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February 24, 2014

Buffett's annual letter: What you can learn from my real estate investments

Warren Buffett is the CEO of Berkshire Hathaway. This essay is an edited excerpt from his annual letter to shareholders.

This story is from the March 17, 2014 issue of Fortune and sent along to us by Garrett with our thanks.  This is a wonderful letter.  It basically says investing isn't all that hard but that most people shouldn't try it - they should just go buy an index.  Buffett's been saying the same thing for years.  What's different here is that he lays out his rules for buying stuff more succinctly than I've seen before.  

Buffett's annual letter: What you can learn from my real estate investments

February 24, 2014: 5:00 AM ET
 
 

In an exclusive excerpt from his upcoming shareholder letter, Warren Buffett looks back at a pair of real estate purchases and the lessons they offer for equity investors.

By Warren Buffett

The author visiting (for just the second time) the 400-acre farm near Tekamah, Neb., that he bought in 1986 for $280,000

The author visiting (for just the second time) the 400-acre farm near Tekamah, Neb., that he bought in 1986 for $280,000

FORTUNE -- "Investment is most intelligent when it is most businesslike." --Benjamin Graham, The Intelligent Investor

It is fitting to have a Ben Graham quote open this essay because I owe so much of what I know about investing to him. I will talk more about Ben a bit later, and I will even sooner talk about common stocks. But let me first tell you about two small nonstock investments that I made long ago. Though neither changed my net worth by much, they are instructive.

This tale begins in Nebraska. From 1973 to 1981, the Midwest experienced an explosion in farm prices, caused by a widespread belief that runaway inflation was coming and fueled by the lending policies of small rural banks. Then the bubble burst, bringing price declines of 50% or more that devastated both leveraged farmers and their lenders. Five times as many Iowa and Nebraska banks failed in that bubble's aftermath as in our recent Great Recession.

In 1986, I purchased a 400-acre farm, located 50 miles north of Omaha, from the FDIC. It cost me $280,000, considerably less than what a failed bank had lent against the farm a few years earlier. I knew nothing about operating a farm. But I have a son who loves farming, and I learned from him both how many bushels of corn and soybeans the farm would produce and what the operating expenses would be. From these estimates, I calculated the normalized return from the farm to then be about 10%. I also thought it was likely that productivity would improve over time and that crop prices would move higher as well. Both expectations proved out.

MORE: Buffett widens lead in $1 million hedge fund bet

I needed no unusual knowledge or intelligence to conclude that the investment had no downside and potentially had substantial upside. There would, of course, be the occasional bad crop, and prices would sometimes disappoint. But so what? There would be some unusually good years as well, and I would never be under any pressure to sell the property. Now, 28 years later, the farm has tripled its earnings and is worth five times or more what I paid. I still know nothing about farming and recently made just my second visit to the farm.

In 1993, I made another small investment. Larry Silverstein, Salomon's landlord when I was the company's CEO, told me about a New York retail property adjacent to New York University that the Resolution Trust Corp. was selling. Again, a bubble had popped -- this one involving commercial real estate -- and the RTC had been created to dispose of the assets of failed savings institutions whose optimistic lending practices had fueled the folly.

Here, too, the analysis was simple. As had been the case with the farm, the unleveraged current yield from the property was about 10%. But the property had been undermanaged by the RTC, and its income would increase when several vacant stores were leased. Even more important, the largest tenant -- who occupied around 20% of the project's space -- was paying rent of about $5 per foot, whereas other tenants averaged $70. The expiration of this bargain lease in nine years was certain to provide a major boost to earnings. The property's location was also superb: NYU wasn't going anywhere.

buffett-graph

I joined a small group -- including Larry and my friend Fred Rose -- in purchasing the building. Fred was an experienced, high-grade real estate investor who, with his family, would manage the property. And manage it they did. As old leases expired, earnings tripled. Annual distributions now exceed 35% of our initial equity investment. Moreover, our original mortgage was refinanced in 1996 and again in 1999, moves that allowed several special distributions totaling more than 150% of what we had invested. I've yet to view the property.

