Saturday, September 19, 2009

Fairfax Financial Holdings (FFH) to Acquire another Subsidiary

A couple months ago, I wrote an article about one of Canada’s main reinsurance companies. Namely Fairfax Financial Holdings Limited, I also elaborated on how the company had been incredibly positioned to benefit from the financial meltdown of 2008. Through the sale of its large credit default swaps portfolio and a recent $1 billion public offering, the company has built an impressive cash position that it has used to invest in numerous ways, mainly by investing in the stock market but more importantly by acquiring the minority interest of two of its jewel subsidiaries.

At the beginning of December 2009, Fairfax Financial made an offer to the minority shareholders of it’s Canadian subsidiary Northbridge Financial Corporation. The details of that transaction were quite simple and very attractive to any single one of the company’s shareholders at the time.

It was an offer to acquire all of the outstanding common shares of Northbridge, other than those shares already held by Fairfax, for $39.00 in cash per common share, representing total cash consideration of approximately $686 million. At the time, $39.00 per Northbridge common share represented a premium of approximately 28.9% over the $30.25 closing
price of Northbridge common shares on the Toronto Stock Exchange on November 13th, 2008, the day Fairfax approached Northbridge’s board of directors to consider the proposed transaction.

As Fairfax’s press release underlined it, the proposed transaction also represents a 31.8% premium over the 30-trading day volume-weighted average closing price for the period ended November 28, 2008 of $29.59 and a 160.0% premium over the May 21, 2003 initial Northbridge public offering price of $15.00 per common share, it was pretty rewarding for long term as well as trading shareholders of Northbridge Financial. At the time, Fairfax owned 30,111,306 common shares or approximately 63.1% of Northbridge’s outstanding common shares.

It seems that Vivan Prem Watsa is striking again; this time with Northbridge’s American sibling, Odyssey Re Holdings Corporation. According to the September 18th press release, the price of $65 per share in cash represents a 29.8% premium over the closing price on September 4, 2009 (the date on which Fairfax publicly announced that it was proposing to acquire all outstanding shares of common stock of Odyssey Re that Fairfax does not currently own for $60 per share) and a 33.4% premium over the 30-day average closing price for the period ending on September 4, 2009. The complete transaction would amount to about $1.8 Billion. Based on Odyssey Re’s initial public offering price of $18.00 per share in June 2001, the purchase price represents a compounded annual return of 17.3% through the date of the merger agreement.

The acquisition of those two reinsurance powerhouses and the investing incredible investment ability of Fairfax’s CEO Prem Watsa reinforce my conviction in the future growth of the company. I remain convinced that even at a price of 398$ per share at market close on September 18, 2009, this company is clearly undervalued by the market.

10-year target selling price: 651$


Disclosure: The author is long FFH.TO

Thursday, September 10, 2009

The High Yield Royalty Trust

During the past five years, Canadian legislation has been pretty rough on companies that have decided to convert to income trusts. In the past, this had been a very advantageous situation for them, since distributions were not taxes by any government, whether it would be federal or provincial.

Royaly trusts tend to work a lot like income trusts, except that they must operate in the oil and gas business. Their most appealing similarity is that almost all of the income generated by their assets is distributed, on a monthly or quarterly basis and at a very advantageous 10% tax rate, to unitholders, thus generating a very interesting form of income.

As it happened for income trust, legislation has been passed by the conservative government to fully tax realty trusts starting in 2011. Depending of the result of the next federal elections, investors still have about a year to still take advantage of the their incomes from realty trusts.

The one that has charmed to me the most is Provident Energy Trust, which is, according to their financial statements, an open-end investment trust created to hold, directly and indirectly, all types of petroleum and natural gas and energy related assets, including without limitation facilities of any kind, oil sands interests, electricity or power generating assets and pipeline, gathering, processing and transportation assets. The Trust’s business activities are conducted through two business segments: Canadian oil and natural gas production (Provident Upstream) and Provident Midstream. Provident Upstream includes exploitation, development and production of crude oil and natural gas reserves. Provident Midstream includes processing, extraction, transportation, loading and storage of natural gas liquids, and marketing of natural gas liquids. The Trust’s oil and gas production business segment operates in Canada, and Midstream business operates in Canada and the United States.

With a 0.06$ monthly distribution and a unit price of hovering around 6$, this gives this trust a yield a little bit over 12%, which is a very reasonable rate of return in the current economic conditions. In the past, the unit price change has matched the changes in the distribution amount, always keeping the distribution yield between 10% and 13%. As the economy recovers and energy consumption increases, I expect to see the distribution amount raise back to historical levels, consequently making the yield even more interesting.

10-year target selling price: 13$

Disclosure: The author is long PVE.UN


Saturday, June 13, 2009

The Best Player in the GPS Devices Market?

Many car drivers have been noticing the increasing popularity of GPS navigators, they are offered optionally on many new models, but most people get them by purchasing them in a specialized electronics store. Investigating companies with a very low amount of debt made me fall on a very familiar company: the GPS maker Garmin Ltd.

Garmin Ltd. was incorporated in the Cayman Islands on July 24, 2000 as a holding company for Garmin Corporation, a Taiwanese corporation, in order to make possible a public offering of Garmin shares in the U.S. Credit Suisse, First Boston and Merrill Lynch were the lead underwriters of their 2000 initial public offering, selling 21.0 million shares at $7 per share. Garmin owns all of the operating companies in the Garmin group.

As stated by the company, Garmin Ltd. provides navigation, communications, and information devices, which are enabled by global positioning system (GPS) technology. Garmin has two segments: consumer, which accounted for about 91% of their 2008 revenues and the remaining 9% from the aviation industry. Consumer products include handheld GPS receivers, portable automotive navigation devices, and fixed-mount GPS/Sounder products, which are used in automotive, marine, and recreation applications. Aviation products include GPS and VHF navigation enabled receivers.

What makes this company very interesting is the fact that the it has been growing very impressively, and at the same time gaining a big market share of GPS receivers. At the end of 2008, the company had no long term debt. The common shareholders' equity of the Garmin Ltd. has been growing by 29% over the past five years. There is little probability that the company will achieve such levels but it is a great point to start from. The last five years 30% profit margin also ensures that their profits will remain strong even after such difficult economic conditions as we witnessed in 2008 and throughout the rest of 2009.

2008 was, as for many companies, a very difficult one for Garmin Ltd. Still, longer-term growth generators will aid profits. The company has quite a lot of new and improved software devices to be introduced shortly. These improvements will boost the features of existing items in its mapping, aviation, and other business segments, thus giving the company an even greater competitive edge and market-share lead. It also has launches for two new phones within the next couple of months. These actions will likely increase advertising costs, but should increase awareness about the company, too. Also, Officers and directors own a cumulative amount of 45.8% of common shares. This ensures that they are very likely to take actions that will be favorable to the shareholders of the company.

At current prices, I estimate Garmin Ltd. To be a great long term buy and should provide satisfactory performance over the next 10 years.

