Sunday, December 9, 2012

Recent Comments

I received a couple of interesting comments this week on my blog and I thought I would take a few minutes to address them.

The first comment was, "Does it not bother you that these same US banks were bailed out at taxpayers expense only to give their bosses big bonuses, when these banks are the very ones that created the mess in the US economy?"

My short answer is No.  Here is my long answer. 

While I understand your hatred of the US banks, along with many other US citizens, I don't believe you are considering all of the facts.  Naturally everyone wants to look for someone or something to blame when things go wrong.  The US banks were not doubt a big player in the financial crisis, but they do not deserve all of the blame. 

Let's examine a few of your points a little closer. 

1) You said, “US banks were bailed out at taxpayers expense.”

FACT: No US bank was bailed out at taxpayers expense.

What exactly is an expense?  Here is a definition from Wikipedia. 

Wikipedia: In common usage, an expense or expenditure is an outflow of money to another person or group to pay for an item or service, or for a category of costs. For a tenant, rent is an expense. For students or parents, tuition is an expense.

So yes, the US government did give the US banks money but every cent of the money was paid back with interest. This is not an expense.  Secondly, it was done to bring stability and confidence in the midst of a crisis. Lastly, some banks, like Wells Fargo, didn’t even want the money. 

So because the money was paid back (with interest), perhaps the question should be asked why did the US taxpayer profit at the banks expense?

2) You said, "only to give their bosses big bonuses."  

FACT:  It is a free country and the shareholders of each US bank are allowed to pay their managers whatever bonus they feel like. Why the Jealousy?

With that said, I do agree with you that some managers make too much money.  So, as a shareholder I often but not always exercise my right to vote against pay packages at the annual meeting. 

The problem Mr. and Mrs. Mutual Fund holder is that they do not directly own shares but the fund manager votes for the shares held in their funds.  Often these fund managers don't want to upset the apple cart of their own high wages so they vote along with whatever management says.  In my opinion Mr. and Mrs. Mutual Fund holder should also fire their fund manager but that's another post all together. 

3) Lastly you said, “these banks are the very ones that created the mess in the US economy.”

I agree that they did play a role but they are not the only factor.  Let's take a look at a few.


a) Every US citizen who refinanced their home and never paid back the money was a huge beneficiary, No?  Where is the morality of the citizens who collectively borrowed billions of dollars from the banks and never paid it back. 

b) The GSE’s (Fannie Mae & Freddie Mac) backed by politicians who pushed for the expansion of home ownership to marginal buyers helped create the housing bubble. 

c) Many speculators caused the huge run up in housing prices which then caused a 30% collapse in real estate.  This caused the banks, and every other financial institution to run into financial difficulty.

d) The federal government kept interest rates too low for too long thus contributing to the housing bubble.

So the blame game really isn’t as cut and dry as you make it out to be.

Another Angle

Perhaps we can look at it from another angle.

Does it bother you when someone loses their job and collects unemployment from the government? They are being bailed out by fellow taxpayers and beyond that they keep all the money for themselves.  This is truly an expense and the individual is never required to repay the money. 

So if you want to be consistent you much hate everyone that receives money from the government (elderly, children, disabled, etc), especially those individuals who never pay back the money. 

Another Reader Comment

Also, you should know that your blog is simply the best Canadian investing source on the web. Period. I like the no-BS, evidence based analytical style. This site is a great starting point for investments, I basically read your thesis, due my own due diligence which generally confirms what you are saying and I'm done. My only complaint is that there is just so little material. Not to put that on you, I'm sure this is something you do in your spare time but I could use more. Could you recommend any other similar sites?

Thanks for the kinds words.  I would like to put more material up but what is the point? 

This blog is free and I don't necessarily like giving away my best investment ideas.  I often discuss the rationale for very large companies when the discussion here will have little to no effect on the stock price.  For smaller companies where there could be any hint of competition in my bidding for price I will not disclose.  After the fact, I often will discuss the investment rationale here.  An example of this is my Peyto investment from earlier this year. 

Even with the large cap companies I know that any buying ahead of me can and will influence the price and that still bothers me a little.  I like getting the best price possible. 

I don't invest for the applause or the appreciation of others.  I do it for myself.  I write on this blog to meet like minded individuals, and to be honest they are hard to come by. 

As for other sites, I couldn't recommend one where I ever found a good investment idea.  I have read some but often the writer is only recycling the ideas of others.  This is crucial point and to quote Nathanial Branden, "there is profound distinction between those who fundamental orientation is to think for themselves and those who notion of thinking is to recycle the opinions of other people." 

Here is what I recommend if you want to find cheap stocks.  First check out any list of 52-week lows.  One I use is over at the Wall Street Journal (click here).  Do your homework and every once and a while you may find a good bargain on that list.  Be patient and hold your nose.  If it's on that list it will be hated by most everyone.

Secondly, I watch what other "value" investors are buying. is a good place.  Again use it as a starting point.  Often these professionals employ a number of analyst who can save you time when looking for value stocks.   

Lastly, find a good stock screener and look for excellent businesses selling below book value.  Book value is probably the single most important measure when investing.  The balance sheet is more important to the income statement, and understanding the link between them is important.  Book value is an important starting point when evaluating any security but you must understand it's makeup.  For those who invest that do not understand the importance of book value, I would suggest you read up on it. 

I will pay more than book value for some companies but the business returns must be bullet proof.  Remember investor goodwill is no different than balance sheet goodwill. 

2012 Year End

2012 is quickly coming to a close and the returns this year are solid.  As a summary, I made three purchases this year, two new securities and added to an existing position.  On the sell side, I sold out of one position completely this year.  Not a lot of action from this value investor.  I prefer to make myself rich instead of my broker. 

I laugh when others ask me if I "trade" stocks.  I prefer to "own" them and only "trade" them when someone offers pay me a fair to high price. 

Best Regards,

Kevin Graham

Disclosure: Long PEY. 

Sunday, November 25, 2012

US & Canadian Bank Valuations

Well, I have been pounding the tables on the US Large Cap Banks for a while so I thought I would explain once again why they are cheap but from another angle.  The below table, courtesy of TD Securities, gives a very quick and easy picture showing a comparison between the US and Canadian Banks. 

The average Price to Book Value Per Share (BVPS) for the six largest banks in Canada is 1.8 times.  The US Money Center Banks, which include Bank of America (BAC), Citigroup (C) and JP Morgan Chase (JPM), sell on average for 0.6 times book value.  Even the US Super Regional Banks, which includes US Bancorp (USB) and Wells Fargo (WFC), sell at an average of 1.5 times book value.

Now the table above clearly shows significant upside for the large US Money Centered Banks.  That said, lets look at little deeper at the individual valuations of the the five large US banks above.

Note: USB is technically the seventh largest bank in the US.  JPM, BAC, C, and WFC are the four largest banks in the US ranked by assets respectively.

US Large Cap Banks - Price to Book Value Per Share

So looking deeper, BAC sells for under the average and JPM for above average of 0.6 times BV.  Likewise for the Super Regional Banks, WFC sells for less than the average and USB sells for the about the same valuation as the large Canadian Banks. 

So this begs the questions.  What would the stock price be if the US Banks sold for the same valuation (P/BV) as comparable Canadian banks?  Now for this exercise I used the average P/BV of 1.8 times for large Money Centered Banks and 2 times for the Super Regional Banks.  I made this adjustment because WFC and USB are much stronger banks and earn higher returns on assets than the Money Centered Banks. 