Income from both the farm and the NYU real estate will probably increase in decades to come. Though the gains won't be dramatic, the two investments will be solid and satisfactory holdings for my lifetime and, subsequently, for my children and grandchildren.

I tell these tales to illustrate certain fundamentals of investing:

  • You don't need to be an expert in order to achieve satisfactory investment returns. But if you aren't, you must recognize your limitations and follow a course certain to work reasonably well. Keep things simple and don't swing for the fences. When promised quick profits, respond with a quick "no."
  • Focus on the future productivity of the asset you are considering. If you don't feel comfortable making a rough estimate of the asset's future earnings, just forget it and move on. No one has the ability to evaluate every investment possibility. But omniscience isn't necessary; you only need to understand the actions you undertake.
  • If you instead focus on the prospective price change of a contemplated purchase, you are speculating. There is nothing improper about that. I know, however, that I am unable to speculate successfully, and I am skeptical of those who claim sustained success at doing so. Half of all coin-flippers will win their first toss; none of those winners has an expectation of profit if he continues to play the game. And the fact that a given asset has appreciated in the recent past is never a reason to buy it.
  • With my two small investments, I thought only of what the properties would produce and cared not at all about their daily valuations. Games are won by players who focus on the playing field -- not by those whose eyes are glued to the scoreboard. If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays.
  • Forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important. (When I hear TV commentators glibly opine on what the market will do next, I am reminded of Mickey Mantle's scathing comment: "You don't know how easy this game is until you get into that broadcasting booth.")

My two purchases were made in 1986 and 1993. What the economy, interest rates, or the stock market might do in the years immediately following -- 1987 and 1994 -- was of no importance to me in determining the success of those investments. I can't remember what the headlines or pundits were saying at the time. Whatever the chatter, corn would keep growing in Nebraska and students would flock to NYU.

There is one major difference between my two small investments and an investment in stocks. Stocks provide you minute-to-minute valuations for your holdings, whereas I have yet to see a quotation for either my farm or the New York real estate.

MORE: Buffett looking to exit Washington Post's former owner

It should be an enormous advantage for investors in stocks to have those wildly fluctuating valuations placed on their holdings -- and for some investors, it is. After all, if a moody fellow with a farm bordering my property yelled out a price every day to me at which he would either buy my farm or sell me his -- and those prices varied widely over short periods of time depending on his mental state -- how in the world could I be other than benefited by his erratic behavior? If his daily shout-out was ridiculously low, and I had some spare cash, I would buy his farm. If the number he yelled was absurdly high, I could either sell to him or just go on farming.

Owners of stocks, however, too often let the capricious and irrational behavior of their fellow owners cause them to behave irrationally as well. Because there is so much chatter about markets, the economy, interest rates, price behavior of stocks, etc., some investors believe it is important to listen to pundits -- and, worse yet, important to consider acting upon their comments.

Those people who can sit quietly for decades when they own a farm or apartment house too often become frenetic when they are exposed to a stream of stock quotations and accompanying commentators delivering an implied message of "Don't just sit there -- do something." For these investors, liquidity is transformed from the unqualified benefit it should be to a curse.

MORE: Yahoo sued over Buffett's billion-dollar basketball bet

A "flash crash" or some other extreme market fluctuation can't hurt an investor any more than an erratic and mouthy neighbor can hurt my farm investment. Indeed, tumbling markets can be helpful to the true investor if he has cash available when prices get far out of line with values. A climate of fear is your friend when investing; a euphoric world is your enemy.

During the extraordinary financial panic that occurred late in 2008, I never gave a thought to selling my farm or New York real estate, even though a severe recession was clearly brewing. And if I had owned 100% of a solid business with good long-term prospects, it would have been foolish for me to even consider dumping it. So why would I have sold my stocks that were small participations in wonderful businesses? True, any one of them might eventually disappoint, but as a group they were certain to do well. Could anyone really believe the earth was going to swallow up the incredible productive assets and unlimited human ingenuity existing in America?