10-year target selling price: 73$

Disclosure: The author has no position in GRMN but intends to initiate one in the coming weeks.


Saturday, May 30, 2009

A Small Year for iStar Financial

A couple of weeks ago, I wrote an article about a REIT I am currently invested in that goes by the name of iStar financial (NYSE: SFI). The position of a long term investor gives the advantage of having quick access to financial statements as soon as they are issued. This year, I have been very disappointed by the performance of the management of, this REIT, which was, before 2008, the soundest of such companies in my opinion.

In the upper stated previous article, I elaborated on the attractiveness of iStar, which unfolded to be a yield trap, meaning by that a dividend so attractive that it cannot be sustained forever. At the time of my first analysis of iStar, their average quarterly dividend for the last five years hovered around 70 cents per share. This amounts to roughly $2.80 per year. With an average cost per share of 3.98$ such a dividend would provide a staggering dividend yield of 70%! Such a yield is mouth-watering for a value investor and many dividend investors have probably noticed the same phenomenon. The only problem is that the board of directors decided to suspend the company dividend during the last half of 2008, at the same time making the company’s stock less attractive relatively to the initial reasons that made iStar Financial so appealing.

The annual letter by chairman of the board and chief executive officer Jay Sugarman was more of a desperate call for shareholders not to leave the company’s beaten down stock than a real explanation of what happened. Plus one of the matters that had to be voted in the annual shareholder’s meeting was the board of directors proposed vote in favour of the 2009 Long-Term Incentive Plan and Performance-Based Retention Award to the chairman and Chief Executive Officer. The plan allows Jay Sugarman to get compensated in stock about every three years relative to the performance of the company. They justify the plan by with the fact the company purchased about 32.6 million shares between July 1st 2008 and March 31st 2009. The only reason I disagree with the plan is that in three years, iStar’s performance will be significantly better than in 2008. Jay Sugarman will be automatically awarded for the good performance of the company. I just hope the stock price will be significantly up enough to ensure little dilution of shareholders’ wealth. This is another good example of the institutional imperative.

My only solace is that the company proceeded to a huge share buyback program, thus bringing the common stock count from 133 million shares to 105 million as of December 31st 2009. This is great news since it will allow the company to spend proportionally about 21% less cash when they reinstate their dividend. At the time of making the investment in iStar, or in any dividend paying company for the long term, a yield of 10% is enough to justify a 10 year commitment from my capital. Taking this into assumption, iStar needs to have a quarterly dividend of at least 10 cents per share to make a long-term investment worthwhile.


Disclosure: The author is long on SFI

Friday, May 22, 2009

Liddy Intends to Step Down

As it is now common knowledge, AIG (NYSE: AIG) has been considered by the US government as being the only company that was not involved in the banking business, but was big enough to affect the global financial system due to the seize of its credit default swaps portfolio. It thus acquired the critically recognized expression of being too big to fail in November 2008, at the moment the whole financial world got scrambled. At that precise moment, the US government was forced to bail out AIG, providing it the staggering rescue amount of $185 billion. That is an amount larger than any single bank received to better manage the financial crisis. In exchange for the 80% ownership stake that the government got at that time, the Obama administration appointed Edward Liddy as the chairman and CEO of the troubled firm.

Liddy used to be the chairman of the insurance company Allstate and served on the board of Goldman Sachs. He has been a seasoned leader for insurance and financial companies and was definitely the right person to occupy such a critical position in the leadership of AIG. His announcement about his pending resignation after the end of the restructuring at AIG was quite surprising. It is happening sooner than expected, but it is fully understandable for two reasons. First, due to all the scandalous events surrounding former AIG executives, Edward Liddy got a total compensation of... $0. That includes his salary, stock options and warrants. His only financial solace came from about $500000 of tax advantages from a government who wanted to make sure Liddy did not end up paying to work as chairman and CEO of AIG, which would have been pretty embarrassing for the treasury department. A second reason that would justify a resignation is that Liddy was actually in retirement at the time he was asked to step up to the plate.

However, the task he faces seems to be a lot more impressive than expected. In his opinion, AIG will be able to reimburse the US government after about 3 to 5 years. From a value perspective, that makes AIG a company that has nothing interesting to offer to investors. Also the fact that AIG might be reverse-splitting their stock is only a short term solution to keep the stock from being unlisted from the NYSE as soon as they reinstate their tough guidelines.

From all that information, I would lead to assume that AIG is currently fairly valued by the market. Even after they managed to showcase $20 billion of revenues in their filing for Q1 2009, they are still a long way from their profitability of previous years. There is also a lot of uncertainty about AGI’s earning power. According to Liddy, the company still has to be spitted; which would respond to the US government’s need to have very few companies “too big to fail” under their oversight. In the meantime, for a value investor, AIG seems to be a company to pass over, at least for the next 3 years, or when they start to be profitable again.



Disclosure: The author has no position in AIG.

Wednesday, May 20, 2009

A Stock Investing Methodology

When investing in a company, I am usually looking at the price of the stock at the end of my analysis and it makes total sense. As many value investors know, price is only a way to figure out if you are getting a bargain relative to the underlying value of a business. That value is almost always an estimate, but when you compare it to the price of the company some bargains become screaming bargains. By that I mean that their price is so attractive that even the most pessimistic estimate of their future earnings offers a margin of safety. Let’s look at the process:

The best tools an investor can use while searching for interesting stocks is usually a stock screener. The best performing one I have used to date is the one provided by Yahoo! Finance.

When searching for a new stock to invest in, the first ratio I look for is return on equity. The higher it is, the better. After reading many books written by famous investors, it has appeared to me that most of them tend to choose companies with an average return on equity for the last 5 years of at least 10%. Because they had a better track record than me, I tend to overlook companies with a return on equity of less than 10%. When he uses a stock screener, this will clear almost 50% of publicly listed companies’ from your investment possibilities, since most of them fail to sustain such a high return on equity for prolonged periods. An important point to raise here is that the company must preferably be very lightly leveraged, because that is the corporate equivalent of performance enhancing drugs, as investor Jim Chuong puts it.

Another determining factor is the net profit margin of the company. Once again we look over that metric for the last five years to get an average number. This shows me the strength of the earnings of the company. Investors with a great track record tends to choose companies with a net profit margin of about 8% to ensure that the company’s profits will not be affected much by an increase of their costs (inflation).

My holding period for a stock will usually range from 3 to 10 years. I start by estimating the free cash flow per share of the company over the next 10 years and discount them to their present value. My objective, when doing that, is to get an estimate of the intrinsic value of the stock. Then, I want to know if I have a margin of safety. It is only at this step that I will need the current price of the stock. If the stock is trading at 70% or less of its intrinsic value per share, I will be tempted to make a purchase, as long as the price remains attractive.

I also want to have a target for a price at which I will be selling the stocks that I own. To get that figure, I use a modification of the Gordon Model. Using a predetermined capitalization rate, I will divide the present value of the free cash flow at the year following the year I intend to sell and then. I then add the value I just got to the sum of present value of free cash flow per share of the company. Now we have a long term target selling price.

