Monday, December 8, 2014

AutoCanada - ACQ - An update

Below is an update to the ACQ article I wrote a few months ago.  It was selected for an award at  Please note the article will be open to the public for the next 48 hours. 

The article also explains why I haven't written much in the past few months.  I am currently pursuing my MBA.

Best Regards,

Sunday, August 24, 2014

The Value Proposition by Kim Shannon

One of the perks of having a blog like this is that you get contacted by a wide variety of people.  Most people want to discuss investment ideas, some discuss startups, and some are company executives or directors.  A few months back, I was contacted to do a book review on a home grown Canadian value investor.  Since I love to read I could never turn down a book, particularly one related to value investing.
The book is called The Value Proposition – Sionna’s Common Sense Path to Investment Success written by Kim Shannon (CFA, MBA).  Kim has over 25 years of investment experience as a value investor and since 2002 has served as chief investment officer and president of the firm she founded, Sionna Investment Managers Inc. 
Overall ,I would recommend the book to those who want to understand the fundamentals of the value investing framework.  The book caters to a wide audience and I feel both investors and non-investors will learn something from the book.  One thing I found particularly interesting was the reasons why they talk to the management of the firms they invest in, while most value investors don’t (more below)
The book is divided into three sections.  The first section is an introduction to Kim Shannon and the firm she founded.  The second is about Sionna’s philosophy and the last section is about the how Sionna implements its own take on value investing.
In this article I will describe my key takeaways from the book and a few principles that I found interesting or disagreed with.   

Introduction and History

This section discusses Kim’s unconventional upbringing in a military family.  Which had its positives but also had it's negatives.  The most positive lasting impacts were that she developed independent thinking abilities and wasn’t afraid to stand alone (pg. 11).  These attributes will help any value investor as you must be able to trust your own judgment.  Kim also had a passion for reading and learning.  Those are both cornerstones for personal development and are critical for investment success. 

Sionna’s Philosophy

Sionna is based on a value philosophy and they strive to be client centered.  Although most investment firms say they are client centered, I definitely took away from the book that they have more integrity than most investment firms in this regard.  One of the most important keys to a successful investment management firm is to have clients who both understand and share the investing mindset of the firm.  For value firms, this means underperformance when bull markets are raging and outperformance often comes when markets turn down.  The reason this happens is that value investors have a belief in the rationality of the markets over the long term, but definitely not in the short term. 

When you think about it clearly, companies can’t alter their underlying values to a large degree over the short term, but their share price can fluctuate dramatically.  Companies simply don’t have the capacity to double or triple in a matter of months, but the prices of their shares can.”  (pg. 27)

I couldn’t have agreed more when I read this quote.  People don’t get quotes on land, houses, or other assets they own every hour, but they do get quotes on price of businesses on the stock market every second.  These values can and do rise and fall quite dramatically over short periods of time.  This is what makes value investing successful because if you can successfully value a company and buy at a discount you have much better odds at outperforming those who don’t have a clue as to what they are doing.  And that includes more investment professionals than you realize.   
One key difference from Sionna to other investment firms is that they use a relative value approach.  This means they select stocks from all sectors and also stay invested in bull or bear markets.  They are always looking for the cheapest companies in each sector at all times.  This is particularly important in Canada where resource and financial firms dominate your investment choices. 
The benefits of the relative value approach listed in the book were better diversification and a smoother ride.  The smoother ride is definitely helpful to keep clients from selling out at the wrong times.
While the relative value approach has some benefits I couldn’t help but ask myself, what are the downsides?  This is where I found the book lacked because it didn’t discuss the downside. 
I feel there are a few downsides to this approach.  First of all, a relative value approach may take you into a sector where all companies are overvalued.  Just because a stock is the cheapest in a sector doesn’t mean it is cheap.  It could also be overvalued, so why risk the capital for the sake of diversification?  Secondly, the smoother ride is nice but you can't do this without sacrificing the highest attainable total return.  Personally, I prefer to go where the value is and not be constrained by any sector or requirement to be diversified. 
Some of the other foundations to their approach are reversion to the mean and the sources of total equity returns.  What I found interesting is that in range bound markets (see GDP & Stock Market Returns ) 90% of equity returns comes from dividends.  This makes total sense when you look at a company like Microsoft that has been range bound for more than a decade.  While the company has experienced very strong earnings growth, it has been masked by shrinking multiples (P/E ratio).  In Microsoft’s case the P/E ratio fell from over 40x to under 10x during the last 14 years.  The only return investors in MSFT’s stock have seen (until very recently) was in the form of dividends. 
The book briefly talks about other philosophies such as growth, momentum, speculators and Growth at a Reasonable Price (GARP).  I find GARP to be self-deception at its finest.  I constantly see lots of wannabe value investors turn to “GARP” to justify the purchase of their stocks.  Once you start to talk about “growth” you are now turning from what you know to trying to predict what you don’t know.  Being able to differentiate between what you know and what you don’t know is critical to investing.
On a whole I must say I was greatly drawn to the firm and the principles on which they stand.  I wouldn’t hesitate to send potential clients there way as they appear to have more integrity than most investment managers. 

Implementing Investing at Sionna

This is where the book does a really good job and opened my eyes to help me improve my investing ability.  First of all, the book describes their Intrinsic Value Model (IVM).  You will have to read the book for the details; I can’t give it all to you here.  What I will say is that it involves three major quantitative factors: book value, historical ROE, and relative P/E ratio.  Those are all foundational to my own philosophy, so I almost felt I was reading my own approach to investing. 
I tend to think in terms of slightly different factors, those being: book value, normalized ROE, and relative P/BV.  These are only slightly different ways of thinking about the same quantitative factors they use at Sionna.  
From the three quantitative factors they calculate a rough intrinsic value and expected return.  After it passes this preliminary test they do more fundamental research into the company’s financial position.  I especially liked how they approach financial statements very skeptically.
Another key difference to Sionna’s approach is that they attempt to meet with the management of the firms they invest in.  The reason why they do this isn’t to find out more information, although they usually do, but it is to determine whether management is honest and trustworthy. 
Most value investors don’t bother meeting with management because they don’t find it worthwhile and it may even lead to a bad decision.  The reason is that most CEO's are typically quite charismatic and are able to sell ice to an Eskimo. 