Upside in US Large Cap Banks - Common Shares

So if US Money Centered Banks simply sold at the same average valuation they would be worth anywhere between 1-3 times higher.  That is quite a bit of upside.  For the US Super Regional Banks the upside for WFC and USB is 61% and 9%, respectively.  Perhaps this explains why Warren Buffett is still buying WFC every quarter.   He's buying a 60 cent dollar laying out in plain view for all to see. 

Can we do even better than the common shares?  Lets take a look a the TARP warrants sold off by the US treasury a couple years ago.  For this analysis I didn't include the Citigroup warrants because I have no interest in buying Citi common or warrants.  USB bought back the warrants directly from the treasury so they are not publically traded.

Upside in US Large Cap Banks - TARP Warrants

***BAC Class A Warrants shown in table above. 

Here I assumed the common shares were selling at the same P/BV as the Canadian banks and subtracted the strike price.  For example the BAC Class A warrants would be worth $26.01/warrant ($39.31 - $13.30 = $26.01).  Now that leaves quite a bit more upside in the warrants. 
Now I should also mention that these warrants are also adjusted for dividends beyond a certain price.  For the BAC Class A warrants the strike price is adjusted for any dividends above $0.01/share.  The JPM and WFC warrants are adjusted for dividends above $0.38/share and $0.34/share, respectively. 
Now I should mention that the dividend adjustment isn't as straight forward as first appears.  There is a formula in the prospectus that adjusts not only the warrant strike price but ALSO adjusts the number of shares per warrant.  This has been referred to the double racketing feature of these warrants.  I have modeled these adjustments in a spreadsheet and the reader will have to make their own assumptions to estimate the final strike price and the number of common shares that each warrant will purchase many years from now.
It should be noted by the readers that I have not included any upside in the above table for the aforementioned dividend adjustment.  You will have to make your own assumptions. 
The US Large Cap Banks are severely undervalued compared to Canadian Large Cap Banks.  I know this analysis is crude and high level but makes the point of my discussion here very clear.  One would have to look more closely at the price to tangible book value for each bank and determine what types of returns each bank is capable of.  
Lastly the riskiness of each bank should be examined based on the type of assets each hold.  The Level 3 assets should be considered.  I have discussed these factors in the past here on my blog. 
Clearly there is significant value among the US Large Cap Banks.  Once the smoke clears and the real earnings power of these large banks appear, they will trade much higher.  It should also be noted that a number of the US Large Cap Banks are very well capitalized.  For example BAC requires a minimum Basel III capital level of 8.5% and after the third quarter of 2012 their capital level stood at 9%.  I fully expect BAC and all of the US Banks mentioned above to increase the dividend next March.
Good Decisions. 
Best Regards,
Disclosure: Long WFC, JPM.WS, & BAC.WS.A

Wednesday, October 17, 2012

US Energy Independence



Welcome to the shale revolution.  The US is definitely moving toward energy independence with the dramatic rise in shale oil and shale gas. 

Don't be fooled, this is a paradigm shift.


Sunday, October 7, 2012

The Enterprising Investor

In my last post we looked at defensive or passive investing.  Defensive investing is for those with limited time and knowledge yet still want satisfactory results.  On the flip side, if you are willing to put in the time and pick individual stocks you would be considered an enterprising investor. 

So, what exactly is an enterprising investor?  Here is a definition.

The determining trait of the enterprising investor is his willingness to devote time and care to the selection of securities that are both sound and more attractive than the average. Over many decades, an enterprising investor of this sort could expect a worthwhile reward for his extra skill and effort in the form of a better average return than that realized by the passive investor.

Benjamin Graham - The Intelligent Investor

What are the characteristics of the enterprising investor? 

1.  Willingness to devote time
2.  Careful selection of sound and attractive securities
3.  Committed to the effort over a long period of time 

So if you want to be a value investor and your just starting out it is going to take a lot of time.  If your are passionate about the journey it will be a joy, if your are not it will be a huge burden.  Reading financial reports are not for the faint of heart.  As the quote says, the rewarded for your extra skill and effort may be realized by a higher than average return compared to the passive or defensive investor.  

That said, you should also have some realistic expectations.  A few percentage points over an index is reasonable.  If you think you are going to do much better you are self-deceived.  Keep in mind that gains for the entire stock market is a zero sum game.  By this I mean that if the entire market increases by 6% this year and you gain 8%,  another investor of similar size will have a return of 4%.  If you think you can consistently outperform, it will require a number of characteristics. 

Below are three characteristics that I personally believe are helpful in becoming a successful enterprising investor.

1.  Time & Patience

The first key to the success of any enterprising investor is the willingness to spend a lot of time.  Good investment ideas don't just drop from the sky and nobody is going to tell you where the bargains are.  You will have to search them out. 

This involves the second and third points below, namely reading and thinking respectively. 

If you are starting out I would recommend starting with a printed annual report of a company that you are interested in.  Start reading and when you get to some terminology or accounting information you don't understand stop.  Then go on the internet or look in a textbook and find out what it means.  I purchased a good textbook called The Analysis and Use of Financial Statements by Gerald White for this purpose. 

Once you have figured out your missing "gap" go back to the annual report and continue.  I know at the start this will seem like a painstaking process, but unless you want to back for further education you it's not a bad option.  The difference between going back to school and learning on your own is you willingness to persevere.  If you need someone to hold your hand through the process perhaps school is the best option. 

Secondly, you will need patience.  Just because you have money to invest doesn't mean you should invest it right away.  I waited almost two years before I purchased my first stock.  Don't get in a rush, in fact, the more patient you can be the higher your returns will be.  Markets go up, markets go down.  If you ever feel like chasing a stock because you missed the low prices and it's now running up, stop yourself.  The ability to say no and stick to your buying price will be the key. 

A good way to be patient is by using a checklist.  Good thinking requires good questioning ability.  Using a checklist you will bring items to your mind that you otherwise wouldn't have thought of.  You will not miss part of the analysis, will keep things more rational and less emotional.  Remember, the easiest person to fool is yourself.  Our egocentric nature is perhaps the most formidable barrier to clear thinking.  No matter how biased our thinking is it will appear rational to ourselves. 

Perhaps you think you are cool and always rational.  We'll lets test that idea.  Try thinking of a recent disagreement where you were closed-minded while listening to the views of someone else.  Can you think of one?  Perhaps you can only think of examples where the other person was closed-minded, but not yourself?  If you cannot think of any closed-minded examples in yourself, ask you self why? 

(If after some reflection you still cannot think of any closed-mindedness in yourself , you may have moved to a higher level of self-deception.)

2.  Reading

Reading is essential if you want to be a successful investor.  You will want to read widely but also read selectively.  Reading is a time consuming process so you will want to focus your efforts to get the maximum results.  Sell your TV if you don't feel you have any time. 

What kind of reading do I do? 

First off I do not spend hardly any time reading about investing on the internet.  You will not find any good information or sound investment advice there.  I have said before that if you think you are going to find good stock tips on the internet you are only fooling yourself.  Honestly, reading this blog can be a waste of your time.  My online reading consists of a few national newspapers and a few financial reporting websites.

I regularly get my reading material off SEDAR or the U.S. equivalent. SEDAR is an essential source for individual investors in Canada.  There you can get all the documents that companies file with the regulators, so it can help filter some of the nonsense found on company websites.  I particularly enjoy reading what are called Annual Information Form (AIF) found there.  It gives a much better overview of the company, it's history and other important information (ie. Oil & Gas reserve reports). 

Often the most useless pieces of information found on company websites are investor presentations.  While they may give a quick snapshot of the operations, you should always questions the information given there.  All of them have an entire page of legal disclosure at the beginning that tells you that you shouldn't bother reading any further. 