After that, what is left to do is to check those stocks on a periodic basis and make the necessary adjustments. Buy if the price gets even more interesting. I acquired my definition of the time to sell from Philip Fisher; who advised to sell at the moment the stocks reach a high price because of mass market speculation. For more on the reasons that would really justify selling a position, I recently provided an article explaining the methodology of the late Phil Fisher. There is a lot to be learned from this successful investor and the way he went at finding attractive stocks at fire sale prices.

Saturday, May 16, 2009

What About Consumer Electronics?

The business of retail consumer electronics is incredibly competitive; there are very few big companies involved in that domain and not too many of them manage to be profitable on a consistent basis. This is very intriguing to me since, according the firm Euromonitor International, the amount of sales of that industry in North America amounted to $147 billion in 2008 and that the market has been growing on average by 8% a year during the five years going from 2003 to 2008. That same market of consumer electronics is very interesting since the giant company Circuit City (OTC: CCTYQ) went on a bankruptcy fire sale, thus leaving more room for the remaining competitors.

Here is a quick snapshot of the company; according to their official documents, Best Buy Co., Inc. (NYSE: BBY), incorporated in 1966, is a specialty retailer of consumer electronics, home office products, entertainment software, appliances and related services. The Company operates retail stores and Web sites under the brand names Best Buy, The Carphone Warehouse, Five Star, Future Shop, Geek Squad, Magnolia Audio Video, Napster, Pacific Sales, The Phone House and Speakeasy. It operates through two business segments: Domestic and International. The Domestic segment consists of the store, call center and online operations in all states, districts and territories of the United States operating under the brand names Best Buy, Best Buy Mobile, Geek Squad, Magnolia Audio Video, Napster, Pacific Sales and Speakeasy. The International segment is comprised all Canada store, call center and online operations, under the brand names Best Buy, Best Buy Mobile, Future Shop and Geek Squad. Its International segment offers products and services similar to that of its U.S. Best Buy stores. On June 28, 2008, the company acquired a 50% stake in Best Buy Europe. On October 25, 2008, the Company completed the acquisition of Napster, Inc.

As of February 28, 2009, the Company operated 1,023 U.S. Best Buy stores, 38 U.S. Best Buy Mobile stand-alone stores, 34 Pacific Sales stores, six Magnolia Audio Video stores, and six Geek Squad stand-alone stores, totalling approximately 40.9 million retail square feet. As of February 28, 2009, the Company operated 897 The Carphone Warehouse stores, 1,568 The Phone House stores, 58 Best Buy Canada stores, three Best Buy Mobile Canada stores, 139 Future Shop stores, five Best Buy China stores, 164 Five Star stores and one Best Buy Mexico store totalling approximately 13.3 million retail square feet.

The dominant position of Best Buy Co. in North America in the consumer electronics market is pretty obvious, and it led me to think that this was their main competitive advantage in that business. However, after taking a look at their financial statements, things got more interesting.

First, their 42% debt to equity ratio is very decent compared to the 83% of the industry or the 131% of S&P500 companies; such a low level of leverage is one of the main reasons why the company continues to be profitable even in these difficult economic times. The preeminent thing is that consumer durables are usually the products that are hurt the most in a recession! They also managed to extract a 24% return on equity from their business, which is more than double of the 12% achieved by the rest of the industry.

There seems to be a catch though, their profit margin of 2.3% is incredibly low... that means that for every $100 of revenue, only $2.30 turned into profits, compared to the $12.20 average generated by S&P500 companies. Such a fact is really the persistent downside of the retailing business, big sales volumes doesn’t necessarily mean hefty profits.

In my mind, Best Buy remains the most interesting long-term play in the consumer electronics business and, everything being equal and assuming there were no better opportunities available, I would definitely buy it as long it is priced under 39$ per share to ensure a sufficient margin of safety. Take note that my long term price target does not take future stock-splits and dilutions into account

Full Disclosure: The author does not have a position in BBY.
10-year target selling price per share: 153$

The "Equity Puts" Bet of Berkshire Hathaway

The 2008 and Q1 2009 reports of Berkshire Hathaway (NYSE: BRK.A, NYSE:BRK.B) has showcased many of the downsides of investing in derivatives. Many things remain unclear for most people so I thought it would be important to transmit the message, as clearly as Warren Buffett wanted it to be, about the phenomenal derivative position currently held by Berkshire.

I provide here an excerpt of Buffett’s most recent letter to shareholders, in the 2008 annual report of Berkshire Hathaway, where he explains why he got into that derivative position and explains what are his plans regarding it. I chose to show it because there is now way I could have but it in better words than he did. It is pretty hefty, mostly due to the amount of details regarding how equity puts work:


Considering the ruin I’ve pictured, you may wonder why Berkshire is a party to 251 derivatives contracts (other than those used for operational purposes at MidAmerican and the few left over at GenRe). The answer is simple: I believe each contract we own was mispriced at inception, sometimes dramatically so. I both initiated these positions and monitor them, a set of responsibilities consistent with my belief that the CEO of any large financial organization must be the Chief Risk Officer as well. If we lose money on our derivatives, it will be my fault.

Our derivatives dealings require our counterparties to make payments to us when contracts are initiated. Berkshire therefore always holds the money, which leaves us assuming no meaningful counterparty risk. As of yearend, the payments made to us less losses we have paid – our derivatives “float,” so to speak – totaled $8.1 billion. This float is similar to insurance float: If we break even on an underlying transaction, we will have enjoyed the use of free money for a long time. Our expectation, though it is far from a sure thing, is that we will do better than break even and that the substantial investment income we earn on the funds will be frosting on the cake.

Only a small percentage of our contracts call for any posting of collateral when the market moves against us. Even under the chaotic conditions existing in last year’s fourth quarter, we had to post less than 1% of our securities portfolio. (When we post collateral, we deposit it with third parties, meanwhile retaining the investment earnings on the deposited securities.) In our 2002 annual report, we warned of the lethal threat that posting requirements create, real-life illustrations of which we witnessed last year at a variety of financial institutions (and, for that matter, at Constellation Energy, which was within hours of bankruptcy when MidAmerican arrived to effect a rescue).

Our contracts fall into four major categories. With apologies to those who are not fascinated by financial instruments, I will explain them in excruciating detail.

• We have added modestly to the “equity put” portfolio I described in last year’s report. Some of our contracts come due in 15 years, others in 20. We must make a payment to our counterparty at maturity if the reference index to which the put is tied is then below what it was at the inception of the contract. Neither party can elect to settle early; it’s only the price on the final day that counts.

To illustrate, we might sell a $1 billion 15-year put contract on the S&P 500 when that index is at, say, 1300. If the index is at 1170 – down 10% – on the day of maturity, we would pay $100 million. If it is above 1300, we owe nothing. For us to lose $1 billion, the index would have to go to zero. In the meantime, the sale of the put would have delivered us a premium – perhaps $100 million to $150 million – that we would be free to invest as we wish.