If you are looking for a decent book to explain the value investing approach, I would recommend this book.  It provides enough information on both the quantitative and qualitative approaches to solid investing and doesn't waste pages with useless drivel.  As I like to say, most books could be written as a pamphlet and very few authors actually provide new material, chapter after chapter. 
While I understand why they use a relative value approach, I personally could never take such an approach.  I just can’t invest in something only because it is relatively cheap. 
If you are interested in learning how to determine the intrinsic value of a business, the model discussed in this book gives a solid framework on which to do that.  From there you have to dig deeper and look at other quantitative and qualitative measures that are discussed in the book. 

Best Regards,

P.S. I am currently reading Stress Test by Tim Geithner, and it is a fantastic book about the financial crisis.  I'm about half way through and so far I am fascinated at how the various government officials felt like they had to act during the crisis.   
Disclosure: Long MSFT

Monday, June 30, 2014

AutoCanada: CEO sell Millions

  • The CEO is selling between $115 and $150 million of AutoCanada stock.
  • The company is selling $200 million in equity, doubling its equity capital.
  • These actions confirm the overvaluation of AutoCanada.
In my recent article AutoCanada: An Easy Short, I demonstrated the overvaluation of AutoCanada (OTC:AOCIF) (TSE:ACQ). This thesis was recently validated when AutoCanada announced it was raising $200 million in equity. Beyond this, Canada One Auto Group (CAG) is selling $150-200 million of ACQ shares in a secondary offering. Both of these offerings are quite intriguing for different reasons, and will be investigated separately.

Click here to read the press release.

You can read the rest of the article here:

I sold the company, the CEO is selling the company, and senior management is selling the company.

That leaves the question, who would buy the company at the current price?

Best Regards,

Disclosure:  I am short ACQ

Saturday, June 14, 2014

Short Idea - AutoCanada (ACQ)


  • AutoCanada's market cap has exploded from $350 million to $2 billion in a year and a half.
  • AutoCanada's valuation is 3-4x higher than its US peers on a P/E, P/S, P/B, and P/CF basis.
  • The strong auto sales market over the past 4 years has been a huge tailwind. It will no longer have this tailwind going forward.
  • AutoCanada doesn't have voting control over some of its dealerships.
  • Analysts present the illusion of a huge number of acquisitions targets and unlimited growth in Canada. They truth is it only has 3x upside in Canada.

I don't typically share my stock purchases, but this is a unique situation in that I am shorting a stock and I am seeking to bring about a more rational price in the shortest time frame possible.

The stock is AutoCanada (OTC:AOCIF, TSE: ACQ), listed on the Toronto stock exchange. Simply put, the company owns and operates around 34 car dealerships in Canada. The reasons why I am short the stock are explained in the graph below.

To read the rest of this article click on link below:

Best Regards,
Kevin Graham

Disclosure:  Short ACQ

Saturday, May 24, 2014

EconTalk - Marc Andreessen

Every Monday morning I listen to EconTalk, a weekly podcast where Russ Roberts interviews various people of different backgrounds to discuss relevant economics issues.  Russ is a research fellow at Stanford University's Hoover Institute.  He is a fantastic interviewer, makes you think, and often discusses the "unintended" economic consequences of various economic ideas or policies. 

This past week Russ interviewed technology venture capitalist Marc Andreessen.  Mark is best known for co-creating the early web browser Mosaic, and later co-founded Netscape. 

The interview this past week between Russ and Marc was absolutely fantastic.  It is not very common for me to discuss these podcasts with friends/fellow investors but I couldn't resist after listening to this one.  They discussed the challenges of being a venture capitalist (predicting future trends in tech), how smartphones are causing a technology revolution around the world, how Bitcoin is so much more than a digital currency, and how technology has and will affect areas such as newspapers, healthcare, and education. 

The entire interview is great but I found the second half of the podcast to be outstanding.  As many investors understand, the newspaper industry has come under heavy pressure from the internet starting around 2007.  Newspapers, once fantastic businesses are now losing money and have lost their monopolistic dominance over local markets.  The internet now allows people to access news much faster and from different cities.  Marc discusses how the internet has fragmented newspapers and how competition is forcing them to change.  The local monopoly's they once enjoyed are over.  He also discusses the one gift that the internet has given to the newspaper industry.  Myself, like Russ and Marc believe there is still a market for good journalism and news but the future will look different than the past. 

Also, the discussions about Bitcoin, healthcare and education are all well worth the free price of this podcast.

You can stream or download the podcast here:


Kevin Graham

Monday, May 19, 2014

GDP & Stock Market Returns (DJIA)

Today I want to examine the relationship between Gross Domestic Product (GDP) and stock market returns.  The purpose will be to determine if periods of strong economic growth correlate to strong stock market returns.  Does looking at the macro economic data help or hinder you as an investor?

Let's look at the data for the 20th century.  To begin we will examine stock market returns from 1900-2000.  For our purposes we will use the Dow Jones Industrial Average (DJIA), a common market index, as our proxy for overall market returns*.  It is one of the only indexes that has data going back that far. 

The first thing we notice from the graph is that stock markets over this 100 year period can be divided into six distinct periods of time.  The red highlighted periods indicate flat or down markets.  The green highlighted periods indicate upward or bull markets. 

The periods 1900-1921, 1929-1948, & 1966-1981 all saw flat or declining stock prices.  These were fairly long periods of time ranging from 15-21 year in length.  These flat markets accounted for 54.25 years. 

The periods 1921-Fall 1929, 1948-1966, & 1981-2000 all saw huge bull markets for the stock market.  These periods ranged in length from 8.75 years to 19 years.  The stock market gained between 9.8% to 21% annually over these periods.  These bull markets accounted for 45.75 years. 

Let's breakdown and look at the economic growth for each period of the above periods highlighted both red and green in the graph above. 


The first time period was from 1900 until 1921.  So what did GDP do during this period**?

It wasn't exactly smooth growth but for the entire period real GDP grew from $457 billion to $726 billion (all figures in 2009 dollars).  For this period GDP increased 59% or 2.2% annually.  Stock market increased by only 9% or 0.4% annually. 

1921 - Fall 1929

The second period was from 1921 to the fall of 1929, shown below.

During this time period the growth was consistently up with no down years.  Real GDP increased from $726 billion to $966 billion (end of period data used).  During this 9 year period GDP increase 33% or 3.2% annually.  In contrast, the stock market was on fire, increasing 430% or 21.0% annually.

Fall 1929 - 1948

The third period began with the Great Depression in the fall of 1929 lasted until 1948, shown below. 

This period began with a serious decline in real GDP (the Great Depression), but then growth rebounded.  Real GDP increased from $966 billion to $2,018 billion.  During this 18.25 year period real GDP increased 109% or 4.2% annually.  In contrast, the stock market went into a deep slump losing just over half if its value (-52%) or -4.0% annually.