I also read at least two books per month.  Often related to investing but at other times related to the sciences.  I don't read fiction.  I am particularly interested in the soft sciences, such as economics and psychology.  I read to understand human nature and what makes people behave the way they do. 

I just finished an excellent book called The Worldly Philosophers by Robert L. Heilbroner.  It begins by discussing human nature and how we are naturally self centered.  He then walks you through economic thought starting with Adam Smith, David Ricardo, Karl Marx, Thorstein Veblen, John Maynard Keynes, and Joseph Schumpeter.

I enjoy reading, and learning.  It is definitely a passion of mine.  I find it amazing how much the world opens up with the more you learn. 

3.  Independent Thinker

This point has become more clear to me after I read the book called The Snowball by Alice Schroeder.  It is a biography of Warren Buffett, the world most successful investor.  In that book she describes an inner and outer scorecard and how Warren is 100% inner scorecard when it comes to investing.  He doesn't care what others think, if others are buying or selling, or if every wall street analyst has a sell recommendation on a stock he likes. 

I have discussed this along with the topic of self-esteem on my blog before.  Most people derive there self-esteem and self worth based on what other people think and what they think specifically of them.  That would be 100% outer scorecard.  That is why I have written on my blog that the success of Facebook is not hard to understand.  Facebook users are obsessed with impressing others and influencing their friends opinions.  Sadly, too often, they have the opposite result than intended. 

Now if you derive your self-esteem from others you will struggle as an investor.  Once you buy a stock you will mindless watch to see if everyone else agrees with you or not.  Emotions are a huge obstacle to sound reasoning.  Those who have studied the human brain understand this works.

Don't ever forget, the stock market is a collection of irrational individuals.  This would include myself at times.  The key is to understanding and thinking clearly about the irrationality and fears of other market participants.  That is where you will gain an edge over time. 

This blog post is getting long so I'll end this point with two book recommendations.  The first is The Six Pillars of Self-Esteem by Nathaniel Brandon and the other is Critical Thinking by Richard W. Paul & Linda Elder.  Both are excellent books on their respective topics. 

I should also add that you cannot simply learn about critical thinking from a book.  Critical thinking involves objective self examination and comes through increased self awareness.  It is a journey where you build your self awareness and as a result you begin to think more rationally. 


Becoming a enterprising investor involves a large commitment for those who what to be successful.  It involves Time & Patience, Reading, and Independent Thinking.  It isn't easy but the results are rewarding.  You will gain and develop new skills.  You will increase your thinking ability and self-esteem.  Looking back at what I have written above, it appears to be quite a tall order.  While it does appear to be quite an undertaking, start by taking one step at a time. 

One final caveat is in order.  If you want to be an enterprising investor and are solely focused on the money or getting rich, the whole process is doomed to failure.  You will be too emotional and will end up making risky bets.  On the other hand, if you focus on the process of finding a bargain you will be much more successful.  So focused on the process, enjoy the process, and the results will come. 

Best Regards,

Kevin Graham


Disclosure: Long BRK.b (Warren Buffet's company)

Saturday, September 15, 2012

Defensive Investing

I received an email from an aspiring value investor.  He was inquiring about how and where to start on his value investing journey. 

Here is my initial response. 


We'll your background sound a lot like mine but I'm sure you didn't lose as much (percentage wise) as I did when I started.

Taking responsibility for your own investments is a very wise move because there are ways to invest that will save you a lot of money in the long run.

For example, if you invest in mutual funds, you are basically giving away 2-3% of your money every year for expert money management. The problem is these so called professionals don't really care about you. All they care about is their job. You see the biggest risk to them is losing their million dollar a year job. So what they do to minimize that risk is to perform as close to the index as possible. If their performance is to far below the index people will pull their money out and if they are relatively close nobody will pull their money out. So they don't really care about you doing well or outperforming in the long run.

The solution to this problem is quite easy. Fire all advisors and just buy a very low cost index fund, like a vanguard fund or a TD e-series fund. These index funds effectively get you the same thing without the huge fees and expenses.

Now the next question is if you want to be an passive or active investor. Ben Graham used the terms defensive or enterprising investors in his book.

If you want to minimize the time you spend on investing you would be a defensive or passive investor. If you want to do this I would recommend three investment options for you. They are, in no particular order, investing in Fairfax Financial common stock, investing in the Horizons HAV ETF, and lastly investing in Chou mutual funds.

With that said, it appears that I have gone against what I have said above regarding mutual funds. The major differences are in the cost and value you receive. Always remember price is what you pay, value is what you get. When you buy the Horizons HAV ETF you are paying a relatively low fee of 0.7%, I believe. Now that is a very low fee but what you are getting is top notch investment management by Vito Maida, a proven value investor. His long term record speaks for itself and he is ultra conservative. Don't expect huge gains but you will achieve steady long term growth.

As for the last option, Chou mutual funds, you are again getting top notch investment management from a great value investor. Francis Chou has slightly higher fees but again you are getting a good money manager. He doesn't buy stocks just for the sake of buying them. He is disciplined to buy when they represent good value and isn't afraid of going against the crowd. He can and does underperform at times but so do all value investors. Value investors are patient and wait for bargains. That said, Mr. Chou has an outstanding long term track record.

Last and certainly not least is Fairfax Financial (FFH). You can buy the common stock in CAD or USD on the TSE. Put your money in Fairfax and sleep soundly at night. Fairfax is run by Prem Watsa who is sometimes referred to the Warren Buffett of Canada. Fairfax is similar to Berkshire Hathaway (Warren Buffett's company) in that they are predominately insurance companies, Fairfax more so. When you match an insurance company with proven value investing, what you get a cash flow machine. This is proven in Fairfax's long term record. The have grown book value at something like 24% for the past 26 years. Now don't get too excited because the past is the past. Looking forward expect them to grow book value at 10-15% over the long term, not the short term.

If you want an even better strategy, buy or dollar cost average into Fairfax when it trades below book value. Be more aggressive the lower it goes. The rest of the time just keep accumulating cash in your savings account. Fairfax's stock price, like all companies, move up and down based on expectations of fear and greed. When it sells below book value people are fearful, and when it sells for 3 times book value people are greedy. With that said, Fairfax will likely only sell below book value when it appears the sky is falling and all the pundits on TV are screaming sell, sell, sell. It takes courage and a willingness to stand alone when everyone else is heading for the exits.

Now if you want to be an enterprising or active investor that is another story... (to be continued).


Disclosure: Long FFH

Wednesday, September 12, 2012

Peak Oil is a Myth

I just read an interesting article in the Globe and Mail on U.S. oil production.  Here is the quote that I found most interesting.

The coming change, according to Bentek, is startling: By 2016, the U.S. will surpass its 1970 oil production peak of 9.6 million barrels a day; by 2022, it will have leapt to 11.6 million barrels a day.

So much for peak oil, it's clearly a myth. 

When you don't account for changes in technology and prices, sure peak oil sound reasonable.  The problem is you can't treat a dynamic situation as a static analysis.  Assumptions make for pretty formulas but don't reflect reality. 

For the full article:

In other news, the North Dakota Department of Mineral Resources just reported record oil production of 20 million barrels in July.  That is up 59% from the year before.  If you step back and look at the big picture, oil production in the state is up 7 times in 7 years.  Remarkable.   


Saturday, September 8, 2012

Canada - Headed for a Crash

I thought I would write down a few thoughts on the markets, specifically macroeconomic themes.

For those who have read this blog for any amount of time will understand that I am quite worried about the collapse of the commodity bubble.  I know some disagree that we are in a commodity bubble and that is fine.  China, a huge consumer of commodities, has started to falter lately and GDP growth estimates keep falling.  The housing bubble in China has recently collapsed.  That will lower demand for all commodities.  Goldman Sachs just issued a warning regarding Chinese growth as well.