Our put contracts total $37.1 billion (at current exchange rates) and are spread among four major indices: the S&P 500 in the U.S., the FTSE 100 in the U.K., the Euro Stoxx 50 in Europe, and the Nikkei 225 in Japan. Our first contract comes due on September 9, 2019 and our last on January 24,2028. We have received premiums of $4.9 billion, money we have invested. We, meanwhile, have paid nothing, since all expiration dates are far in the future. Nonetheless, we have used Black-Scholes valuation methods to record a yearend liability of $10 billion, an amount that will change on every reporting date. The two financial items – this estimated loss of $10 billion minus the $4.9 billion in premiums we have received – means that we have so far reported a mark-to-market loss of $5.1 billion from these contracts.

We endorse mark-to-market accounting. I will explain later, however, why I believe the Black-Scholes formula, even though it is the standard for establishing the dollar liability for options, produces strange results when the long-term variety are being valued.

One point about our contracts that is sometimes not understood: For us to lose the full $37.1 billion we have at risk, all stocks in all four indices would have to go to zero on their various termination dates. If, however – as an example – all indices fell 25% from their value at the inception of each contract, and foreign-exchange rates remained as they are today, we would owe about $9 billion, payable between 2019 and 2028. Between the inception of the contract and those dates, we would have held the $4.9 billion premium and earned investment income on it.

• The second category we described in last year’s report concerns derivatives requiring us to pay when credit losses occur at companies that are included in various high-yield indices. Our standard contract covers a five-year period and involves 100 companies. We modestly expanded our position last year in this category. But, of course, the contracts on the books at the end of 2007 moved one year closer to their maturity. Overall, our contracts now have an average life of 2 1/3 years, with the first expiration due to occur on September 20, 2009 and the last on December 20, 2013.

By yearend we had received premiums of $3.4 billion on these contracts and paid losses of $542 million. Using mark-to-market principles, we also set up a liability for future losses that at yearend totaled $3.0 billion. Thus we had to that point recorded a loss of about $100 million, derived from our $3.5 billion total in paid and estimated future losses minus the $3.4 billion of premiums we received. In our quarterly reports, however, the amount of gain or loss has swung wildly from a profit of $327 million in the second quarter of 2008 to a loss of $693 million in the fourth quarter of 2008.

Surprisingly, we made payments on these contracts of only $97 million last year, far below the estimate I used when I decided to enter into them. This year, however, losses have accelerated sharply with the mushrooming of large bankruptcies. In last year’s letter, I told you I expected these contracts to show a profit at expiration. Now, with the recession deepening at a rapid rate, the possibility of an eventual loss has increased. Whatever the result, I will keep you posted.

• In 2008 we began to write “credit default swaps” on individual companies. This is simply credit insurance, similar to what we write in BHAC, except that here we bear the credit risk of corporations rather than of tax-exempt issuers.

If, say, the XYZ company goes bankrupt, and we have written a $100 million contract, we are obligated to pay an amount that reflects the shrinkage in value of a comparable amount of XYZ’s debt. (If, for example, the company’s bonds are selling for 30 after default, we would owe $70 million.) For the typical contract, we receive quarterly payments for five years, after which our insurance expires.

At yearend we had written $4 billion of contracts covering 42 corporations, for which we receive annual premiums of $93 million. This is the only derivatives business we write that has any counterparty risk; the party that buys the contract from us must be good for the quarterly premiums it will owe us over the five years. We are unlikely to expand this business to any extent because most buyers of this protection now insist that the seller post collateral, and we will not enter into such an arrangement.

• At the request of our customers, we write a few tax-exempt bond insurance contracts that are similar to those written at BHAC, but that are structured as derivatives. The only meaningful difference between the two contracts is that mark-to-market accounting is required for derivatives whereas standard accrual accounting is required at BHAC.

But this difference can produce some strange results. The bonds covered – in effect, insured – by these derivatives are largely general obligations of states, and we feel good about them. At yearend, however, mark-to-market accounting required us to record a loss of $631 million on these derivatives contracts. Had we instead insured the same bonds at the same price in BHAC, and used the accrual accounting required at insurance companies, we would have recorded a small profit for the year. The two methods by which we insure the bonds will eventually produce the same accounting result. In the short term, however, the variance in reported profits can be substantial.

We have told you before that our derivative contracts, subject as they are to mark-to-market accounting, will produce wild swings in the earnings we report. The ups and downs neither cheer nor bother Charlie and me. Indeed, the “downs” can be helpful in that they give us an opportunity to expand a position on favorable terms. I hope this explanation of our dealings will lead you to think similarly.


You can also read the full 2008 annual report of Berkshire Hathaway (NYSE: BRK.A, NYSE:BRK.B) on the annual report section of the company’s website.

Full Disclosure: The author does not have a position in BRK.A or BRK.B.


Timothy Geithner’s Plan for the Financial System

Secretary of treasury Tim Geithner is absolutely the right person President Obama could have appointed to the job. He has been working for some time on a way to better regulate the financial system. It has taken form lately as a legislative proposal to congress. It will be a major step in overhauling the nation's financial regulatory system. It’s main characteristics is that it will allow better regulation of the derivatives market and, to investors, a better understanding of the impact of those products on financial markets.
New rules would discourage financial firms from taking excessive risk, prevent fraud and make sure that instruments called derivatives are marketed appropriately. Current legislation concerning derivatives, for the most part, excludes regulation of instruments that are not traded on the open market, those referred to as "over-the-counter" derivatives because they are traded privately.

I really wonder how the new tougher rules will affect hedge funds, those big, mostly unregulated pools of money that use intricate trading tactics to earn big returns for exclusive investors. The fact is that many hedge funds currently use derivatives contracts to offset risk on their other transactions. The need for improved regulation is really evident; the value of over-the-counter derivatives depends of another figure or commodity, which in turn makes verifying the real value of a derivative very complicated. The primary use of a derivative is to reduce the risk of loss from the underlying asset, not try to create huge amount of profits out of thin air. What worries me even more is that the global business world, at the end of 2008, held an overwhelming $600 trillion of such contracts; while the stock market capitalization, for all exchanges on the planet combined, was of $33 trillion at the same period.

The most well-known examples of derivatives are certainly credit-default swaps, some of them were sold by American International Group Inc (NYSE: AIG). AIG was selling the swaps to investors as a sort of insurance to protect against defaults on mortgage-backed securities, the CDOs that I talked about in a previous article. The rest is history...

Under Geithner's new plan, companies like AIG would have to prove they have a sufficient amount of reserved capital to support a continuing sale of derivatives, thus reducing the systemic risk of a company. I really hope such a plan passes because it will ensure more stability from financial companies that have the potential to impact the economy as a whole.

Full Disclosure: The author does not have a position in AIG.