1948 - 1966

The fourth period was from 1948 and lasted until 1966, shown below.

This period saw solid growth, once again, with a few down years.  For the entire period real GDP increased from $2,018 billion to $4,235 billion.  During this 18 year period real GDP increased 110% or 4.2% annually, almost exactly the same as the previous period.  The stock market finally woke up to the strong growth.  The DJIA increased from 181 to 969, increasing 435% or 9.8% annually.

1966 - 1981

The fifth period was from 1966 and lasted until 1981.  This period was marked by high inflation and other worries and is shown below.

This period again saw solid growth again with a few down years.  For the entire period real GDP increased from $4,235 billion to $6,611 billion.  During this 15 year period real GDP increased 56% or 3.0% annually.  The stock market however went into hibernation during this time.  The DJIA was essentially flat with the DJIA falling slightly from 969 to 964.  This equates to a 0.5% decrease for the entire period, or -0.0% annually. 

1981 - 2000

The sixth period was from 1981 and lasted until 2000, shown below.

This period began with a slight recession but once again saw solid growth.  For the entire period real GDP increased from $6,611 billion to $12,565 billion.  During this 19 year period real GDP increased 90% or 3.4% annually.  The stock market once again resumed it's upward march.  The DJIA increased from 964 to 11,497 during this time.  This was the longest bull market during the 20th century with the index increasing 1093% or 13.9% annually. 

To summarize the data, here are the results for the DJIA for each of the six periods. 

Taken as a whole, the DJIA increased from 66 to 11497 from 1900-2000.  During that time the DJIA rose 173 fold or 5.3% annually. 

The DJIA saw a total of 54.25 years of flat or declining values.  Remarkably the DJIA recorded all if its gains over a period of 45.75 years, or less than half of the time.  While economic growth was fairly constantly upward, the returns of the stock market were anything but steady. 

Here is a summary of the data for both real GDP (top table) and real GDP per capita (bottom table) for all six time periods. 

From the top table we can see that for the entire period real GDP grew 26.5 fold or 3.4% annually.  The first thing we can notice is that there was economic expansion during each of the six time periods.  While the growth was strong in some periods and weaker in others, overall it was fairly consistent in the 2-4% range. 

Out of curiosity I also calculated the numbers for real GDP per capita (the bottom table).  Due to population growth, real GDP per capita increased by 6.4 times during the 20th century or 2.0% annually. 

What I find ironic is that the highest level of real GDP per capita growth was during 1929 to 1948 where it increased by 3.2% annually.  This was a time when the stock market was cut in half but the standard of living increased immensely***. 


So what conclusions can be drawn from this?  Over the entire century, 1900-2000, real GDP grew at 3.4% annually and the stock market gained 5.3% annually.  As a whole, real GDP increased slowly and steadily between 2 to 4%.  The same can't be said for the stock market.  Over that same time period the stock market was flat or down 54.25% of the time, while the stock market was up only 45.75% of the time. 

Don't count on macro economic data to help you out in determining where the markets will head next year or next month. 

What about GDP and DJIA returns since 2000?

Here is the data here for your reference and amusement. 

Remarkably, the DJIA was flat for the first 12 years and has only started to rise since late 2012.  History seems to be repeating itself all over again. 

If the stock market rises 5.3% annually during the 21st century, the DJIA will reach 41,811 by 2025, 152,055 by 2050, and 2,011,044 by 2100. 

There will be a few new 52 week highs from the current DJIA level of 16,512.

Best Regards,

Kevin Graham

* DJIA Data Source: Samuel H. Williamson, "Daily Closing Values of the DJA in the United States, 1885 to Present," Measuring Worth, 2014

** US GDP Data Source:  Samuel H. Williamson, "What Was the U.S. GDP Then?" Measuring Worth, 2014.

***Standard of living is commonly measured by growth in real GDP.  While this may be one indicator of our standard of living, it is not a complete measure.  Today, many items we enjoy are free and some items have fallen in price yet have much higher quality and features than previous models and this is not reflected in standard GDP calculations. 

Sunday, April 20, 2014

Investment Risks - China and Market Valuations

The students of Columbia Business School publish an investment newsletter entitled Graham & Doddsville.  I was reading the winter issue on Saturday night and I came across an interesting comment by Jim Grant, publisher of Grant's Interest Rate Observer.  Grant has been commenting on the credit markets since 1983.  Here it is. 

Graham & Doddsville:  

Given the current state of the economy and the low interest rate environment, it sounds like you perceive risks that others do not. What facts, measures, or indications bother you most?

Jim Grant

Here’s a fact: China’s banking assets represent one-third of world GDP, whereas China’s economic output represents only 12% of world GDP. Never before has the world seen the likes of China’s credit bubble. It’s a clear and present danger for us all. 

And here’s a sign of the times: Amazon, with a trailing P/E multiple of more than 1,000, is preparing to build a new corporate headquarters in Seattle that may absorb more than 100% of cumulative net income since the company’s founding in 1994.   

Now, there are always things to worry about. Different today is the monetary policy backdrop. Which values are true? Which are inflated? In a time of zero percent interest rates, it’s not always easy to tell.

The risks in China have not gone away.  Here is an update on why.

As I have written before, defining risk is the most important aspect of investing.  Risk is not volatility, risk is permanent loss of capital.  The risks of the real estate bubble in China are huge and is a real reason to be defensive. 

Once this bubble in China bursts, Canada will not be spared.  We avoided the recession of 2007/2008 because of high commodity prices. 

To build 50 Manhattans between 2008-2012, a lot of commodities were used.  At the current pace in China, they could build 1 billion housing units in roughly 16 years.  I don't know how many housing units there are already in China but the math doesn't look real good.

Once commodity prices collapse, Canada will have its recession. 

Market Valuations

As Friday April 17th, the Price to Earnings (P/E) ratio of the Russell is now over 100x based on trailing earnings. 

To see current data, Click here:

I read elsewhere that nine companies in the Russell 2000 index have a P/E ratio of over 1000x.  Better yet, 1/4 of in companies in the Russell 2000 don't have any profits and so far this year they have outperformed the profitable companies by a three to one margin. 

I often wondered why Fairfax shorted the Russell back at the 661 level, roughly half the current level.  I don't wonder any more.  This market is completely irrational.   

Best Regards,


Disclosure: Long FFH

Tuesday, March 25, 2014

Thoughts on Warren Buffett's 2013 Shareholder Letter

Below are my thoughts on portions of the 2013 Berkshire Hathaway Annual Shareholder Letter.