For a refresher I would suggest reading the comments from Prem Watsa on China/Commodity bubble that I posted earlier this year.  Much of what he has said is starting to come to light today.

What worries me is the spillover into Canada, which will not be spared.  Vancouver real estate appears to begun to falter as seen here:

I believe Canada, Australia, and most of the mining sector is in for much harder times.  This isn't really surprising given the record high profit margins all these commodity companies have enjoyed for the past several years.  A number of companies such as BHP Billiton, Rio Tinto, Teck and others have recently issued warning about falling demand. 

As for positives here in Canada I don't see much.  I own a select few stocks from Canada and could generate a solid list of short candidates, starting with the banks. 

How about positives?

So what areas do I see as a positive going forward?  In no particular order:

US homebuilders and Mortgage Originators are good bets.  The sector is going to have nothing but a tail wind behind it going forward.  I own the largest mortgage originators in the US and one of the largest homebuilders. 

I like the US banks and I would sell the Canadian Banks.  The US banks have strongly recapitalized themselves and could suffer huge losses before running into trouble.  I know most people shy away from the sector because the financial crisis is fresh in their mind.  That is perhaps the biggest reason for bargains to be found in the sector. 

On the other hand, the Canadian banks sell for much higher valuations and are loaded up of over-leveraged Canadian consumer debt, some worse than others.  The graph below makes this point rather clearly. 


The problem is that Canadians have been using their houses like ATM machines, much the like the US did in the run up to their correction.  In the US, home equity withdrawls peaked at 8-9% of personal disposable income in 2006.  Here in Canada we apparently didn't get the memo that this is a problem and is not sustainable.  Since 2006, Canadians have been using their home ATM at a rate 8-9% of personal disposable income.  That will end... and it will end badly for our economy. 

South of the border the US real estate markets appear to be on the mend.  Housing prices have bottomed and most regions are up marginally.  This bodes well for the healing necessary in the housing market.  As Warren Buffett has said, the unemployment rate will fall dramatically once the housing sector begins to rebound. 

As noted in my previous post, natural gas is at very low prices and that is showing up strongly in the reduction in drilling.  Investing in any commodity that is selling at prices below the marginal cost of production is always a good bet to take.  I own the lowest cost explorer and producer of natural gas in Canada. 

One theme I particularly like but haven't actively invested in would be companies that buys commodities and sell a brand.  These companies are the most likely beneficiary of lower commodity prices as margins are likely to expand in the short to medium term.  If you have any suggestions feel free to email ("contact" tab above) or add your comments below. 

I think insurance companies are a good bet as interest rates rise.  That said, I don't expect interest rates to rise any time soon.  The debt deleveraging process has only begun and I believe we are in the midst of a debt deflation period.

As for stocks that I believe are cheap, Fairfax Financial (FFH) just hit a 52 week low this past week, JP Morgan (JPM) is a no brainer with an easy 20% upside from here even in sideways market.  Magna International (MG) appears quite cheap and auto sales are on the rebound.  General Motors (GM) looks interesting as cash on the balance sheet almost equals its market cap.  A number of technology names look cheap such as Dell (DELL) and Intel (INTC) now that the stock has come down again.  I have mentioned Speedway Motorsports (TRK) here before and now the the stock has come down again I think the price is reasonable. 

I have looked into at least 30 small caps over the past month and haven't found anything to get excited about (mostly in Canada).  I believe most small caps to be overvalued at this point in time because of the fragile nature of the economy.  With so many cheap, high quality, large caps available today I don't see much reason to look elsewhere.  Many of the large caps have strong balance sheets, can and have been issuing debt at record low interest rates recently, and can weather any storm in the economy much better than smaller competitors. 

So far, year to date, my portfolio is soundly outperforming the S&P 500 and trouncing the S&P/TSE index.  Because of the strong markets, I am in the process of reducing most of my holdings and keeping the proceed in cash.  That said, I don't tend to make wide changes in my portfolio and this year I have only made a few select purchases.  I will be looking at short ideas for Canada in the near future.  Suggestions always welcome. 


Disclosure: I am long FFH, and JPM TARP warrants.

Sunday, September 2, 2012

US Oil and Gas Drilling

Here are a few interesting graphs on the Natural Gas (NG) supply situation.  The current oversupply has led to a sharp drop in exploratory and development drilling for NG in the US.  Also show is the record levels of US oil drilling. 

(Click on image for a larger view)

Exploratory drilling in the US has come to a complete halt.  In both May and June not one exploratory gas well was drilled in the US.  Since March of this year only 14 exploratory gas wells have been drilled. 

Meanwhile exploratory drilling for oil is at the highest level in 27 years. 

As seen in the above graph, development drilling for gas has finally fallen to decade lows. We have not seen this low of a level of development drilling since the mid 1990's. Low gas prices are finally starting to have an impact.

By comparison, oil development drilling is at a 26 year high and for good reason, oil prices are in a bubble.  This has led to an explosion in oil production in the US.

Crude Oil Production US Lower 48

Due to the strong exploratory and development drilling for oil, crude oil production in the lower 48 is at a 23 year high as seen above.  The increase in production over the last couple years is quite remarkable. 

So much for peak oil, as many bloggers have aptly named peak idiocy.  I have commented before how peak oil theorists misunderstand basic economics, especially how price impacts both technological advancement and substitutionary effects. 

The bottom line is that oil production is strong and growing in the US.  Couple this with weak global demand, especially from China, crude oil is likely to fall.  I can't tell you when but it will fall. 

As for NG, low prices have finally taken their toll as exploration and production companies have nearly stopped drilling.  One of the main exceptions to this trend is Peyto, who has 8 rigs running as of the end of August. That makes them the second most active driller in Alberta for 3000+ meter rigs. 

It will be interesting to see how fast the production response will be to the decreased natural gas drilling.  The sooner the better, I hope. 


Disclosure: Long PEY

Saturday, September 1, 2012

Inflation or Deflation?

I have been thinking lately (go figure), and I have been trying to understand the whole inflation/deflation debate.  My question is below.   

Almost everywhere I look I see comments that all the money printing by the US Federal Reserve will lead to inflation.  Despite tripling their balance sheet inflation hasn't shown up at all.  The data actually points to slowing inflation. 

Are people making a flawed assumption that the money printing at the Fed will lead to inflation? 

That brings me to my second point, it appears that we are more likely headed toward deflation instead of inflation.  That seems at odds with conventional wisdom, but the Japanese experience of the 1990's comes to mind.  Add to this the fact that Fairfax Financial has some derivatives bets on deflation, they must feel deflation is a higher probability. 

What I find interesting is that people automatically link money printing to inflation, but is that a flawed assumption?  Don't get me wrong, I do believe it will have long term ramifications but in the short term we see some fairly astute investors (at Fairfax) betting the other way.  What gives?  Is the huge amount of debt in the system going to lead us toward deflation? 

Any Thoughts? 

I have some ideas on the subject but would like to see others think about this.  You can comment, anonymous comments will be allowed, or you can send me an email. 


Disclosure: Long FFH

Sunday, August 26, 2012

The Peyto Advantage

This is perhaps one of the best videos I have ever seen on the Peyto Advantage.  As mentioned in my previous post, Peyto is the low cost operator and developer of natural gas in Canada. 

Darren Gee, the current CEO of Peyto, gives an excellent overview of the company in this presentation.  I know Peyto isn't real popular at these energy conferences, mostly because they often show a lot of industry comparison slides.  Darren doesn't do that much in the following presentation but you can find more industry comparison slides on their website (Click Here).