Thursday, May 14, 2009

The Great Housing Bubble

At the end of the 90’s, investing in the bull market was kind of a walk in the park for all the people hunting for a quick profit. The internet was promising to revolutionize how people buy what they need and many companies ending with .com flood the market with  IPOs. Thousands of speculators rush on them, certain to bet on the next IBM. Their illusions are quickly scattered when they notice that most of those companies burn more cash than they can get on the open market. Between 2000 and 2001, investors pull out of the market and many speculators follow them swiftly, causing one of the worst panics to hit the stock market since the Oil crisis. However, those events remained silent for most people because they were eclipsed by the horror of 9/11. 

Governments were quick to react, in most industrialised countries; they asked their central banks to reduce interest rates at levels so low to make credit inevitable. That spurred a takeoff in consumer spending, mostly financed by credit and avoided a recession in some countries. It also generated an explosion in the housing market and the mortgage market at the same time. That was a close call. Banks were able to offer really affordable mortgages to almost anybody who wanted to buy a house.
For those same banks, making money on those mortgages wasn’t enough, they had to make more; mostly on the lower quality mortgages that could easily default. Some investment banks, like Lehman Brothers (OTC: LEHMQ), started recycling those mortgages in investments vehicles of smaller size called collateralized debt obligations. They also got rating agencies to give those financial instruments a rating ranging from AAA to B depending of the seniority of those vehicles. To make sure they would be able to repay in case of default, they bought bond insurance, to companies like AIG (NYSE: AIG) on those CDOs to ensure payment on the holders, hence the AAA ratings, no matter the safety of the underlying investments. That system could have worked forever based on the assumption that home prices ALWAYS go up; since people could have refinanced their mortgages.

Closer to us, in 2007, the first wave of mortgage try to get some refinancing. But there is a big problem; since 2002, interest rates have almost doubled, affecting mortgage rates and at the same time doubling mortgage payments. Millions of homeowners in the US could not afford their new payment and since home prices were not going up; in some cases, they were going down! This led to an increase in the number of bankruptcies, forcing many financial institutions to write-down many of those mortgages, which in turn caused most of the sophisticated investors who had acquired CDOs to write-down their assets. What we have here a good example of systemic risk.

This is the chain of events that caused the current recession. It has been many years in the making and many rational investors saw it coming. The good thing with the current financial environment is that it will force most companies to deleverage, making them safer and reducing their systemic impact in the process. Those events also showed the need to regulate the market of derivative contracts that are still selling over the counter because their current value is now a staggering 600 trillion dollars.

Tuesday, May 12, 2009

Microsoft’s Surprise $3.75 Billion Debt Offering

Times like those of a recession leave many companies in desperate need of liquidity to bolster their operations. But it came to my surprise this morning to notice that a powerhouse such as Microsoft Corporation (NASDAQ: MSFT) is issuing their first ever lot of corporate bonds.

In more details, the proposed offering of $3.75 billion senior unsecured notes is composed of five-year, 10-year and 30-year notes and are rated "AAA" by Standard & Poor’s Rating Services. In a press release, Microsoft said the offering would be divided as follows: there would be $2 billion of 2.95% notes due June 1, 2014; $1 billion of 4.20% notes due June 1, 2019 and $750 million of 5.20% notes due June 1, 2039. For a company that has generated a 52% return on average shareholder’s equity in a year as bad as 2008, that is pretty cheap financing.

A press release from the Microsoft Corporation says that the proceeds from the offering will be used for general corporate purposes, including funding for working capital, capital expenditures, share buybacks and potential future acquisitions.

The real move I can see here is probably that when the board of directors of Microsoft saw interest rates at such historically low levels in September 2008, they allowed the company to take on up to 6 billion in debt. It is a pretty good idea since the company has showed that it could generate very high returns for its shareholders at a very low price.

What I am not quite getting is that the company doesn’t really need the money. With 7 billion dollars in cash and 18 billion in short term investments that are very liquid, I wonder what an extra 3.75 billion would change in the investment strategy of the company to increase returns for shareholders.

Full Disclosure: The author does not have a position in MSFT.

Sunday, May 10, 2009

Aldila: Another Interesting Company

Cigar-butt companies have that particularity that they are cashflow machines on the end of their life. They are rarely fashionable and trendy on the market and that is one of the reasons why they are often undervalued for long periods of time, which in turn makes them very attractive for value investors. But some of them defy that rule.

Being an investor without very much experience on the market, companies that make my portfolio tend to be screaming bargains, by that i mean bargain and near arbitrage situations that are so obvious that one would need to be blind or underestimating of his own intellect not to take advantage of them.

From their website, we can get that Aldila, Inc. designs, manufactures and markets high performance graphite golf shafts used in golf clubs assembled and marketed throughout the world by major golf club companies, component distributors and custom clubmakers, and is a leading shaft brand among consumers and on the PGA tour. Aldila also manufactures hockey sticks and most recently hockey blades, in addition to composite prepreg (Carbon fiber reinforced polymer) material for its golf shaft business and external sales. Externally, Aldila manufactures carbon fiber for internal use through and ownership interest in Carbon Fiber Technology, LLC.

The company describes itself as having the hottest shafts in golf and that doesn’t go without reason. We could be led to think that huge companies specialized in sports equipment, like Callaway Golf would be their competitors but in fact companies like Callaway are clients of Aldila Inc. To make things clear, companies like Aldila manufacture the shafts of golf clubs and then sell them to club manufacturers like Callaway. Taking those fact into account, there are really not many competitors to Aldila.

What’s even more interesting is that many professional golfers like Tiger Woods and Boo Weekly, and many more regular players are using the shafts developed by Aldila on their clubs.

Another interesting thing is the dividend history of the company. As soon as they get an interesting amount of retained earnings, the management of Aldila Inc. distributes a special dividend over the usual dividend. In 2005, the company distributed 2.30$ per share and in 2008, they distributed 10.30$ per share. I am convinced that they will not be able to accomplish that during FY 2009, but am confident that with an average cost per share of 2.54$, if they happen to give, in 2010 or 2011, a dividend equivalent to the amount given to shareholders in 2005, I will be very tempted to scoop up more shares for the long haul and even more if they go 50% or more lower than my average purchasing price. I intend to hold my position for as long as necessary.

Full disclosure: the author is long on ALDA

Investing Performance for 2008

As a value investor, I use a benchmark to monitor my investing performance. It is mportant that a measure it in my local currency, the Canadian Dollar to avoid currency bias. My objective is to beat the S&P/TSX on a yearly basis and I think I should elaborate on that point. The Standard & Poor’s TSX Index is composed of the 200 biggest companies in Canada, and is denominated in Canadian dollars (CAD). Since its inception, it has been the best performing benchmark of the Canadian economy and people investing in an Index fund that follows the S&P/TSX tend to have a better performance than almost 80% of all the mutual funds in Canada and North America, and that is before fees! Every year I beat that yardstick means that I beat the average investor by a larger margin. Over a period of 10 years, beating that index by just 2% every year will equal a significant difference in the capital that will have been accumulated.