To read the entire letter CLICK HERE.

As I’ve long told you, Berkshire’s intrinsic value far exceeds its book value. Moreover, the difference has widened considerably in recent years. That’s why our 2012 decision to authorize the repurchase of shares at 120% of book value made sense. Purchases at that level benefit continuing shareholders because per-share intrinsic value exceeds that percentage of book value by a meaningful amount.

The writing on the wall doesn't get any clearer than this. Buffett thinks that Berkshire (BRK) is worth much, much more than book value and he will be aggressive at buying back stock at the 120% level from any shareholder willing to sell.  This is interesting because BRK is selling at 131% of book value. It was selling for around 120% of book value earlier this year.  Do what you want with that but the implications are clear.

Over the stock market cycle between yearends 2007 and 2013, we overperformed the S&P. Through full cycles in future years, we expect to do that again. If we fail to do so, we will not have earned our pay. After all, you could always own an index fund and be assured of S&P results.

This is an interesting comment because Buffett has laid out some guidelines in the back of the annual report on a 5 year yardstick that compares BRK's performance to that of the S&P 500.  It is true that BRK did not meet this test and that Buffett seems to have changed his yardstick to 6 years now.   

Over the past 5 years the per share book value of BRK has risen 91% while the S&P 500 index has gained 127%.  What I find interesting is that the per share book value of the S&P 500 has risen roughly only 50% over that same period.

Take from that what you want but to me the implications are clear.  Either BRK is cheap, the S&P 500 is overvalued, or some combination of the two.  My vote is BRK is cheap.

We completed two large acquisitions, spending almost $18 billion to purchase all of NV Energy and a major interest in H. J. Heinz. Both companies fit us well and will be prospering a century from now.

Going by our yearend holdings, our portion of the “Big Four’s” 2013 earnings amounted to $4.4 billion. In the earnings we report to you, however, we include only the dividends we receive – about $1.4 billion last year. But make no mistake: The $3 billion of their earnings we don’t report is every bit as valuable to us as the portion Berkshire records.

This is what I love about owning Berkshire.  They continually make good long term investments, which ensure good long term results.  BRK is a conglomerate that will be prospering a century from now... long after Buffett is dead and gone.  The market is currently willing to value the latest hot tech stock at absurd levels while BRK underperforms the broader market.  Let's be clear, BRK is built to last. 

Berkshire’s extensive insurance operation again operated at an underwriting profit in 2013 – that makes 11 years in a row – and increased its float. During that 11-year stretch, our float – money that doesn’t belong to us but that we can invest for Berkshire’s benefit – has grown from $41 billion to $77 billion. Concurrently, our underwriting profit has aggregated $22 billion pre-tax, including $3 billion realized in 2013. And all of this all began with our 1967 purchase of National Indemnity for $8.6 million.

So how does our float affect intrinsic value? When Berkshire’s book value is calculated, the full amount of our float is deducted as a liability, just as if we had to pay it out tomorrow and could not replenish it. But to think of float as strictly a liability is incorrect; it should instead be viewed as a revolving fund... 

If our revolving float is both costless and long-enduring, which I believe it will be, the true value of this liability is dramatically less than the accounting liability. 

To put this is simple language, BRK has a $77 billion revolving fund (or loan).  I like to think of it as a loan but a loan that has a number of unique features.  First you never have to pay it back, so long as BRK's insurance companies are still operating.  Second, the loan has a negative interest rate.  In 2013 BRK was paid 3.9% to hold this loan.  Talk about having your cake and eating it too!

Now the lingering question in my mind is what is a loan like this worth, specifically one that has an indefinite term and a zero interest rate (assuming a long term combined ratio of 100%)? 

To give a simple answer this from a financial perspective you must turn to the perpetuity formula, where PV= C/d.  "PV" is the present value, "C" is the annual investment return, and "d" is the discount rate.  Assuming BRK can earn 10% on it's float and it doesn't grow from here, the annual investment return would be $7.7 billion. 

From here it is easy to see that choosing a discount rate of 10% gives a present value of $77 billion dollars for the float.  If we choose a 15% discount rate the present value is $51 billion.  Similarly if we choose a 5% discount rate the float is worth $154 billion. 

So what is the true value the float?  Make your own assumptions but Buffett makes it clear that the true value of this liability is dramatically less than the accounting liability.  I totally agree and in the past, given the investment returns it has generated for BRK, the liability was perhaps ZERO.

Our subsidiaries spent a record $11 billion on plant and equipment during 2013, roughly twice our depreciation charge.

In layman's terms, If BRK can earn 10% on that incremental invested capital beyond the depreciation charge, it will add approximately $550 million in annual earnings. 

In a year in which most equity managers found it impossible to outperform the S&P 500, both Todd Combs and Ted Weschler handily did so. Each now runs a portfolio exceeding $7 billion. They’ve earned it.

I must again confess that their investments outperformed mine. (Charlie says I should add “by a lot.”) If such humiliating comparisons continue, I’ll have no choice but to cease talking about them. 

Todd and Ted have also created significant value for you in several matters unrelated to their portfolio activities. Their contributions are just beginning: Both men have Berkshire blood in their veins. 

Looks like BRK has some top notch talent in line to take over the equity portfolio.  I find the comment in the last paragraph quite interesting.  To me it is foreshadowing a larger role in the company for either Todd or Ted.  Perhaps one will be the next CEO.

Going by our yearend holdings, our portion of the “Big Four’s” 2013 earnings amounted to $4.4 billion. In the earnings we report to you, however, we include only the dividends we receive – about $1.4 billion last year. But make no mistake: The $3 billion of their earnings we don’t report is every bit as valuable to us as the portion Berkshire records.

Buffett here is describing the "look through" earnings of the companies which BRK is a part owner of(common stock).  I wonder how many investors could actually tell you the "look through" earnings of their own portfolio?  That result might prove to be an interesting for many so called value investors. 


There is another fantastic portion of the BRK annual letter that I would highly recommend.  It is an essay entitled, "Some Thoughts About Investing".  In this essay Buffett compares buying a 400 acre farm north of Omaha and a commercial real estate investment to investing in common stocks.  The principles are exactly the same.

At the end of the annual report you will find the two page offer Buffett took over to purchase Nebraska Furniture Mart in 1983, the Financial Statement for Nebraska Furniture Mart for the yearend 1946, and a fantastic memo on the "Pitfalls of Pension Promises" by Buffett from 1975.  Click Here to read these sections.  They are located at the end of the annual report.   