My favorite quote from Darren has to be from a couple years ago when he said something like, "Every oil and gas company comes to these conferences and announce they can drill 100% rate of return wells.  What I don't understand is why aren't those same economics coming out of the back end of the company in the reported financial statements?"  Good Question!


Disclosure: Long PEY.

Wednesday, August 22, 2012

Peyto Exploration & Development

Well I guess it's time to reveal the company I said I was about to purchase back in April (Click here for that post).

We'll that company was Peyto Exploration and Development (PEY). I really thought that natural gas (NG) prices were going to stay low for the summer, perhaps even lower than where they are today.  I was surprise to see the run up in the share price since my purchase, up just shy of 45% excluding dividend.  I was hoping to make more purchases during the summer at even lower prices but that did not materialize. 

I did put over 5% of my portfolio in PEY, and wanted to take it to 10%, but I don't think that will be happening now.  (I also purchased for a family member's account)

For those who know me, you already know that I have had a significant amount of my portfolio in Peyto for just about ten years.  Needless to say its been a very successful investment (see chart below).  I started selling over the past couple years, after natural gas prices started falling.  Now that gas prices are at the bottom I feel it is a good time to start accumulating again.  I also happen to hit the bottom of the falling share price this year, within a day, but that was 100% pure luck. 

I wrote a fairly extensive writeup of PEY a few years back on seeking alpha.  You can read it here:

Peyto is a unique company in the energy space and their track record clearly backs it up. 

When I look to invest in any commodity company I am only interested in one thing.  Who is the lowest cost operator?  Everything else really isn't not all that important.  All the competitors sell the same product at nearly the same price and you have absolutely no differentiation between businesses.  So when you find the lowest cost operator you need look no further because they will make the highest profit margins within the category.  It's really that simply. 

I really don't spend a lot of time looking at other names in the space because being the lowest cost operator is THE ONLY competitive advantage you can have.  You will earn the highest profit margins when commodity prices are high and you be the only company to earn a profit when prices are low. 

Beyond buying the lowest cost company you must also ask yourself what is the price of the underlying commodity going to do?  Since Peyto produces NG, you must be sure that NG prices are going to rise.  You can own the most fantastic business in the world but if their prices are falling your investment is likely to fall also.  Since Peyto is the lowest cost operator, by a large margin, this means they will be the last company to earn a profit as NG prices fall.  We have seen this through this cycle as nearly every NG company is losing money while Peyto is still profitable, even at these current low gas prices. 

Because companies cannot control the price of the commodity I tend to stay away from the sector because the risks are too great.  It's really speculation on the underlying commodity.  All the company can control is production.  Peyto and their operations are with my circle of competence, while commodity prices are not.  Let me explain.

Circle of Competence

I define your circle of competence a little differently than others.  I consider it to be the separation between what you know and what you don't know.  The difference between your facts and your assumptions. 

I have told my son the difference between smart people and dumb people is that smart people understand what they don't know.  Or at minimum they try to determine where that line is.  I have heard this referred to as second level thinking, or critical thinking.  The ironic part is many people have no idea where that line is and more importantly when they cross that line.

So, what about yourself?  Let's take a little test to see if you know where that line is. 

Q1.  Driving due south from Detroit, what is the first country you will come to when you leave the U.S.?

a) Cuba
b) Canada
c) Mexico
d) Guatemala

Are you 100% sure? 95%? 90%? Or less?

Q2.  Which country derives more than 75% of its energy from nuclear power?

a) United States
b) France
c) Japan
d) none of the above

Are you 100% sure? 95%? 90%? Or less?

Q3.  Approximately how many microbes live in the typical person's gastrointestinal tract?

a) 100 trillion
b) 100 billion
c) 100 million
d) 100,000

Are you 100% sure? 95%? 90%? Or less?

(Answers below)

I am likewise just as capable of crossing that line (and don't even realize it when I do).  I am just aware and try to minimize crossing that line but I'm not foolish enough to think that I never cross it.  The more consciously I live, the more likely I will stay in and around my circle of competence. 

So this is what Warren Buffett means when he talks about your circle of competence.  It's separating your facts from assumptions.  The more you can rely on facts and not assumptions the more successful your investment results will be.  Assumptions require judgement, and often a range of possibilities.  Minimizing these assumptions will maximize returns. 

In value investing, the more you can define what you know versus what you don't know the more successful you'll be.

This is how Warren Buffett operates.  He invests in consistent companies that have a strong competitive advantage and pricing power selling at a cheap price.  If a company has very consistent operating history and has a slight hiccup, the market can be unforgiving.  If you know the hiccup is non life threatening and non reoccurring it likely is a good opportunity.  This is what Buffett refers to jumping over a 1 ft bar rather than trying to clear a 8 ft bar. 

Similarly Buffett doesn't need to make assumptions regarding bubble gum, ice cream, carpet or Coke.  Every one of these products will have growing demand in the future. 

How about commodity prices?  How many investors know where prices will end up next year?  If you find someone who knows the answer, I'll introduce you to a liar. 

So when you invest in commodity companies you start with a huge assumption and that assumption plays a huge part of success of the investment.  That is why I typically stay away from commodity companies.

When are Commodity Companies a Good Investment? 

The only good time to buy a commodity is when its price is low.  That usually happens when the prices are lower than the marginal cost of production.  In the NG sector we are experiencing record low gas prices and many producers are losing money.  To me, that represents a great time to invest. 

Coming out of last winter's heating season it was clear we were headed for a NG supply glut and that is exactly what happened.  NG prices have been falling for a few years now and around late 2011 they really started to tank.  They seem to formed a bottom this summer. 

Much of the low NG prices can also be attributed to drilling bonanza in the US shale gas plays.  That will continue while capital continues to flow into the sector while the land grab is on but won't last forever. 

Perhaps low gas prices are the new normal?  If that's the case, many companies might be left holding a lot of worthless assets.  Buyer beware. 

Why Peyto? 

For those familiar with Peyto you will know that they are operationally on a roll.  Production per share has risen dramatically over the past few years.  Last year was an excellent year for drilling results that was masked by low gas prices.

Peyto is currently selling for around 40 times Q2 earnings (annualized) and three times book value.  Goes to show you those metrics don't really matter in some investments.  It's much more about valuing the assets and buying with a margin of safety.  Peyto has the assets and if NG prices rise over the next couple years, Peyto is going much higher. 

Looking back Peyto may be a screaming buy at current prices, but again that hinges on your outlook for NG prices. 

An important consideration for me was the fact that this spring Peyto was selling as cheap as it was during the darkest days of the credit crunch in 2009 (adjust for the increase in production and decline in NG prices).  Technical analysis wouldn't have caught this information.  I watched the stock fall and then it started to sell off really hard for a few days, just before I purchased...  I couldn't resist anymore.  I didn't think twice about buying while the share price was plunging.  Anyway, Peyto was selling as cheap as it was during the recession.  It was also yielding over 4.8% at the time of my purchases.

More recently, Peyto just announced they closed their Open Range (ONR) acquisition.  It was the first acquisition for Peyto since inception.  This was really a great opportunity for Peyto to add to their land base and give them more production capacity in the greater Sundance area.  Open Range brought around 5500 boe/d of production to the marriage and Peyto brought 42,000 boe/d.  The resultant company will be 3.75% owned by Open Range shareholders and 96.25% owned by Peyto shareholders.  Considering ONR is contributing 11.5% on a production basis, I like the deal.  While this is a very simplistic way of looking at the deal, the real value is in what Peyto will be able to do with the ONR lands & facilities. 