A year like the one we just had is the perfect opportunity for the long term investor. Some of the most outstanding companies now have their stock trading at a discount to their intrinsic value or even their book value per share; a couple of them are even selling for less than their last year’s earnings per share. Assuming the worst case scenarios for the year, current P/E ratios are really at lows unseen since the great crash of 1929. These are very exciting times for value investors. As I will elaborate further, the companies that make my portfolio are greatly undervalued and we will continue to take advantage of that fact.

2008 will be a year to remember as the exuberance of the market has really been proven. The financial crisis has powerfully hit the market. I remain pleased to announce that I have still been able to showcase a better performance than the index I have to beat and also that the financial crisis has hit me only merely.

My positions for the year 2008 go as follows and they were initiated around September.

Long:
Fairfax Financial Holdings Limited (TSE: FFH)
iStar Financial Inc. (NYSE: SFI)
Dryships Inc. (NASDAQ: DRYS)

Short:
None

Taking those positions into account, my performance in 2008 was -2.1%, and the S&P/TSX did -28.9%, so it makes it that I beat it by 26.8%; the Dow Jones and the S&P500 did a little bit better than the S&P/TSX. I am relieved to know that I also beat them both by a significant margin. The downside is that even if I showcased a better performance than those indexes, -2.1% is not a good number to put on the investing scoreboard, but I’ll manage to do better in 2009.

Warren Buffett and Taxes

Every year, in the month of April, Forbes magazine comes with the list of the billionaires of the planet ranked by wealth in UDS. Warren Buffett came number one in 2008, but for 2009 his friend Bill Gates came back to claim his number one spot of the past 13 years before 2008. It has always amazed me that even for the amount of wealth those two persons own, they are the most avid fighter for an equal distribution of wealth in society, starting with the fairness of the tax system.

Warren Buffett and Bill Gates are known for the more liberal opinions, and it surprised me for a while, since I would expect the richest guys on the planet to be conservatives and protective of their money. I fell on an interview of Buffett explaining his stance on taxes and comparing the lack of fairness between his own tax rate and, for example, the tax rate paid by his secretary.



I also saw a video from the senate finance committee hearing on November 14th 2007 when Warren Buffet showed up to share some of his impressions of about the current tax system and his proposition on what could be change to make taxation more equal.



From these videos, it is good thing to have such a successful and socially responsible investor as Warren Buffett representing value investing. He certainly gives capitalism a good name.

Dendreon Corporation: What Hype Does To The Herd

Long-term investors of Dendreon Corporation (NASDAQ: DNDN) must have had quite a ride since the beginning of 2008. Looking at their price range in the last 52 weeks, the stock went as low as 2.55$ to the recent high of 27.40$! Most people invested in the market must have noticed the consecutive days of double digits percentage raises of the stock price. Those have been cause by recent news about a pending approval by the FDA of the Provenge cure for prostate cancer. But what is really behind all that buzz about a company that has been reporting an average 90 million dollar loss for the last four years?

Quoted from their official description, Dendreon Corporation (NASDAQ: DNDN) is a biotechnology company whose mission is to target cancer and transform lives through the discovery, development and commercialization of novel therapeutics. The Company applies its expertise in antigen identification, engineering and cell processing to produce active cellular immunotherapy product candidates designed to stimulate an immune response. Dendreon is also developing an orally-available small molecule that targets TRPM8 that could be applicable to multiple types of cancer as well as benign prostatic hyperplasia. The Company has its headquarters in Seattle, Washington.

The encouraging news about Provenge boosted the confidence of many investors. Now I don’t know much about the future prospects of that cure but the from the buzz, I know that it gives patients affected with cancer an average 4 months prolongation of the survival of the patients, which is similar to a product that is currently approved by the FDS but Provenge has fewer side effects. What I know now is that the stock price of the company is currently too inflated to ensure a margin of safety on an investment. The only persons who have been able to make a satisfactory profit on the recent rise are long term shareholders and insiders.

What intrigued me are the strange events that have happened since the announcement that sent the stock skyrocketing and they are usually the type of things that send value investors running away from a company like a plague.

Insiders are dumping shares
My first red flag is that management has been dumping their shares for a quick profit. For example, since april 17th, Mitchel S. Gold CEO of Dendreon Corp. (NASDAQ: DNDN) has sold over 500000 of his own shares for an average price of about 20$ that he had acquired throughout Q4 2008 and Q1 2009 for less than 5$ a share. That looks like a quick 7 million $ profit on a single good news. He is not the only one, his chief financial officer and many directors took advantage of that price jump, as it can be seen on Reuter’s website. People more courageous will take a look at Dendreon’s SEC filings. Over 337 million shares of Dendreon have changed hands from April 13th to May 8th and the company currently has 98 million shares outstanding, that is way more than enough liquidity to convince someone let go of his shares for over 20$ when they were worth 4$ just three months ago.

The common stock offering
With their stock price in a comfortable position, the management of the company did exactly what anybody would had done in their place: they are issuing more shares, about 11 million of them based from their press release. It is the perfect time for them to do it and they will probably make enough money from it to finance their capital needs and the marketing of Provenge. This will probably dilute the control of some shareholders but, the benefit of increased capital is attractive.

As a value investor, I remain sceptical about who will benefit the most from the commercialization of Provenge. Will it be the management or long term shareholders? One thing is clear in my mind, those two groups have a bigger margin of safety on their investment than investors who bought their shares after April 14th because they were following the crowd on a hot rising stock.

Full Disclosure: The author does not have a position in DNDN.

Saturday, May 9, 2009

Investment philosophies

Since value investing came to my knowledge over a year ago, i have had the opportunity to read numerous books and publications about the subject from various authors. From Ben Graham to Warren Buffett and closer to Jim Chuoung and Stephen Jarislowsky, I have gained a lot of information and concepts from each of those men. One of the most crucial points I came to understand is that each investor, and mostly in the case of value investors, needs to have some of investment philosophy based on firmly held principles.

Such a philosophy takes time to acquire and being in the process of developing mine for about a year allowed me to understand to a deeper extent what each of the investment gurus are talking about. I have learned a lot by looking at the investment principles of some of them and I will expose those of Philip Fisher and Stephen Jarislowsky.

Starting with Fisher, I understood his principles after reading his most famous book entitled Common Stocks and Uncommon Profits that was first published in 1958 I recently talked about him in this article, but it is important to explain his investment principles in further detail.

He suggested to buy companies that have disciplined plans for achieving dramatic long-range profit growth and have inherent qualities making it difficult for newcomers to share in that growth. What we see today as barriers to entry.

He also said to buy those companies when they are out of favour. I guess it is from Fisher that Buffett got his quote: “Be fearful when others are greedy and be greedy when others are fearful”. He also suggested to hold a stock until either: there has been a fundamental change in its nature (e.g., big management changes), it has grown to a point where it no longer will be growing faster than the economy as a whole or, it is trading at a high P/E ratio because of mass market speculation only.