Best Regards,

Kevin Graham

Disclosure - long BRK.b

Tuesday, March 4, 2014

2013 US Bank Asset Quality

Citigroup finally released their 10-K this past weekend allowing me to compare the asset quality of the four large banks in the US.  I always like to see what percentage of the assets are the so call "marked to fantasy" assets.  These assets, also called Level 3 Assets, are valued by management WITHOUT any market comparables.  Management basically values them at whatever they want so long as they can convince the auditors that the rationale is not unreasonable. 

This year Bank of America takes top honors, while JPM comes in last.  The rankings haven't changed much over the years other than BAC has overtaken WFC for top spot. 

I am amazed at how quickly Brian Moynihan has cleaned up the books at BAC.  Level 3 assets were around two and half times the current amount only two years ago.  Today, even if you discount the book value by the $32 billion of mark to fantasy assets, you can still buy the company at an $11 billion dollar discount.  I can't resist a bargain. 

I have commented on balance sheet of JPM in the past.  In particular, I noted before the London Whale incident that you could drive a truck through their balance sheet (Read Here: Bank of America & Europe).  Then after the losses from the incident were exposed, I couldn't resist and bought a whole bunch of JPM (Read Here: Why JPM Is Cheap). 

As I read the annual reports of the various banks I found the disclosure this year is better than ever.  The US financials have never been in better shape.  They are soundly capitalized and the quality of the assets have never been better.

The results of the stress tests can't come soon enough. 

Best Regards,

Disclosure: Long WFC, BAC Class A warrants and JPM warrants


Saturday, March 1, 2014

2013 Berkshire Hathaway's Shareholder Letter

Today is the day Warren Buffett releases his annual letter to shareholders.  Grab a coffee and enjoy the words of wisdom from this investment icon.



Disclosure - Long BRK.b

Sunday, February 23, 2014

Are Profit Margins Mean Reverting?

Over the past couple of years, many readers have messaged me to ask about good blogs to read.  As I have said before most everything you read on the internet is useless and often repetitive.  Original ideas and thoughts are rare. 

That said, I stumbled upon a blog a few weeks back called Philosophical Economics and found it to offer interesting perspectives on many investment issues.  The author of the blog often challenges the status quo and provides unique thoughts that are contrary to many conventional wisdom.  Ideas are also well supported with evidence and not just conjecture. 

In a recent post the author questioned the commonly held idea that profit margins are mean reverting and bound to fall from currently elevated levels.  I thought the arguments were interesting enough to share, so here is a link:

As I've said before, unless you understand both sides of an argument you really don't understand anything.  There are intelligent people on both side of every debate and to simply write off the opposite side without thoroughly understanding their position is quite dangerous.  With that said, you still don't have to agree with one side or another but it should allow you to better defend whatever position you take. 

Best Regards,


Saturday, February 15, 2014

Bank Dividend Increases & 2014 CCAR

Historically the banks have released their capital plans mid March, so we are approximately one month away from finding out the results for 2014.  This process is often called the Comprehensive Capital Analysis and Review (CCAR).  All bank holding companies over $50 billion in assets are required to submit their capital plans for review.  I thought I provide a few details on what I am looking for from the banks as I am a shareholder in a few of them. 

Over the past 4 years the banks have been building fortress balance sheets.  Under the new capital rules, called Basel III, banks are require to hold more capital against risk weighted assets.  The new rules also require a surcharge for Systemically Important Financial Institutions (SIFI), or banks that are too big to fail.  This surcharge ranges from 1% to 3.5% depending on the institution.  WFC requires 1%, BAC requires 1.5%, and both C and JPM require a 2.5% buffer.

While these additional capital requirements are being phased in over time, most of the US banks have set out to meet them today.  Full requirements are not required until March 31, 2018.

So where do the banks sit today? 

Wells Fargo

WFC has met their 1% SIFI buffer, which is an additional $12.9 billion in capital.  In addition to meeting this buffer, WFC has $22.9 billion above that level.  They are generating about $22 billion in capital per year and have been paying out approximately 30% of that in dividends, or $1.20/share ($6.8 billion).  I would estimate that they raise their dividend to around $1.60-$1.80/share ($9-10 billion) and have authority to buy back $5 billion in stock. 

Bank of America

BAC is required to hold an additional 1.5% SIFI buffer.  This is an additional $19.3 billion in capital on a fully phased in basis, a 8.5% tier 1 capital requirement.  They have already met that buffer and have an additional $19.9 billion in capital above that amount (9.96% Tier 1 Basel III).  They are in decent shape among the big banks.  Currently BAC pays a $0.04/share annual dividend, or one cent per quarter ($400 million/year).  They are currently generating about $12 billion in capital per year, but are still under earning their potential.  I would estimate they return $5 billion in dividends this year, or around $0.40/share, and up to $7 billion in share buybacks.  If they leaned toward doing more buybacks verses increasing the dividend I also wouldn't be surprised. 


Citi is the next strongest bank with respect to capital.  Citi is required to hold an additional 2.5% SIFI buffer, amounting to $30.0 billion.  They have met this amount and have an additional $11.7 billion above the buffer.  Like BAC they pay almost no dividend at $0.04/share annually ($120 million).  Citi is currently generating $12 billion in capital per year and also under year earning their potential.  I would estimate they return $5 billion in dividends this year, or around $1.60/share, and another $5 billion in share buybacks.  If they leaned toward doing more buybacks verses increasing the dividend I also wouldn't be surprised given their low stock price.  It would be the intelligent thing to do.  Citi also has a pile of deferred tax assets (DTAs) that greatly reduce their Tier I capital under Basel III (to the tune of $43 billion).  This is really a huge buffer and will lead to huge capital returns in the future. 

JP Morgan Chase

Lastly, JPM requires a 2.5% SIFI buffer, which amounts to $39.8 billion.  They just barely met this fully phased in requirement  last quarter and have nothing above that buffer.  This puts them in the weakest position from a capital standpoint but keep in mind that these requirements do not need to be met for another 4 years.  JPM is currently generating around $22 billion in capital annually.  They pay $1.52/share in dividends per year ($5.8 billion), and were approved for a $6 billion buyback last year.  Look for JPM to return $7.5 billion in dividends or $2/share and buy back $6 billion in stock this year. 


I'm really looking forward to the CCAR results as the banks have rebuilt themselves and are in a position to begin returning large amounts of capital to shareholders.  This trend will continue for a number of years as the banks are over capitalized and some have significant DTA's and other capital deductions, mostly C and BAC.  This gives an additional buffer to shareholders and will allow for increasing capital returns over time.