When Charlie Munger and I buy stocks -- which we think of as small portions of businesses -- our analysis is very similar to that which we use in buying entire businesses. We first have to decide whether we can sensibly estimate an earnings range for five years out or more. If the answer is yes, we will buy the stock (or business) if it sells at a reasonable price in relation to the bottom boundary of our estimate. If, however, we lack the ability to estimate future earnings -- which is usually the case -- we simply move on to other prospects. In the 54 years we have worked together, we have never forgone an attractive purchase because of the macro or political environment, or the views of other people. In fact, these subjects never come up when we make decisions.

MORE: Buffett does Detroit

It's vital, however, that we recognize the perimeter of our "circle of competence" and stay well inside of it. Even then, we will make some mistakes, both with stocks and businesses. But they will not be the disasters that occur, for example, when a long-rising market induces purchases that are based on anticipated price behavior and a desire to be where the action is.

Most investors, of course, have not made the study of business prospects a priority in their lives. If wise, they will conclude that they do not know enough about specific businesses to predict their future earning power.

I have good news for these nonprofessionals: The typical investor doesn't need this skill. In aggregate, American business has done wonderfully over time and will continue to do so (though, most assuredly, in unpredictable fits and starts). In the 20th century, the Dow Jones industrial index advanced from 66 to 11,497, paying a rising stream of dividends to boot. The 21st century will witness further gains, almost certain to be substantial. The goal of the nonprofessional should not be to pick winners -- neither he nor his "helpers" can do that -- but should rather be to own a cross section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal.

MORE: Buffett 'major mistake' leads to Berkshire acquisition

That's the "what" of investing for the nonprofessional. The "when" is also important. The main danger is that the timid or beginning investor will enter the market at a time of extreme exuberance and then become disillusioned when paper losses occur. (Remember the late Barton Biggs's observation: "A bull market is like sex. It feels best just before it ends.") The antidote to that kind of mistiming is for an investor to accumulate shares over a long period and never sell when the news is bad and stocks are well off their highs. Following those rules, the "know-nothing" investor who both diversifies and keeps his costs minimal is virtually certain to get satisfactory results. Indeed, the unsophisticated investor who is realistic about his shortcomings is likely to obtain better long-term results than the knowledgeable professional who is blind to even a single weakness.

If "investors" frenetically bought and sold farmland to one another, neither the yields nor the prices of their crops would be increased. The only consequence of such behavior would be decreases in the overall earnings realized by the farm-owning population because of the substantial costs it would incur as it sought advice and switched properties.

Nevertheless, both individuals and institutions will constantly be urged to be active by those who profit from giving advice or effecting transactions. The resulting frictional costs can be huge and, for investors in aggregate, devoid of benefit. So ignore the chatter, keep your costs minimal, and invest in stocks as you would in a farm.

MORE: For investors, diamonds might be the new gold

My money, I should add, is where my mouth is: What I advise here is essentially identical to certain instructions I've laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife's benefit. (I have to use cash for individual bequests, because all of my Berkshire Hathaway (BRKA) shares will be fully distributed to certain philanthropic organizations over the 10 years following the closing of my estate.) My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard's. (VFINX)) I believe the trust's long-term results from this policy will be superior to those attained by most investors -- whether pension funds, institutions, or individuals -- who employ high-fee managers.

And now back to Ben Graham. I learned most of the thoughts in this investment discussion from Ben's book The Intelligent Investor, which I bought in 1949. My financial life changed with that purchase.

Before reading Ben's book, I had wandered around the investing landscape, devouring everything written on the subject. Much of what I read fascinated me: I tried my hand at charting and at using market indicia to predict stock movements. I sat in brokerage offices watching the tape roll by, and I listened to commentators. All of this was fun, but I couldn't shake the feeling that I wasn't getting anywhere.

MORE: A popular 401(k) choice is still badly broken

In contrast, Ben's ideas were explained logically in elegant, easy-to-understand prose (without Greek letters or complicated formulas). For me, the key points were laid out in what later editions labeled Chapters 8 and 20. These points guide my investing decisions today.