Philip Fisher also advised keeping the size of a portfolio at 20 companies or less and to never accept blindly whatever may be the dominant current opinion in the financial community; however warning that nor should investors reject the prevailing view just for the sake of being contrary. He finally insisted on the fact that serious investors had to understand that success greatly depends on a combination of hard work, intelligence, and honesty.

Stephen Jarislowsky, put himself on the public scene more recently when he published in 2005 his book called The Investment Zoo: Taming the Bulls and the Bears. The astonishing fact is that his writings are rarely about the precise subject of investing but tend to talk about the wider economy and his disagreement with the ways of the North American financial services industry. But I manages to find some interesting notes about what he looks for when investing in a company.

Stephen Jarislowsky talks about wait at least 6 months after the official announcements of a recession to make purchases on the open market and justifies that during that period, mutual funds, which are big players in the stock market, are dumping their shares to satisfy the redemption requests of their clients. He also notes that, at the same time, panicked investors pull their money out of the market and sit on the sidelines waiting for signs of an early bull run.

He does not invest in what he considers to be failing industries. Jarislowsky means by that industries that have not created value for their investors overall: citing commercial flight and car manufacturing. The events of the last decade sure show him right.

But as for many value investors, the most important think he looks for in a company is able and honest management, no matter the operating performance of the company. Stephen wants to know that the managers of companies he invests in are shareholder oriented above all.

The investment principles are very insightful and I hope they will put you on a road to learn more about value investing and the outstanding results showcased by those who follow it.

Who is that Benjamin Graham Anyways?

It is pretty obvious that this page focuses on Ben Graham and the influence he has had on the investing community. Any person claiming to be a value investor knows the fundamentals of his approach and any person doing transaction in the stock market have heard about him as the Dean of Wall Street. More precisely, with his colleague David Dodd, he initiated the idea of fundamental analysis and the value investing philosophy.

He started his career as a teacher at the Columbia Business School teaching about investing. The Great Crash of 1929 severely affected the performance of the Graham-Newman Partnership, which he had started a couple years ago with his partner Jerry Newman. Disappointed whit those results he pondered for years on a way to invest in the stock market but rationally and changed his teaching methods. His assistant, the professor David Dodd was mostly taking notes during those classes. In 1934, they decided to publish Security Analysis. With a staggering 770 pages, it laid the foundation for what would later be called value investing and since then, it has been considered by many investors to be a book that cannot be passed by. In 1949 he published the Intelligent Investor, which was a lighter version of Security Analysis, for some of the concepts had to be explained in further details. It is also from The Intelligent Investor that he publicized the character of Mr. Market.

The most fundamental statement he initiated in his book is that stocks were not just pieces of paper that went up and down in value, in responses to the forces of supply and demand; he stated that they were first and foremost parts of ownership in a business. Benjamin Graham insisted on the fact that if an investor comes to an approximation of the intrinsic value of the company per share and bought those share at a discount the their value, in the long haul, the market would converge to the fair value of those stocks, regardless of short term price fluctuations. And to date, many people still seem to ignore that because value investing is not the mainstream methodology.

Ben Graham also believed that there was a distinction between speculation and investment by a short statement with huge implication for the long standing definition of an investor. On page 18 of the fourth edition, it reads: “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” In other words, fundamental analysis is crucial of an investor.

Those assumptions lead to think that investing in the stock market is a time consuming activity to take seriously; they imply going through the financial statements of interesting companies and doing your own research.

The teachings of Benjamin Graham have impacted his students and associates in a deep way. Warren Buffett is the one with the most impressive track record. The late William J. Ruane of the Sequoia Fund was also greatly influenced by his teachings and those are just a few of the great investors to have taken their framework from Ben Graham. Value investing is a very interesting way of looking at stocks and I greatly anticipate the results of its use, in the coming years, on my portfolio.

Thursday, May 7, 2009

Relief from the Banks Stress Tests Results

After several months of waiting to see what would be the capital needs of 19 of the biggest banks in the US, the department of treasury provided a lot of information and if seems to me that they are a lot better than what has been expected by most investors and traders.

Since March, there has been a massive rally in stocks that has been triggered by internal memos at JPMorgan Chase (NYSE: JPM) and Citigroup (NYSE: C) that they had been profitable for the first two months of 2008. Those announcements revealed to be a source a major relief among many traders, even with the possibility of nationalization that was looming over most of them.

The goos news now is that those banks will not need more capital injection from the US government, but a couple of them will have to issue common shares to fulfill their needs for more Tier 1 capital. Those needs have been calculated by the treasury department assuming jobless rates rises above 10% and that home prices continue to tumble. The Washington Post came out with a very interesting article explaining the results of those stress tests that can be accessed here.

One thing is for sure, investors will probably feel more confident since banks like Bank of America Corporation (NYSE: BAC), Citigroup Inc. (NYSE: C) and JPMorgan Chase and Co. (NYSE: JPM) have seen major gains in their stock prices in afterhours trading on May 7th. What is left to see is how that market will react to those announcements on May 8th, even if some of the results have been leaked at the beginning of the week.

Full Disclosure: The author does not have a position in BAC, C or JPM.

You Broker and Transactions fees

A lot of people want to invest in the stock market, but I’m seldom sure that they know how they can do that. The first thing they need to know is that you need a broker to start investing in the market. The second thing is that they have to do a lot of research.

So how does one get started with trading? Many important financial institutions offer brokerage services to their regular clients and some independent brokers offer the same service. The first step is to open an account and then fund it. Pretty quick isn’t it? As soon as that is done, a trader can start investing.

Now there is a lot of choice available to investors, retail brokerage houses offer services ranging from 20$ to 30$ a trade. If you have been following the Q1 results of most banks in North America, you surely have heard that they showed the biggest increase in revenues compared their first quarter last year. A big chunk of those revenues actually came from their brokerage business, more precisely, from all the trades on all the trading of stocks and government bonds. Their profit margins must be appreciable since many independent brokerage houses offer the same services for a fraction of the price.

Right about now, many must wonder where it is possible to have a brokerage service that asks less than 20$ without having the usual minimum 100000$ or 150 trades per quarter? Being a value investor, it is pretty clear that the number of trades that I make around one per month or less. Doing business with a broker that allows a low volume of trades with a minimal fee is the option that makes perfect sense for me.

When i started looking for a broker, my first thought fell on E*TRADE, but their fee structure and, in my humble opinion, their poor service to help me get started with an account made me think that they were not the best choice for me. Fortunately, I fell, with enough luck, on a internet ad about an independent Canadian broker that goes by the name of Questrade.


What amazed me was their very flexible fee structure. It thinks as much about long term investors as much as about frequent day traders. They charge 1 cent per share on each trade, for a minimum of 4.95$ to a maximum of 9.99$, with no minimum required balance.

I have been a client since September 2008 and I have been incredibly satisfied with the swiftness of execution of my trades and their useful live costumer service. For those unsatisfied with their current broker, you can find more information on their website : www.questrade.com.