As a shareholder I would prefer capital returns sooner than later but it doesn't really matter when it is returned since it's all money in the bank.

Best Regards,

Disclosure: Long WFC, BAC class A warrants, & JPM warrants. 

Saturday, January 4, 2014

2014 Investment Commentary


Ezcorp is a short term financier, putting a positive spin on it. To put it bluntly they are a pawn broker and payday loan lender. Here is a breakdown of the operations of Ezcorp:
  • 495 U.S. pawn stores (operating primarily as EZPAWN or Value Pawn & Jewelry);
  • 7 U.S. buy/sell stores (operating as Cash Converters);
  • 239 pawn stores in Mexico (operating as Empeño Fácil);
  • 489 U.S. financial services stores (operating primarily as EZMONEY);
  • 15 buy/sell and financial services stores in Canada (operating as Cash Converters);
  • 24 financial services stores in Canada (operating as CASHMAX);
  • 19 buy/sell stores in Mexico (operating as TUYO); and
  • 54 financial services branches in Mexico (operating as Crediamigo or Adex).
  • Offer consumer loans online in the U.S. and the U.K. operating primarily as and, respectively.
  • Own approximately 30% of Albemarle & Bond Holdings, PLC, one of the United Kingdom's largest pawn broking businesses with approximately 230 stores.
  • Own approximately 33% of Cash Converters International Limited, which is based in Australia and franchises and operates a worldwide network of approximately 700 locations that provide financial services and buy and sell second-hand goods. O
  • Own the Cash Converters master franchise rights in Canada and are the franchisor of eight stores there.
Ezcorp had an unusually bad year in fiscal 2013 for a couple of reasons. The biggest reason for this was the huge drop in the price of gold. Gold started 2013 at around $1700 per ounce and ended around $1200 per ounce. That 30% decline contributed to some really tough business conditions. In the pawn business, gold and jewelry are the two most common forms of collateral. Moreover, unless you’ve been living under a rock in recent years, the gold scrapping business has been big business. 
Conditions in Mexico were extremely tough for the company in the gold pawn business. On the latest conference call they discussed how competitive it has gotten down there. The industry got so competitive that everyone was posting the price of gold they were willing to pay for scrapping. That squeezed margins. This also led to the closure of 57 gold only stores in Mexico. 
Now to add more insult to injury, the company recorded a $43 million ($29 million after tax) impairment charge on its investment in Albemarle & Bond. The UK pawn lender had a very tough year and was delayed in releasing their financials. This wrote off the majority of their investment in the company. Albemarle is now for sale. 
Lastly, the company’s operating expenses have gotten way out of line. In 2011 operating expenses were 33% of revenue and in 2012 they were 34%. In 2013, operating expenses rose to 41% of revenue. This is obviously not very good performance but leaves lots of room for improvement. 
So what does all this mean for you? Basically EZPW was still profitable in 2013, albeit marginally. Earnings have risen every year since 2002. The company sells for 70% of book value.  Book value has grow at 17.5% over the past 10 years.  Debt is only 19% of total capital so they are not heavily financed.  Interest is well covered.  There are a few weird quirks with this small cap but I won't bother you with them here (read the 10-k and listen to the conference call for details).
If you exclude the one-time expenses that occurred in 2013 the company would have earned around $1.70 per share. That works out to a current P/E ratio of 6.5. Now if you, like me, assume that the gold scrapping hay-days are over (no recovery of this business) but they can reduce operating expenses by 3%, then EPS will rise to $2.35 per share (P/E = 4.7). If operating expenses can get back down to historical levels of 34% of revenue, EPS will rise to $2.95 per share (P/E = 3.7). 
It doesn't take an advanced degree in math to see that EZPW is worth at least double the current quote (at a minimum) and up to four times the current quote (at a maximum).  Let's call fair value roughly $30/share. 

"It is better to be roughly right than precisely wrong." - John Maynard Keynes
Lightstream Resources (TSE - LTS, $5.88)
This is the former PetroBakken and Petrobank, if you're familiar with those companies.  They put some lipstick on this pig by giving it a new name back in May 2013.
If you don't remember I wrote about both Petrobank and Petrobakken quite a few times back in 2010.  I even had a spirited debate with a fellow blogger called Devon Shire over the valuations of the companies.
The original article can be found here:
The back and forth can be found here:
Here is what I said about the company back then:

Lets start with Petrobakken (TSE - PBN). First, the PBN's reserves have a net present value, discounted at 10%, before tax value (NPV10-BT) of $2.46 billion for proved reserves (1P) and a NPV10-BT value of $3.65 billion for proved plus probable reserves (2P). I tend to be conservative and use proven reserves but for this analysis it won't matter much so we'll use the more optimistic value of $3.7 billion, which includes reserves that are not yet on production. The company has a convoluted debt structure of bank debt, net working capital deficiency and convertible debentures. The convertible debentures are convertible into common shares at prescribed prices so for the sake of analysis I will add them to the fully diluted shares and only consider the debt to be the sum of the bank debt and working capital deficiency. For PBN the total debt is $698 million. The fully diluted shares outstanding if you include all options and convertible debentures is 207.7 million shares. Petrobank owns 58% of PBN.

NAV10-BT 1P = ($2460 million – 698 million) / 207.7 million shares = $8.48/share

NAV10-BT 2P = ($3650 million – 698 million) / 207.7 million shares = $14.21/share

The PBN shares closed today at $22.84, a sizeable premium to the reserves. This is a 61% premium to the 2P reserve value.

Needless to say Devon Shire was wrong.  If you read the comments over at gurufocus you'll see that I struck a nerve with a number of individuals who didn't want to be shown they were wrong.

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

Anyway, fast forward to today and the picture is quite different.  The biggest change is the major drop in price.  It now sells for a fraction (1/4) of the price compared to when it was being promoted by Devon Shire.  Those who bought at those inflated prices got what they deserved. 

I am a value investor, price is of paramount importance.  I could care less about what the market values the company at.  I want to see my own analysis make sense and have a significant margin of safety.

So today if you read the reserve report in conjunction with the financial statements you can calculate that:

NAV10-BT 1P = $9.26/share

This is the net asset value of the proven reserves using a discount rate of 10% before taxes (debt adjusted per share).  As you can see not much has happened since the 2009 reserve report.

In layman's terms this means that if you bought the entire company, stopped drilling (except remaining proven undeveloped reserves, PUDs), and put the company into blow down mode the net present value company's production stream would be worth $9.26/share discounted at 10%. 

Now this figure is strongly influenced by the commodity price forecast so if you believe oil will rise it is worth more than this, and if you believe oil will fall it would be worth less than this. 