A couple of interesting sidelights about the book: Later editions included a postscript describing an unnamed investment that was a bonanza for Ben. Ben made the purchase in 1948 when he was writing the first edition and -- brace yourself -- the mystery company was Geico. If Ben had not recognized the special qualities of Geico when it was still in its infancy, my future and Berkshire's would have been far different.

The 1949 edition of the book also recommended a railroad stock that was then selling for $17 and earning about $10 per share. (One of the reasons I admired Ben was that he had the guts to use current examples, leaving himself open to sneers if he stumbled.) In part, that low valuation resulted from an accounting rule of the time that required the railroad to exclude from its reported earnings the substantial retained earnings of affiliates.

MORE: myRA is not the way to save for retirement

The recommended stock was Northern Pacific, and its most important affiliate was Chicago, Burlington & Quincy. These railroads are now important parts of BNSF (Burlington Northern Santa Fe), which is today fully owned by Berkshire. When I read the book, Northern Pacific had a market value of about $40 million. Now its successor (having added a great many properties, to be sure) earns that amount every four days.

I can't remember what I paid for that first copy of The Intelligent Investor. Whatever the cost, it would underscore the truth of Ben's adage: Price is what you pay; value is what you get. Of all the investments I ever made, buying Ben's book was the best (except for my purchase of two marriage licenses).

Warren Buffett is the CEO of Berkshire Hathaway. This essay is an edited excerpt from his annual letter to shareholders.

This story is from the March 17, 2014 issue of Fortune.

 
 

http://finance.fortune.cnn.com/2014/02/24/warren-buffett-berkshire-letter/?iid=Lead

January 13, 2014

CLAY POSTS ON EBAY FOR YOUR CONSIDERATION

This is an analysis by Clay, taking his first public shot at determining for us whether a business is wonderfful and on sale.  His focus in this article is EBAY.  My notes follow at the end:

 

MEANING

     I've been an eBay member since 1999.  I know the ins and outs of how eBay and PayPal function both as a buyer and a seller. I’ve bought or sold everything from motorcycles, auto parts, vintage vacuum tubes, curly maple lumber, camping supplies, clothing, jewelry to high-end guitars, books and music.  It's a straight-forward concept.  Retailers/individuals provide the products,  eBay and Paypal provide the means to sell those products worldwide. (I've sold to Israel, Japan, UK, Spain etc myself) This one point illustrates a large difference from competitor Amazon.  eBay doesn't provide the product, so if it doesn't sell they still make money on the listing, whereas Amazon is at the mercy of inventory.  PayPal may have been beholden to eBay as an income source at one time but that's not the case currently.  With new retail partners, new mobile card reading hardware and partnership with Discover Paypal looks to expand its TAM far and wide.

 

 

 eBay vs. Amazon:    Amazon sells retail, supplying 60% of the actual products sold, while eBay provides exactly zero of the products sold on its website(s).   This means Amazon pays to purchase, ship and warehouse items.  Amazon may also have to eat a loss if the product doesn't sell well.   eBay on the other hand makes money regardless of actual sales completed.   eBay collects listing fees, insertion fees, photo fees, final value fees etc.  and if it doesn't sell?  They collect more when the seller relists the item....and if the item DOES sell?  Well, They take their fees and/or a percentage (depending on listing/category) and more fees if you use PayPal to complete the transaction    EBay basically has nothing to lose!   They get paid through two different cash flows if a sale is facilitated, and one source of cash  if the item doesn't sell.  If the merchandise gets re-listed or has to be sold at a loss eBay takes none of the loss, yet realizes cash flow every time listed.  With a gross 75% and net 34%  profit margin compared with Amazon's 26%/-.015% (according to yahoo finance).  Its a glaringly different business model.  Im not saying there isnt overlap, just that the way they go about things are very different.  Amazon doesn't carry as many items as eBay.  A simple search for "Jeep wheel" shows 25,000 more entries on eBay.  Also, none of the vintage /used/niche/collectible and one of a kind jewelry, items or art work that sell on eBay are on Amazon.  Want to find a vintage leather jacket or vintage Levi's ?  How about some authentic native american turquoise? 1957 Cadillac brake lens?  vintage Stratocaster guitar? you wont find them on Amazon.  Amazon doesn't beat eBay on prices for new merchandise either.  I can find most any book on eBay for the same or less than Amazon, Jerry Can for potable water? Lowest price is from Northern Tool ... selling on eBay.  Lots of major retailers use eBay to increase sales or clear dead stock as well. 