Wednesday, May 6, 2009

The BYD Mystery


Have you heard about BYD? If not, you will hear about it a lot more in the coming months because they are the Chinese contenders in the race for the first fully electric car. Many companies want that title and the level public awareness that will be attached to it.

As described in their corporate website, BYD Company Limited (HKG: 1211) was established in 1995, and it is a Hong Kong listed high-tech private enterprise mainly dealing with two businesses: IT manufacturing and auto manufacturing. BYD has nine production bases, including sites in Guangdong, Beijing, Shanxi, Shanghai, etc. with a total area of nearly 7 million square meters. BYD has also set up branches and offices in America, Europe, Japan, South Korea, India, Taiwan, Hong Kong and other regions. BYD’s total number of employees now exceeds 130,000.

The reason I’m talking about that company is that a Berkshire’s subsidiary, The MidAmerican Energy Holdings Company, has invested 230 million USD in September 2008 to acquire a 10% stake in the Chinese battery maker. Being in business for less than 20 years, BYD has developed enough expertise to be a major distributor in battery technology. It isn’t the traditional way to enter the car construction business but it seems to work for the company: they have become one of the mainstream automobile manufacturers in China with hundreds of thousands of units sold for their different models.

They might be the first manufacturer to have a vehicle that can be commercialized with their E6 model. With a 214 hp permanent-magnet type synchronous motor that gives the car an estimated autonomy of 249 miles (400 km) on a single charge, they have developed a car functional enough to be used every day. The only thing left to see if they are going to be able to make it available before competitors like Fisker or Tesla. I wonder if the Buffett endorsement will be good enough to ensure investors that followed him are not deceived.There is more information about the development of pure electric vehicles on each of these company websites.

BYD Motors Website
Fisker Automotive Website
Tesla Motors website

Full Disclosure: The author does not have a position in 1211 (BYD).

The Only Car Manufacturer Worth Investing Your Money In

The automotive industry has rarely be one that has awarded investors with great returns; in fact, the current economic conditions serve as a good example of what I’m talking about. North American constructors are encountering the worst economic environment they have ever faced. European and Japanese brands are faring better, mostly because they were accustomed to building small fuel efficient cars for almost two decades. My main concern is that there is one company that many investors are passing over because its stock is not traded on any North American exchange.

To many people’s surprise, the company I am talking about is Porsche SE (FRA: PAH3), the holding company that owns the Porsche AG constructor and a 51% majority stake in Volkswagen AG. I knew for a while that Volkswagen and Porsche had had a commercial partnership for a while, exchanging various technologies and components for the construction and development of new cars. But it is only recently that it came to my attention that Porsche was the one owning Volkswagen and not the other way around as it is the case for many luxury cars manufacturers to be owned by middle class cars producers.

A quick look at the 2008 financial statement led me to think that there was something there to make investors pay attention. With a 24% net profit margin, it seems to me that the company has a competitive advantage strong enough to ensure the sustainability of their profits. They also accomplished a staggering 48% return on shareholder’s equity for the fiscal year, which is very rare for many companies but literally unseen for a car manufacturer! Though it is important to mention that a important part of their earnings come from dividend payments by Volkswagen AG.

The downside is that all the common shares of the company are privately held by the Porsche family. As the illustrate it on their web page, the 87500000 shares traded on the Börse Frankfurt are preferred shares that represent exactly 50% of the number of shares that have been issued by the company and have no voting rights and that about half of those are owned by institutional investors. The main advantage of those shares remains that they pay a slightly higher dividend than the common share and, as many preferred shares, are senior to the common shares on the dividend payment.

For those you might be interested in investing abroad, you can visit the corporate site of Porsche SE for more information: http://www.porsche-se.com/pho/en/

Full Disclosure: The author does not have a position in PAH3 or POAHY.

Protect your investment gains

One of the many mistakes made by investors if that they often neglect to protect their gains from the burden of taxes. Don’t get me wrong, I am not talking here about illegal means to avoid taxes, there are many ways to save taxes and at the same time remaining compliant with tax laws. The examples I will be showcasing are more specific to the US and Canadian financial systems, but I’m pretty sure it shouldn’t be very hard for somebody industrious enough to find them for their local jurisdiction.


The first tools are traditional retirement savings plans. In their case, the contributions are tax-deductible. So for somebody who is in the 30% marginal tax bracket contributes 5000$ in that plan, he will see his tax return or his tax obligation respectively increase or decrease by 1500$. An investor could use them since they allow for a variety of investment vehicles, ranging from CDs (GICs in Canada) to Stocks, which is of interest. The taxpayer gets the tax benefit during the fiscal year that the money is invested. In the US, there are the IRA (Individual retirement account) and the 401(k). In Canada, it is the RRSP (Registered retirement savings plan) that offers the same advantages. To me it seems it would be very useful for people in higher tax brackets to maximize those types of account.


People in lower tax brackets and some money to spare will find the second type of investment account very interesting. It has been available for a while in the US and has been offered to Canadians only since January 2009. Contributions to a those accounts are not deductible for income tax purposes but their biggest advantage is that investment income, including capital gains, earned in a TFSA are not taxed, even when withdrawn! I might be wrong, but it looks to me like the last tax haven available to the middle class. In the US, they are called Roth IRAs and in Canada, they are named TFSA (Tax free savings accounts). Put the issuance of TFSAs the, the Canadian government provided a graph showcasing the long-term tax advantages:


People not familiar with those accounts should meet with their investment advisor to get more clarifications about them. This article gives only a glimpse of their characteristics and an investor serious about his long term success should think about implementing them in their investment strategy. There should be more effort put in maximizing them to the limits than since they will provide tax relief in the present and untaxed profits in the future.

Tuesday, May 5, 2009

An Investor with a bright future

Value investing is a discipline that is thoroughly practiced by very few money managers and the fact the performance of any given fund is measured quarterly while value investing is an approach that is long-term oriented.

In Canada, I have heard of very few “to the core” value investors. The most infamous of them is certainly Stephen A. Jarislowsky, who has been involved in money management for almost half a century, providing his clients with outstanding returns and at the same time becoming one of the few billionaires of the country.


The second notable value investor in Canada is Vivan Prem Watsa, the chairman and CEO of Fairfax Financial, a company I have talked about in another article that can be found here and that is advantageously positioned to make a lot of money on investment income in the coming years!


Curiosity is a big plus when you want to use the value investing method and as I was going through a MoneySense magazine in 2007; I fell on an article talking about a young money manager in Toronto, named Jim Chuong, who had accomplished a compounded average rate or return of roughly 20% on his investments! I decided to take a look at his website and I was simply astonished by the amount of value investing wisdom that was available there. For the whole period he has been investing, he wrote an annual letter to his partners... pretty much like Warren Buffett did in his early days. The following graph shows how 10000$ invested with him when he began investing in 1997 would have fared compared to the S&P500:



As you can see, he did not achieve such results by sheer luck. His performance has been affected by the broad market meltdown of 2008, but it is normal, since very few managers showed positive returns for the year. If you want to learn more about him and his strategies, his website www.ticonline.com