For those unfamiliar with Peyto I would strongly suggest checking out their website, where you will find one of the more shareholder friendly companies in the oil patch.  I also think I caught a juicy piece of information in the Q2 conference call.  For that information though, you'll have to listen for yourself.  Enjoy!


Disclosure:  Long PEY. 

Answers: b, b, a.  You likely guessed Mexico (100% sure), none of the above (70% sure), and 100 million (50% sure).  Don't worry those are typical answers.  (Questions were taken from Jason Zweig's book, Your Money and Your Brain)

Sunday, August 19, 2012

ATPG - Finally Bankrupt

Well it's official.  ATPG Oil & Gas files for Chapter 11 bankruptcy protection.  Here's the link:

For those with any history on my blog, I wrote some very negative things about ATPG back in 2010.  The company was way, way over leveraged and the clock finally ran out.  What I did run into was a firestorm of controversy from so called "value investors" who thought ATPG was a bargain.  One commenter said it was worth $90/share.  I was lectured by many on the "value" in ATPG. 

One fellow said I didn't understand the economics of "reinvestment" (since that is somehow different from "investment").  He was full convinced he was going to make "ridiculous excess gains" at the expense of the ignorant (myself included). 

The math behind financial statements isn't hard, the problem is we often look at them with glasses that distort reality.  Those glasses ignore facts that don't align with what we want to see. 

Anyway, here are some links from my previous blog post (in order):

I posted the same article on Seeking Alpha, check out the controversy in the comments section.

Looking back at those posts, I am still amazed at how strong the cult following for ATPG was.  I had a ton of comments on those above posts telling me where I was "wrong".  I'm still surprised at those who argued with me that ATPG had earned a profit. 

Devon Shire (aka CanadianValue & aka Swizzled)

Clearly this guy has no idea what he's talking about.  I see that he has now changed the name of his blog to be the same as mine.  It's pretty low of him to try and steal traffic to his blog.  I have tried to email him (through several sources) to see if he'll change it, but so far no reply. 

We had some lengthy debates since I started my blog and so far he's batting 0 for 2.  IF YOU HAVE FOLLOWED HIS ADVICE, YOU WOULD HAVE LOST MONEY.  

I find it amazing that he now charges for an investing newsletter, mainly targeting small to mid cap oil and gas.  If anyone reading this subscribes to his newsletter, please email me a copy and I'll gladly review his recommendations. 

Anyone who knows me understands how much this stuff burns me.  The vast majority of investment advice, professional or not, is worthless.  The people who listen to them deserve what they get, however, the so called advisor still keeps the fees.  The mutual fund industry is the worst. 

So what have I learned from this whole experience?  First you must often stand alone and stick to your principles in the face of intense opposition.  Facts are facts, don't ignore them.  The vast majority of "value investors" on the internet are useless.  Often these people read one misguided individual who in turn repeats the same nonsense and the cycle is repeated until a whole mass of "investors" on the internet believe their own story (I wonder how many of them actually read the ATPG annual reports and financial startments). 

On days like this I am reminded of a quote from Warren Buffett. 

The market, like the Lord, helps those who help themselves.  The market, unlike the Lord, does not forgive those who know not what they do. 

Best Regards,


Disclosure: None. 

Wednesday, July 25, 2012

Microsoft - Value or Not (Part 2)?

Here is the response I got from the fellow investor whom I wrote my original response.  I believe other's will find this interesting.  Enjoy.

Thanks Kevin: I respect contrary views and learn from them, so please keep them coming.

I agree the financial metrics for MSFT are impressive-- as they were for RIMM, HPQ and NOK. Look how quickly that can change. Many highly respected (by me) value investors own all those companies too. The crowd isn't necessarily correct, even amongst the elites-- thank God for that or we'd never have a chance getting an edge in the market.

My view is that the technology sector is a tough neighborhood these days such that once a company loses its momentum, it is very difficult to restore it-- particularly when you are a giant like MSFT. History has borne this theme out. How many *thriving* companies in the tech sector can you name that have existed longer than 10 years? By thriving, I mean gaining market share and growing both the top line and bottom line. A handful, and some of the few that do qualify have questionable prospects, like MSFT and CSCO. 10 years from now, I wouldn't be shocked if MSFT, CSCO, GOOG and even AAPL (gasp!) no longer existed or were irrelevant. That's my opinion, for what it's worth.

Some of the other woes MSFT faces (I'm sure there are more, but I'm not an expert on MSFT):

1. MSFT has entered a gigantic partnership with NOK (!!!) to launch their phone platform. That's not exactly a blue sky situation and MSFT expects billions of dollars of revenue from the venture. NOK is in the ICU on life support with the crash cart by the bedside. Doesn't look too good....

2. PC sales growth these days is mostly sourced from emerging markets where piracy rates are high and IP protection is a low priority. Morningstar forecasts margin compression due to these very important unfavourable effects.

3. The HTML 5.0 web standard should accelerate cloud computing adoption by the same businesses that could not change over to other OS's in the past. There's no reason to believe that MSFT can transition to a cloud based SAAS enterprise easily, efficiently or effectively.

4. MSFT's size has made it a ongoing target for adverse political interventions worldwide. This has adversely affected the corporate culture as you can see from one employee review taken from

While Microsoft always tried to avoid being become large and bureacratic that's exactly what we've become. Our fear was always that we would become IBM after the DOJ settlement. Ballmer swore up and down that we would never fall into that trap, but the reality is with our size and the constant scrutiny be governments around the world we have become this generations IBM. Everything we do is scrutinzed by lawyers first, we all have to go through training to understand what we can't and can do for customers and partners, while our smaller nimbler competitors can react much more quickly than us.

I noticed that Bill Gates has sold $60MM worth of stock in late 2011 and 2012. I originally thought this was due to the funding requirement for his Foundation as part of an orderly liquidation of his portfolio; however, I see he's been buying Diamond Foods, Ecomotors and Tripadvisor in the same time period, so he may well not be a MSFT bull either.



Here is my lastest response:

I enjoy the discussion too. I was just getting tired with the comparisons to RIMM, HP and NOK that you continue to make. Let's start there.

First you said.

I agree the financial metrics for MSFT are impressive-- as they were for RIMM, HPQ and NOK.

This is hardly an accurate comparison. MSFT hasn't stumbled at all from a financial standpoint while all the rest have. Unless you can predict the future, I believe you are giving opinion and not fact. I don't have a problem with opinion, they are needed in investing. But to compare MSFT to these companies is a stretch, but is widely believed by many. That is my point. Many investors look at the chart and conclude the underlying business is struggling. MSFT hasn't struggled over the past 5 years, but instead have doubled earnings.

You also said (not in the above message):

Even more interesting is that I couldn't find a single bear case write up for MSFT on any of the investing websites I frequent (and I frequent most of them)-- not a single one. Talk about a rosy consensus.

What about your original email? Does that one count? Isn't the author a CFA? I really don't get the "not a single one" comment, in light of the article you sent.

Back in 2000 MSFT was selling for 50x earnings. That was a rosy consensus. Today they are devoid of a rosy consensus and sell for 7x earnings (net of cash). They have grown EPS 3.3x over that period.

Anyway, I agree that the tech sector is a difficult neighbourhood these day but that is mainly a function of market sentiment. Technology will continue to change our lives. I agree it is difficult to predict the future, but my argument is different. It's that MSFT is so cheap and generates so much cash that your getting a *free* wild card on the future. I'm not paying up for a rosy consensus, I'm getting any future upside for free.