 

eBay vs. Craigslist:  Craigslist is basically a "non-profit" and eBay actually owns 28.4%.   Thats right, eBay owns part of craigslist and competes directly with its own service "eBay classifieds"(formerly Kijiji). 

 

Paypal: One might think that PayPal only makes money on eBay transactions.  With only $50 billion of PayPal's $150 billion in facilitated transaction revenues coming from eBay and the rest from other web or POS sales.  Its a sizeable portion but not the entirety or even majority by any means.  $3.6 billion of  PayPal's $5.5 billion in revenue comes from non-eBay marketplaces.   PayPal already has 123 million active users (eBay has 112 million) and looks to expand by leveraging partnerships with 23 major retailers throughout the U.S.   18,000 physical stores now let customers shop with PayPal in-store. The chains that accept this service include Advance Auto Parts, The Home Depot, Ace Hardware, Office Depot, Famous Footwear, Dollar General, Mapco Express, RadioShack, Spartan Stores, Abercrombie & Fitch, Aeropostale, American Eagle Outfitters, Barnes & Noble, Foot Locker, Guitar Center, Jamba Juice, JC Penney, Jos. A. Bank Clothiers, Nine West, Rooms To Go, Tiger Direct, and Toys "R" Us.  It's partnership with Discover  will add 7 million more locations.  PayPal provides a multi-source (cash from multiple savings or checking accounts and credit cards) way to pay without sharing your credit card or bank info, an increasingly important service in the age of phishing scams and hacked credit card accounts.  With architectural touch screen technology that would give Steve Jobs a chubby already being implemented in 4 major cities.   eBay inc is implementing new, scaleable ways for customers and retailers to interact, while creating a database that can be used to increase sales/ control inventory, and increase sell through based on customer behavior.

 

GSI/EBay enterprise:  GSI (Global Sports Inc) was started by Mark Rubin in 1999 as an e commerce platform to help sporting goods retailers, with a net revenue of $5.5million.   By 2010 it had expanded to $1.3 Billion by branching into a fulfillment and e commerce management company for everyone from Toys R Us to the NFL, NBA, NHL to Ace Hardware.  Covering all kinds of goods from all kinds of major brands and retailers.  Quite an amazing roster --http://www.ebayenterprise.com/clients/.   In 2011 GSI commerce was acquired by eBay inc.  Also in 2011  "Ebay Inc. completed the divestiture of 100 percent of GSI's licensed sports merchandise business and 70 percent of ShopRunner and Rue La La to a newly formed holding company led by GSI founder and CEO Michael Rubin."  This is where the rubber meets the road for any Amazon vs. EBay discussion in my opinion.  This is where the fulfillment centers come into play and Shop Runner vs. Amazon Prime come into play.  This is the overlap I can see.

 

 

MOAT:

Is it durable?   I think the concept of auctioning/wholesaling is as old as haggling and will be with the human race for a long time to come.  Same thing with paying for those items (Paypal) or trying to get more sales/higher profit margins (ebay enterprise née GSI Commerce)

 

Brand? Yes, I believe eBay, PayPal and GSI now eBay enterprise not only have brand recognition (In the case of GSI within the industry) they have earned the trust  of millions worldwide.  

 

Switching?  Yes, with both PayPal and eBay once you're using their website/software and they are embedded in your business it's a hassle to switch.  

 

 Toll?  eBay are billed as the Largest online marketplace.  Auctions tend to bring more money for items than outright sales, so the attraction for sellers who have high dollar or unique items is intense, and Craigslist or Amazon don't offer that.  PayPal has a "symbiotic" toll moat with eBay since all the auctions allow one to use Paypal.  GSI commerce offers fulfillment and ecommerce website/inventory management.  its fulfilment centers are something only companies like Amazon and Walmart can manage.  They've been at fulfillment and ecommerce since 1999.

