been asked what the best book ever written on Warren Buffett is and I have always said that it’s Roger Lowenstein’s 1995 book: Buffett: The Making of an American Capitalist. However this is no longer true.

I was lucky enough to have been given a copy of The Snowball: Warren Buffett and the Business of Life (by Alice Schroeder). This book is that much better than Lowenstein’s book simply because Buffett, his family and his friends cooperated with Schroeder on the writing of the book.

Schroeder interviewed Buffett over the course of five years for this book and this brings many insights to the reader that are absent from all the other books written about Buffett.

As Buffett is never going to write an autobiography, this book is as close as we are going to get to an autobiography.

Schroeder clearly (but gently) exposes the flaws and genius in Buffett.

Buffett’s family have had their fair share of problems. For example, all of Buffett’s children have had failed marriages and all of them are college drop-outs, some members of his extended family have suffered from mental illness and there has even been the odd suicide in the family. Buffett himself engaged in shoplifting as a teenager.

This is no Brady Bunch family - as many other authors have portrayed it to be. Every family has its problems and the Buffetts are no different to anyone else.

Buffett does come out looking like a rather one dimensional character – obsessed with making money, with his only other interest seemingly being the card game Bridge. This is not really surprising – the vast majority of people who have achieved excellence in their chosen field are fanatical about it, you don’t get excellence any other way.

Buffett’s diet consists of coke, hamburgers, steaks, hash browns, peanuts, ice cream and popcorn (this of course has been well documented elsewhere). Most of these foods (if eaten continuously) are not exactly conducive to longevity and it’s even more surprising when one considers that Buffett has always been obsessed by his own mortality.

In 1989 Buffett was invited to dinner by Akio Morita, the chairman of Sony. Morita had his chefs serve sushi (many courses of it) and Buffett sent every course back without even having tried it. Buffett felt embarrassed about this but even then he could not bring himself to try some of it – this simple example shows an inflexibility that extends far beyond food.

When his sister Doris ended up owing a few million dollars in the wake of the 1987 stock market crash (she had been playing around with derivatives), Buffett refused to clear her debts. He did eventually help her out in a roundabout way, but in his position, I would have helped my sister – most people would have. Whether it was sushi or his sister, he was not prepared to bend his own rules.

He is a person who easily and quickly develops strong emotional attachments to certain people – the late Katherine Graham (no relation to Benjamin Graham), Charlie Munger, Bill Gates, Carol Loomis and Sharon Osberg to name a few. In fact, Buffett is more attached to some of these people than to certain members of his own family.

The whole Salomon debacle (Buffett invested $700m in the 1980s in this now long gone investment bank) occurred primarily because he liked Salomon’s John Gutfreund (they later fell out). Had Buffett known what he was getting into, he would never have touched Salomon.

Many other books do not mention (or gloss over) the failed investments that Buffett has made (there are not too many of them, but they do exist). Dexter Shoe is the most unfortunate investment Buffett has made (up to now).

The book has all sorts of little revelations in it, for example, who knew that Berkshire Hathaway shareholders have been known to steal from some of the stalls set up to promote Berkshire’s businesses at the annual meeting? Who knew that Bono (from U2) was a good friend of Buffett’s daughter Susan and was one of the few non-family members to attend Buffett’s (first) wife’s funeral?

As is normal for this type of book, lots of Buffett wannabes will scour it for some blinding investing insight that they can take away and use to great effect. For me, the best paragraph in the book concerning investing relates to Buffett’s purchase of more than $1 billion of Coca-Cola stock in the late 1980s:

“Buffett applied a margin of safety to his estimates. He did this simply by taking a whack at the number, rather than using some complicated model or formula. He used no computers or spreadsheets in doing any of these calculations; if the answer didn’t hit him over the head like a caveman’s club, in his view, the investment wasn’t worth making.”

No spreadsheets, no computers, no models, no secret formulas – just some basic arithmetic, some historical information and some good judgment – that’s it. It’s as close as you will get (or need to get) to what Buffett does.

Schroeder’s book is 969 pages long (with the index and notes) - it’s one of the largest books I have ever seen. However, it didn’t feel long because Schroeder held my attention all the way through – she has done a superb job. I highly recommend it to you.

Update on my portfolio selected using Graham’s techniques

On 5 December 2008, I selected a portfolio of 11 stocks using techniques detailed by Benjamin Graham in his book The Intelligent Investor (see the original post here).

The initial portfolio value was $1 million with approximately $90,909 invested in 11 companies as follows:

Company	Buy Price	No. of shares	5-Dec-08 Value	2-Jan-09 Value
Caltex	$6.18	14,710	$90,908	$106,206
Harvey Norman	$2.35	38,685	$90,910	$102,515
Soul Pattinson	$8.33	10,913	$90,905	$100,400
Sims Metal	$11.74	7,744	$90,915	$137,611
Flight Centre	$8.30	10,953	$90,910	$95,072
Hills Industries	$2.90	31,348	$90,909	$95,925
Beach Petroleum	$0.75	122,026	$91,520	$114,094
ASX	$31.60	2,877	$90,913	$95,027
Austereo	$1.11	82,271	$91,321	$102,016
WA Newspapers	$4.70	19,342	$90,907	$104,253
Milton Corporation	$14.02	6,484	$90,906	$93,953
Total			$1,001,024	$1,147,072

As can be seen above, as at 2 January 2009 this portfolio had appreciated by 14.6% to $1,147,072. The All Ordinaries Index had appreciated by 6.7% over the same period. So I’m well ahead of the index (for the time being anyway!).

I noted in my original post that ASX, Austereo, WA Newspapers and Milton Corporation were not selected using Graham’s methods – most of those companies are much more to Warren Buffett’s tastes than Benjamin Graham’s. However, I do have confidence in those companies at the prices that were paid above.

It’s pleasing to see a fairly even contribution by most of the companies. The return was not achieved by one company increasing very significantly in value. Sims Metal (up 51.4%) and Beach Petroleum (up 24.7%) were the stand outs but very good contributions were also made by Caltex, Harvey Norman, Soul Pattinson, WA Newspapers and Austereo. In fact, every company had a market value of more than the purchase price.

But let’s not get carried away, this is only one month’s performance and while it is exceptionally good, it doesn’t mean very much. I will keep holding this portfolio and see how it goes. I’m a longer term investor and am happy to ride the ups and downs as long as I have confidence in the underlying values.

Note: None of the above constitutes financial advice. You need to do your own research and consult appropriately qualified people for advice (where necessary).