1. Nokia's partnership. If Nokia fails this will have little bearing on MSFT. It will suffer a blow to MSFT in the phone market but they don't exactly have anything to lose, do they? Again this offers upside and I don't have high hopes but who really knows. You believe that it will be negative, I don't know.

2. PC sales. This has been a headline story for some time. The only problem is that it really hasn't impacted the financial results all that much. I understand PC sales are flat and the trends are moving toward cloud computing, but MSFT does have a strategy for cloud computing.

On the topic of PC's, I am in some training this week with some staff from Intel. I have been quizzing them up on the ultrabook, among other things. The have a strong belief that the laptop won't be going away for some time. I would tend to agree.

3. HTML 5 and cloud computing. I don't understand the sector well enough to make a call on how this will play out. Office 365 is being utilized by many large companies such as Lowe's, Quantas, Japan Airlines and Hallmark Cards. The biggest adoption of Office 365 will likely come from small businesses, which is a huge market.

4. Political risk has been around for decades. The business has grown through it anyway. Company culture may very well suck. I hope it does suck. That is something that can always be changed and improved. Just ask IBM or read the book "Who Says Elephant's Can't Dance."

I find it amazing that a business that enjoys 80% gross margins is a business that people think is a poor one. It's not like they have huge competitors in many of their lines of business. Once competition shows up you will see this needle move significantly... just ask RIMM. And RIMM didn't have anywhere near those types of gross margins. Apple's gross margins are less than 50% for pete's sake.

As for Apple, that is a stock where I would have concern. It's purely a consumer show and sales can rise and fall much quicker than expected. The quarter released today is evidence of that. Despite the headline nonsense, revenue and profits were up nicely. The problem is the forecast doesn't look good. The sales of the ipad and iphone can rise and fall as quickly as the ipod has. What are the entrenched advantage of AAPL? Consumer loyalty? That can change overnight as we saw with RIMM. All it takes is the next "cool" device, crackberry's were the rage before the iphone. MSFT has much stronger ties to business and that doesn't tend to change very much. It's too costly to change and re-train everyone. In some cases it's nearly impossible to change.

As for RIMM I don't have high hopes for the future but QNX (the wholly owned software company) does have a strangle hold on vehicle software market. Something like 65% of new vehicles use their software. If RIMM can leverage that they may have a hope. That said, they also better have good devices going forward.

Anyway I should probably quit with the comments on tech. I'm no expert.

Maybe I should just stay away from MSFT but the math is just too good for me. I also believe I have a margin of safety.

Thriving 10 year tech companies: MSFT, IBM, ORCL, CSCO, INTC, ADBE, ANSS, SAP... to name a few. 
Disclosure:  Long MSFT

Monday, July 23, 2012

Microsoft - Value or Not?

I was recently sent a link to an article on Why Windows 8 Made me Sell Microsoft (MSFT).  The article says that Windows 8 sucks and is going to be bad for Microsoft.  Maybe it will suck...  I don't know that for sure.  This was my response. 

I am long MSFT. Let me tell you why.

Over the past 10 years they have grown revenue by 13%, earnings by 10%. Over the past 5 years they have grown revenue by 14% and earnings by 13.5%. Yes it is value stock, as we will see, but by those numbers you would think MSFT is a growth stock... but anyway.

Last year they generated $31.6 billion in cash from operations and the capex forecast is $3 billion in the coming fiscal year. That means the owner earnings are running around $3.40/shr. They are generating $2.4 billion in free cash per month and have 63 billion of cash at end of the last quarter. I understand the markets believe they will squander some of their cash on dumb acquisitions (they have before), but let's get serious MSFT is a licence to print money.

Many people look at the share price for the past ten years and have no idea about the underlying business performance of the different divisions. I don't know the future, but today you can buy MSFT at 6.4 times owner earnings or a 15.5% owner earnings yield (net of cash). That is cheap, dirt cheap. If I quoted these figures without giving the name of the business, most every investor would be chomping at the bit to know what company I am talking about. Tell them it's MSFT and they aren't interested.

I can't predict the future but I do know the company's operating performance over the past 10 years has been phenomenal. The past 5 years have been even better. Windows 8 may be great or it might be a flop, Vista was a flop too. I do know that Windows is so entrenched in businesses and consumer PC's that they are not going anywhere. Growth in Servers and Tools has been good and Entertainment has been fantastic. The Windows division was down slightly last year.

I just listened to the conference call and came away with the complete opposite impression regarding the outlook of the company.

So let me highlight my reasons why I believe differently:

1) My opinion was based on financial performance that have yet to show any hint of let up, while this guy "thinks" that Windows 8 will be a flop.

2) Secondly even if he proves correct that Windows 8 is a flop and earnings fall flat or down in the Windows division, I still have an large margin of safety. (My cost is also 25% lower than current market prices)

3) I have different opinion of MSFT's entrenched moat, particularly in businesses. Change just isn't an option.

4) While this goes counter to my recent blog posts on social metaphysics, it still is a fact... MSFT is the most widely held stock by value investors and the second most widely held business by % of assets (the first is Berkshire).  You can see the list at the link below. 

Best Regards,

Disclosure: Long MSFT & BRK.b

Thursday, July 19, 2012

Salida Capital - Death of a Hedge Fund?

Salida Capital, the once loved commodities hedge fund may be nearing death. 

See the link below for details why.

They also released this additional commentary on their performance for May.

I don't know how any investor can withstand that kind of wild ride.  Hedge funds have no advantage over an individual investor provided that investor has the right character traits.  Intelligence not required.

In the addition commentary they discuss how loyal their investors are.  Appealing to your investors loyalty seem pretty desperate to me. 

I particularly enjoyed this quote from the commentary letter.  

Though we have reduced our exposures to weather this volatility storm, we believe timing the market is an impossible task. We believe we must “take a side” in order to generate wealth over the long term.

Maybe it's just me but I have a hard time making sense of these two statements.  On one hand they don't believe in timing the market yet on the other hand they must "take a side" (or speculate) in order to generate wealth.  What if they continue to be on the "wrong side?" 

They continue to speculate that the US Federal Reserve will do QE3 and investors will flock to commodity investments. 
I believe they won the ebay auction to have dinner with Buffett a few years ago.  Not sure what they learned but it doesn't seem to be paying off. 

Best Regards,

Tuesday, July 17, 2012

Bank of Canada Statement - Translated

The Bank of Canada (BOC) press release today had some interesting tidbits of information. Many of these issues have been discussed on my blog here before so I won't belabor the points. 

I will quote from the release and then give you my translation of what the BOC statement really means.

While the economic expansion in the United States continues at a gradual but somewhat slower pace, developments in Europe point to a renewed contraction.

Growth in the US is slow. The growth is slow but it is still growth. Europe is a mess and headed for a slow down.  Many Europeans don’t understand that production comes before consumption, but don’t worry they will learn their lesson.

In China and other emerging economies, the deceleration in growth has been greater than anticipated, reflecting past policy tightening and weaker external demand. This slowdown in global activity has led to a sizeable reduction in commodity prices, although they remain elevated. The combination of increasing global excess capacity over the projection horizon and reduced commodity prices is expected to moderate global inflationary pressures. Global financial conditions have also deteriorated since April, with periods of considerable volatility. The Bank’s base case projection assumes that the European crisis will continue to be contained, although this assumption is subject to downside risks.

China is a mess.   The Chinese economy has been artificially manipulated for a long time.  The Chinese real estate bubble has burst and the long held belief that real estate prices only rise will soon be a myth.  The real estate and infrastructure bubble in China has led to a dramatic rise in commodity prices.  China consumes the vast majority of commodities in the world while only contributing a much smaller percentage of global GDP.  Europe is also a mess along with many other emerging countries.  All of these factors are aligning such that commodity prices will fall, and fall hard.

