Tom Brown recently posted a rebuttal to Jason Zweig’s Wall Street Journal column. Geoff Gannon also wrote a great follow-up article with more on Benjamin Graham. I suggest reading all three articles.

In this post, I wanted to comment on a few aspects of Tom Brown’s argument, some of which I have been thinking about lately. The following is a quote from Tom’s post:

True value investors, by contrast, tend not to worry what might happen in the interim. Instead, they come up with their best estimate of a financial company’s intrinsic value by estimating the magnitude of likely losses along with its “normalized” earnings level two or three years out. They then compare that estimate of intrinsic value with the stock’s price today. Zweig says such estimates are impossible. I disagree.

I have always enjoyed Tom’s posts, but I can see a few problems with the above statement. (As a disclaimer, I know relatively little about financial companies, as they are out of my circle of competence. I hold no interest in any financial beside Berkshire Hathaway.)

First observation:
With highly leveraged financial companies, what happens in the “interim” can not only hurt you, it can kill you. Compare a bank to a retailer. Let’s say that you find a cheap retailer, where you estimate normalized earnings a few years out to derive its value. Assuming your estimate is correct, you should be able to ride out any short-term volatility to obtain the long-term value of the company. Like Tom says, that is the foundation of value investing.

Continue reading… »

The following three videos from TED are not necessarily related to business or investing. But you should watch them anyway.

Benjamin Zander: Classical music with shining eyes

Benjamin Zander has two infectious passions: classical music, and helping us all realize our untapped love for it — and by extension, our untapped love for all new possibilities, new experiences, new connections. [See Zander’s book “The Art of Possibility“].

Chris Abani tells stories of people: People standing up to soldiers. People being compassionate. People being human and reclaiming their humanity. It’s “ubuntu,” he says: the only way for me to be human is for you to reflect my humanity back at me. [See his first TED speech here].

Sir Ken Robinson makes an entertaining and profoundly moving case for creating an education system that nurtures (rather than undermines) creativity. [This is an old talk, but if you’ve never seen it, stop everything you’re doing and watch it now.]

Christmas comes but once a year.

This year, it comes three months early for those in the world of value investing. The following two books will be released at the end of September:

September 26 — Security Analysis: Sixth Edition

After a 20 year hiatus, McGraw-Hill is releasing the latest updated edition of Ben Graham’s original Security Analysis. The update includes: a forward by Warren Buffett; a chapter by James Grant; introductions by Howard Marks, Bruce Berkowitz, and Bruce Greenwald; and commentary from Seth Klarman, Roger Lowenstein, and Glenn Greenberg. An impressive lineup. New subjects will include international investing, hedge funds, absolute return strategies, and the efficient market hypothesis.

September 30 — The Snowball: Warren Buffett and the Business of Life

The definitive, nearly 1,000 page biography on Warren Buffett. Written by Alice Schroeder, the insurance analyst who caught Buffett’s eye after her report on Berkshire Hathaway. Much has been written about Buffett’s life, but never from his perspective. My guess is that many details will emerge about Buffett’s personality and the mindset that makes him the greatest investor of all time.

I’ll try as much as possible to keep this tradition up every quarter. Today is the day that the 13F’s are released for funds managing over $100m. Below is a list of 4 picks that I find interesting:

1. WellCare Health Plans (WCG) — Pabrai Investments, Fairholme Fund — I don’t know much about healthcare companies, but Wellcare seems like it might be a very low risk, high uncertainty situation. Recently, a summary of Pabrai’s thesis on Wellcare was posted on the Value Investing Congress Blog. Using the last quarter with information available, WCG is trading at an EV/EBIT of about 1.8x (!).

2. EchoStar Corp. (SATS) — Greenlight Capital, Fairholme Fund (spin-out) — Spun off from Dish Network (formerly EchoStar) back in January. Has multiple holdings, including a set-top box business, SlingMedia, and 7 satellites. SATS could be extremely undervalued if you add up the valuations of its separate companies. See the VIC Writeup for more details. Charlie Ergan, Chairman and major shareholder, is extremely smart and should never be underestimated.

3. WellPoint Inc. (WLP) — Springhouse Capital, Greenlight Capital, Fairholme Fund, Berkshire Hathaway, Baupost Group — Quite the lineup. Another beat-down healthcare company, but with less uncertainty. If you net out cash and unrelated investments, enterprise value is about $16B. Pre-tax income in the past year was $5.3B. So, even if WLP has lower earnings going forward, it’s trading for only 3x EBIT. It may pay to find out. (By the looks of it, healthcare companies must have a thing for logos with little swively waves in them.)

4. American Woodmark (AMWD) — Stadium Capital, Akre Capital, Fine Capital — A manufacturer and distributer of wood cabinets. Trading at about 8x TTM pre-tax free cash flow. It looks like they haven’t done well in the last few years, but if they can get back on track this is a very cheap stock. I don’t know a lot about wood prices, but it looks like gross margins have fluctuated widely in the past.

13F buys archive: Third Quarter 2007; Fourth Quarter 2007
Related link: Search for filings on the SEC website

Disclosure: We own a small position in SATS. This is not a recommendation to buy or sell any security.

The cover story of the May edition of the Bloomberg Markets magazine discusses Nassim Nicholas Taleb’s affect on Wall Street:

On a freezing day in March 2007, Nassim Taleb walked into a conference room at Morgan Stanley’s Manhattan offices on 47th Street and Broadway to address a group of the firm’s risk managers. His message: Your models don’t work.

Using a whiteboard to scribble out his calculations, Taleb, now 48, began one of his rants, this time against stress tests–Wall Street lingo for examining how a market rout will play out. Stress tests are inherently risky because they ignore rare but potentially devastating events, Taleb said.

See the Full Article here

It’s always interesting to see what other investors or thinkers have on their bookshelf. In the introduction to the article, there’s a picture of Nassim Taleb in his library. Using the hard copy, I picked out a few books that Taleb has read (or hasn’t read, by Umberto Eco standards). These should be useful for expanding one’s network of mental models:

• Darwin’s Dangerous Idea, by Daniel Dennett
• Collapse, by Jared Diamond
• Guns, Germs and Steel, by Jared Diamond
• The Selfish Gene, by Richard Dawkins
• Rational Herds, by Christophe Chamley
• The Perception of Risk, by Paul Slovic
• Knowledge and Decisions, by Thomas Sowell
• Serendipity, by Royston Roberts
• The Construction of Preference, by Sarah Lichtenstein and Paul Slovic
• Evolutionary Dynamics, by Martin Nowak
• The Quark and the Jaguar, by Murray Gell-Mann
• Why Beauty is Truth, by Ian Stewart
• The Eastern Origins of Western Civilization, by John Hobson
• For and Against Method, by Imre Lakatos and Paul Feyerabend
• Probability via Expectation, by Peter Whittle
• Probability Theory, by E. T. Jaynes
• Plight of the Fortune Tellers, by Riccardo Rebonato
• Imperfect Knowledge Economics, by Roman Frydman and Michael Goldberg
• The Business of Options, by Martin O’Connell
• The Logic of Scientific Discovery, by Karl Popper
• Unmaking the West, by Philip Tetlock

On another note, I have joined the team of authors at Reflections on Value Investing. If you haven’t already, head over and subscribe to the RSS feed. It’s a must for any value investor. Although this was posted at both sites, for the most part, my occasional posts at Reflections will have different content than FutureBlind.