Just for fun lets apply a 15% and 20% discount rate to the proven reserves. 

NAV15-BT 1P = $6.74/share.
NAV20-BT 1P = $4.99/share.

So when the share price got down to it's 52 week low on December 12th, 2013, you could have purchased the entire company, net of all liabilities, and made 20% on your investment (assuming oil prices match the forecast). 

The above information might explain why the CEO purchased $2.8 million in stock on December 12th, 2013 and has purchased $5.8 million of stock in the past 12 months.

I would also note the analysis above gives no value to the probable reserves.  For a company like LTS this is a reasonable assumption because they are a terrible explorer for oil and gas. 

The only other positives are that the company slashed the dividend and canceled the DRIP program because it is highly dilutive at these prices.  The good news is that even at the new dividend rate of $0.04/month or $0.48/year, the dividend rate is 8.1%.  Whether that dividend rate is affordable or not is a discussion for another day. 

Now I am not planning on purchasing this company for a couple reasons but it should double this year barring a major collapse in oil prices.  Buying today you are getting a 15% return on your money. 

The biggest reason I wouldn't invest in this company is that it is very poorly run.  I could put some information on this blog that comes from reliable industry sources (but hasn't been confirmed as fact) but it would likely earn me a lawsuit.  The other reason I wouldn't buy this stock is because I have no idea where oil prices will be a year from now and if you think you do, I have news for you... you're self deceived. 

So for those long LTS, I applaud you.  You should make a buck here but don't stick around much past $10-12/share.  The current quote is cheap enough to offer a decent margin of safety and a decent dividend.  Management is a key criteria when I decide to make an investment and on this point they fail the test.  

Oh and one last thing... those who subscribe to the investment newsletter from Devon Shire (aka, I hope you getting your money's worth.
Bank of America (NYSE – BAC, $15.57)
I have written extensively about Bank of America over the past few years.  It is still cheap, analysts are starting to get all excited about this bank, that happens to be the largest bank by deposits.  BAC will eventually earn 1% on assets and that works out to more than $2 per share.  Beyond that they will realize significantly higher cash earnings because they have $33 billion in deferred tax assets to utilize.  This means if they report $2 per share and didn't pay taxes, actual earnings would be closer to $3/share.  Now their actual cash earnings will not be this high because the net operating losses have occurred in different businesses and in different jurisdictions.  In order to utilize these tax assets they need to realize a profit in those specific divisions. 

Furthermore, deferred tax assets are being phased out for capital requirements over the next 4 years.  Starting in 2014 they are reduced by 20% for capital requirements.  Not to worry though, BAC has already met Basil 3 capital requirements on a fully phased in basis. 

What will BAC do with the profits over the next few years?  I would bet the dividend gets increased this year and they buy back a large chunk of the outstanding shares.  This will create tremendous shareholder value over the next several years.

For the upcoming year, according to First Call, analysts estimate they will earn $1.32/share.  Factoring in the deferred tax assets, cash earnings could be up to $2/share this year. 

Look for a dividend increase in March after the capital plan/stress test results are announced (CCAR). 

Book value is just shy of $22/share.  That means the market is still discounting their capitalization by $68 billion.  Is this discount reasonable?  You can argue that they are under reserved but by $68 billion??? (Note: last year it was a $99 billion discount). 

Citigroup (NYSE – C, $52.11)

I added Citigroup simple because I wanted to have another financial stock selection for this year.  The nice thing about Citigroup is that they are a little cheaper than Bank of America on a tangible book basis.  Citigroup sells for just under tangible book value, while Bank of America sells for 1.2x tangible book.

First Call calculates the average analyst estimate to be $5.32/share for this year.  That puts them at slightly below 10 times earnings. 

Again if they earn 1% on assets that would work out to $6.10/share. 

Now if you thought BAC had significant deferred tax assets (DTAs) you were right, but Citi has $53 billion.  The kicker is that $47.5 billion of that is US Federal, $4.5 billion is US State and the rest is foreign. 

So actual Citi cash earnings could be in the $8-9/share range going forward.  They did utilize 1.8 billion in their DTAs in 2013 YTD. 

Look for the dividend to rise substantially in March when the capital plan/stress test (CCAR) results are announced. 

Citigroup could easily double and still be fairly valued.  Look for it to gain 30-50% this year. 
POSCO (NYSE - PKX (ADR), $78.00)

POSCO was a selection from last year and was carried over.  Here is what I said a year ago:

POSCO is the third largest steel producer in the world. So what is so great about POSCO? Well to start with, they are selling for about 60% of book value.  Why is that so important? It means you’re paying about the same valuation that Warren Buffett paid for his POSCO shares back in 2005.

Why would you want to own POSCO?  As I've said before, in any commodity business you want to own the low cost producer.  POSCO is likely among the lowest cost steel producers in the world and are much more efficient than US competitors.   Their operating margins are double that of American steel companies.  Lastly, the company has been constantly profitable for the past decade unlike many other steel producers. 

POSCO will also benefit as the world’s economy improves.  I would expect ROE and net profits to improve by a couple percentage points.  You’re definitely not buying the company at a time when they are generating peak returns.  At 6.5 times normal earnings, your getting over a 15% earnings yield.

Nothing has changed except book value grew to around $135/ADR last year.  While that is lower than their 15% annual increase in book value over the last ten years, look for it to continue to grow.

Now earnings will likely come in at around $7.25/ADR in 2013, so you might be asking what's so fantastic about that.  Well, PKX did earn much more than that amount over the past decade.  Typically net profit margins have been in 10-12% range, and up to 15% at times.  Last year they were 7.3%.  That means if they return to past profitability levels earnings will rise to around $11-13/ADR or up 40-80%. 

PKX is a solid long term holding. 

Good luck in 2014!

Best Regards,

Kevin Graham

Disclosure - Long EZPW & BAC class A warrants. 

Wednesday, January 1, 2014

Top Investments for 2014

2013 Year in Review

Well 2013 turned out to be a very interesting year with returns for the broader market that surprised nearly everyone.  Concerns over QE, tapering, Obamacare, and other government interventions were popular news but they didn't stop capitalism from unleashing human potential.  Gold and other commodities got slammed in 2013.  This shouldn't take readers of this blog by surprise as I wrote about this twice in 2012 (Canada - Headed for a Crash & Canada: A Storm Brewing in China?). 

The most surprising thing was the rally in the markets that just wouldn't stop. The S&P 500 was up 29.6% and the Dow Jones Industrial Average was up 26.5% for the year.