While global headwinds are restraining Canadian economic activity, domestic factors are expected to support moderate growth in Canada. The Bank expects the economy to grow at a pace roughly in line with its production potential in the near term, before picking up through 2013. Consumption and business investment are expected to be the primary drivers of growth, reflecting very stimulative domestic financial conditions. However, their pace will be influenced by external headwinds, notably the effects of lower commodity prices on Canadian incomes and wealth, as well as by record-high household debt. Housing activity is expected to slow from record levels.

Despite a huge real estate bubble in China and Europeans who think they can continually live off the backs of others, Canada is in for a wild ride.  Lower commodity prices will lead to lower inflation.  Being that Canada is a huge commodity producing country, the economic impact here will be widespread.  The effect of lower commodity prices will reduce incomes and wealth in Canada. The record level of household debt bodes well for a dramatic increase in bankruptcies.  Housing activity and prices will also fall, perhaps the hardest in Toronto and Vancouver.

The Bank projects that the economy will grow by 2.1 per cent in 2012, 2.3 per cent in 2013 and 2.5 per cent in 2014. The economy is expected to reach full capacity in the second half of 2013, thus operating with a small amount of slack for somewhat longer than previously anticipated.

The Bank has no idea how of the economy will perform.  We previously anticipated faster growth but we were wrong.  Don’t worry though we now have it all figured out and you should believe us going forward.

Best Regards,

For more information on what is happening in China, here is a good place to start:

Disclosure: I have limited exposure to Canadian equities.  I fully expect the Canadian Dollar to fall relative to the US Dollar.

Ben Graham on Social Metaphysics

Here is a quote from Ben Graham,

The true investor scarcely ever is forced to sell his shares, and at all other times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book and no more. Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused by other persons’ mistakes of judgment.

---The Intelligent Investor p. 203

Ignore the market.

Best Regards,
Kevin Graham

Monday, July 9, 2012

Social Metaphysics & Warren Buffett

In my first post (Click Here), I introduced the topic of social metaphysics as defined by psychologist Dr. Nathanial Branden.  I won't repeat the definitions that were developed but wish to continue them in this post.  In short, Social Metaphysics is the process by which men hold the thoughts, values and ideals of others as their source of objective reality.  Social Metaphysicians ask not what is true but what others say is true. 

For example, I constantly hear people say, "Is there a regulation for this or that OR are you certified to do this or that."  Unsure of making their own decisions or learning the answer for them self, they constantly look to others to make judgements.  Often that other person is the government (perhaps my next post will be about Social Metaphysics & Government Reliance).

Moreover, most people believe that the stock market is esoteric or magical.  It's as if some special group of people are the only ones to can decipher its inner workings.  I can assure you it is no such thing.  Anyway, I think you get the point. 

So what does Social Metaphysics have to do with investing.  Well, it turns out quite a bit.  In fact all value investors should be happy that people follow other people.  The herd mentality of wall street is what allows for ridiculous valuations to occur from time to time. 

Because people refuse to trust their own judgement the constantly look to others for guidance and often those "professionals" are similarly misguided.  It's the blind leading the blind.

Social Metaphysics & Warren Buffett

Where I really want to turn this discussion is to investing and Warren Buffett. After I read Buffett's autobiography, "The Snowball", I was struck by his innate self esteem. This is something he calls his inner scorecard. Here is what Alice Schroeder said about Buffett's inner scorecard in an interview:

Schroeder: "In The Snowball, I point out that his father had a 100% inner scorecard about everything. His mother had a 100% outer scorecard about everything. She cared desperately what people thought of the family, of their image. The kids were raised with both of these streams of perception coming in on them. Warren is the product of that. When it comes to investing, business, his principles, his ethics, 100% inner scorecard; he knows what's right. He lives by it. When it comes to how he feels about himself, he is very tender and easily wounded, and other people can make him feel differently. He doesn't have that inner scorecard. And there is a complete separation between the two."

Now if we look back to the original definition of social metaphysics, Mr. Buffett clearly does not suffer from this mental condition. When it comes to investing, he does not care what others think or what others are doing.  He beats to his own drum.  This is perhaps the biggest reason he has been the most successful investor of all time.  He makes his own value judgements and these judgements are often quite rational because they aren't influenced by others (value meaning valuation, not moral judgements).

When it comes to investment decisions, Mr. Buffett is 100% inner scorecard. Charlie Munger is similar to Buffett in this way. Buffett has said many times that Charlie is one of the few people he has met who would tell him his ideas are stupid. Likewise, in most corporations, most junior executives are simply "yes-men" to the CEO.  Dr. Branden would say such individuals lack the sixth pillar of self esteem, namely personal integrity. Buffett and Munger have both personal and mental integrity.  They don't violate their principles in order to stroke a social metaphysician's ego.

It should be abundantly clear why many people struggle when it comes to investing. Amateur investors run around the internet looking for investment ideas from others and that is perhaps why you are reading this blog. Now I'm not suggesting you shouldn't read, you should, but what you read and how you think is much more important.  You should also look to yourself, and only yourself to make value judgement.

Professional money managers, like mutual funds, are generally only concerned with one thing, career risk.  These people run around making sure they don't under perform their peers since that would cost them their job. As Buffett has repeatedly said, nobody ran around and told him what was a good deal.  He had to find those himself.  He just had the rational capacities to make strong value judgements on his own. He wasn't swayed by the lemmings that make the stock market run up and down.

This is a point that needs to be emphasized. Do you buy a stock and then watch what the market does the next hour to see if everyone else agrees with you? How about the next week or month? What if the prices gets cut in half?   Buffett has repeatedly said the market is there to inform you not instruct you, yet countless millions are at the mercy of what other people think. 

What you need to do is independently value a business, buy at a large discount to that value, and ignore the market until it smartens up OR you determine an error in your thinking that led to your valuation.   

A few quotes from Mr. Buffett that relate to our subject.

They (investors) get excited when others get excited, they get greedy when others get greedy, they get fearful when others get fearful... you must detach yourself... from the crowd.

(Speaking about Bill Gates regarding philanthropy)  - He doesn't care if his name is on buildings, I can assure you of that.

You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.

Wild swings in share prices have more to do with the "lemming- like" behaviour of institutional investors than with the aggregate returns of the company they own.

A public opinion poll is no substitute for thought.

Risk comes from not knowing what your doing.

Wall Street is the only place that people ride to in a Rolls Royce to get advice from those who take the subway.

We enjoy the process far more than the proceeds.

You do things when opportunities come along. I've had periods in my life when I've had bundles of ideas come along, and I've had long dry spells. If I get an idea next week, I'll do something. If not, I won't do a damn thing.

Beware of geeks bearing formulas.

The ability to say "no" is a tremendous advantage for an investor.

There seems to be some perverse human characteristic that likes to make easy things difficult. 

Yes Mr. Buffett, it's called Social Metaphysics.


As seen in the quotes above, to be a successful value investor you must be able to:

1) Stand alone & ignore the crowd. 
2) Rely on your own mental faculties and value opportunities independently (then go check what the stock market says).  Be confident in your judgement.
3) Enjoy the (mental) process far more than the proceeds.

Why do people hold the thoughts and values of others above their own?  Mainly, it's to avoid taking personal responsibility.  When you rely on the opinions and ideas of others, it's really easy to blame other when things go wrong. 

I learned this the hard way when I blindly invested in technology back in 1999 and I can assure you it will never happen again.

When you make a mistake once, it's a learning opportunity.  When you make the same mistake twice, it's your fault. 

Best Regards,

Disclosure: Long BRK.b