While many might think that a 20%+ move in the equity markets is rare, JPMorgan notes that such a move is not all that unusual.  The table below groups the annual returns of the S&P 500 (and Dow prior to 1928) since 1897.  What is remarkable is that one out of every three years has been up 20%, and the markets are 3x more likely to be up double digits. This years return was strong but it's not unusual.

Here in Canada, the TSX Composite index was up 9.6% for the year.  As already mentioned commodities got slammed this year and below is a list of the damage.

Nat Gas

I find it remarkable how oil prices have held up in 2013.  US oil production has been off the charts, going up in a parabolic curve.  US dependence on foreign oil fell to a 27 year low (Click Here).  In 2005 the US imported 60.5% of their oil requirements and last year that fell to only 34%.  This is a result of the shale oil revolution in the US where oil production is up 46.5% or 2.36 million barrels a day since 2007.  If oil prices fall in 2014 that will be another significant headwind for the Canadian economy.

Fellow Canadians could have benefited from the fall in commodities by not owning Canadian Dollars.  Canadians who invested in the US not only realized out sized gains this year, they also realized foreign currency gains that contributed an additional 7% to their returns. 

2013 Stock Recommendations

So how did the stock recommendations for 2013 turn out?  Well this is the third consecutive year (ever year since I started this blog) that my stock recommendations outperformed the S&P 500.  On average for 2013, they outperformed the S&P and Dow by 5-10%.  They outperformed the Canadian markets by 25%. 

Company Ticker
Total Return
Bank of AmericaBAC
Berkshire HathawayBRK.b
Sony CorporationSNE
Average Gain

Here is the graphical performance.

Looking at the graph, these picks were up 40% in August, double the market returns at that point.  Of course I pick these stocks for fun and use the year end as arbitrary start and end points but much higher gains can be had for those who sell once a stock returns to its intrinsic value. 

As I said last year, Bank of America has been like shooting fish in a barrel.  After being up 110% in 2012, it came in with another respectable 34% return, and the kicker... it's still recommended for 2014.  Financials were left for dead after the financial crisis and rightly so.  Nobody wanted to touch them because they didn't trust them.  Today the major US financial companies are soundly capitalized and are in great shape. 

Berkshire Hathaway was very safe and very cheap, and remains that way.  Most investors think Berkshire is too large to produce out sized returns.  I disagree.  Their exposure to home building is large and they their equity portfolio is poised for strong gains over the next few years.  Their insurance businesses, which includes GEICO, are best in class.  They consistently report underwriting profits.  Berkshire is still modestly undervalued, I would estimate by 25%.

Sony had some hedge fund activism that got the stock price moving.  This wasn't surprising given the assets Sony owns.  Similarly, Wellpoint turned in a strong result this year as well. 

The outlier was POSCO, which is still cheap and recommended for this year.  POSCO had a tough year as steel demand was not as robust as expected.  The company still sells for well under book value and is profitable because they are a low cost supplier.  Demand for steel will return. 

2013 Other Recommendations

For 2013 I recommended both Well Fargo and Microsoft in the Safe and Cheap category.  They were indeed cheap and both outperformed the market indices last year.  Downside was also very well protected.  I also has some honorable mentions that should have been my top recommendations.  As I mentioned all these companies had wide appreciation potential.  The small energy company I didn't disclose was Rock Energy.  This was because family members were purchasing this stock.  It turned out to be a home run.   

Company Ticker
Total Return
Wells FargoWFC
Teva PhamaceuticalsTEVA
Prudential FinancialPRU
Arkansas Best ABFS
Rock EnergyRE
Average Gain

Top Investments for 2014

The markets have become slim pickings over the past year, but I still believe I have some decent ideas for this year.  The first two have significant upside potential.  US financials are still cheap and I'm selecting two of them for this year.  Finally, POSCO, a holdover from last year is still on the list.  POSCO is still profitable and growing but operationally is under performing due to slack steel demand.  Demand will return and perhaps 2014 will be the year. 


Lightstream Resources (TSE - LTS,  $5.88)

Bank of America (NYSE – BAC, $15.57)

Citigroup (NYSE – C, $52.11)

POSCO (NYSE - PKX (ADR), $78.00)

For Investment Commentary Click Here

Safe and Very Cheap

IBM (NYSE – IBM, $187.57)

IBM is the safe and very cheap pick for this year.  Last year I included this quote from the 2011 Berkshire Hathaway annual letter to shareholders. 

"...Today, IBM has 1.16 billion shares outstanding, of which we own about 63.9 million or 5.5%.  Naturally, what happens to the company’s earnings over the next five years is of enormous importance to us.  Beyond that, the company will likely spend $50 billion or so in those years to repurchase shares.  Our quiz for the day: What should a long-term shareholder (in IBM stock), such as Berkshire, cheer for during that period? 

I won’t keep you in suspense. We should wish for IBM’s stock price to languish throughout the five years...

The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon.  Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day’s supply. 

Charlie and I don’t expect to win many of you over to our way of thinking – we’ve observed enough human behavior to know the futility of that – but we do want you to be aware of our personal calculus. And here a confession is in order: In my early days I, too, rejoiced when the market rose. Then I read Chapter Eight of Ben Graham’s The Intelligent Investor, the chapter dealing with how investors should view fluctuations in stock prices. Immediately the scales fell from my eyes, and low prices became my friend. Picking up that book was one of the luckiest moments in my life."

I couldn't agree more.  The stock has languished, investors are fearful about a lack of revenue growth and cloud computing competition.  IBM is one of the best run companies in the world, especially from a financial perspective.  The two thirds of their revenue from Software and Services is annuity like.  Earnings per share has grown by 12% annually for the past 10 years and 16% annually for the past 5 years.  They generate close to $20 billion in free cash flow per year and have reduced the shares outstanding by nearly half over the past 15 years.  You can call that financial engineering, heck you can call it whatever you want, but the effects are real... Revenue & earnings continue to grow on a per share basis.

If you think of each share of IBM as a separate business, those businesses are doing really well at IBM.  The consolidated noise is only a distraction.   

As I mentioned last year, be sure to do your homework on any investment.  The markets are at all time highs and while that shouldn't alarm you, it should invite caution.  All of these companies have wide appreciation potential but results will depend on the operating results.  All of the recommended companies have short term headwinds that will clear over time.  These issues and problems make for poor short term visibility.  That is why they are avoided, but think like a long term owner and remember fear is your friend. 

Cheers to another great year!

Best Regards,


Disclosure – I own BAC Class A warrants, BRK.b, WFC, MSFT, EZPW, & IBM.