 

Secret Moat?  Well they do have new patented  "shopping glass" currently in use in malls in 4 major cities*[2].  Not sure if I can call things "secrets" like the PayPal mobile app, "Beacon" hands free Bluetooth payment system, or the "PayPal Here" mobile phone card reader (direct competitor to "Square"), but they are things that cost lots of R&D money to replicate.

 

MANAGEMENT:

"We do not wish to join with managers who lack admirable qualities, no matter how attractive the prospects of their business.  We've never succeeded in making a good deal with a bad person"- Warren Buffett

 

 Pierre Omidyar is Chairman of the board, founder and a director.  Born in France.  He wrote the code that eventually became eBay in 1995.  By 1998 when the company came public he was a billionaire.  I think money brings out people's REAL personalities.  When Pierre and his wife became insanely wealthy they showed what was inside by becoming philanthropists!  I'll let them speak for themselves here: 

 

 "Our backgrounds are in technology and science. We are parents, entrepreneurs, humanitarians, citizens, thinkers, doers and philanthropists. We wear all of these hats at different times, and many simultaneously.  We believe that people are essentially good—people can be trusted, and generally have good intentions. This was a key belief in the creation of eBay in 1995, and has remained an integral part of our lives ever since.  We are committed to using our time, energy, and resources for the public good; it’s our passion, and a challenge as great and rewarding as any we’ve experienced. We focus on the efforts we believe in most, and the places where we have distinctive contributions to offer. By cultivating the inherent capabilities that exist within each individual, we hope to have a positive impact on people and communities, promote human dignity, and alleviate suffering.  We believe in the power of people. In their creativity. In their ability to take action and bring about extraordinary change. In their desire to do good for themselves and one another. That belief in humanity is what drives us and unites all of our efforts."--from the Omidyar Network site

 

"As a first generation American who came to this country when I was still young, I continue to be inspired by the founding vision of the American republic and believe that through innovation, dialogue, and bipartisan reform we can take steps that will help us realize that vision." -from his Democracy group web page.

 

He's got a BAG, his philanthropy is as impressive as Buffett and Gates and has signed the Giving Pledge.   Oh, and his salary is $19,916.... Sounds pretty darn good to me.  

 

John  J. Donahoe, CEO, President, Directector.  BA Economics Dartmouth, magna cum laude, MBA Stanford Graduate school of business.  Salary of $970,353 with total annual compensation of $3,975,119.  A former Schlitz Beer employee, and fellow Teamster he went on to join Bain & Co. inc in 1982.  Served as head of San Francisco office for 7 years.  He has been a member of operating and nominating committees.  He was named Worldwide Managing Director from 1999 to March 1, 2006 at Bain.   Mr. Donahoe oversaw Bain's 29 offices and 3,000 employees worldwide.  He also served clients in telecommunications, airlines, aerospace, and financial services industries.  Prior to that he worked for Rolm Corp. and Salomon Bros.  CEO and president of Ebay Inc since March 2008.  President of Auction Business Unit since Feb. '05 and has been a director at Intel since March '09.  Vice Chairman of the Advisory Council at Stanford Graduate School of Business, Board of trustees of Dartmouth College and Sacred Heart Schools. Served as trustee of Bridgespan Group and other charitable organizations.

 

SUMMARY:  I see eBay as a robust platform that does well even in tough times, Paypal as an established and growing player in Omni channel retail with eBay as a strong cash flow Berky to help it expand on its already impressive list of brands/retailers it works with.  GSI/eBay enterprise itself has an impressive list of brands it does work for.  

 

"Since the company’s founding, we have maintained that the value that eBay Inc. creates for its stockholders isn’t strictly financial. In 2012, we articulated a strategy to focus our social innovation efforts around three core areas: creating economic opportunity, powering charitable giving and enabling greener forms of commerce. For example, we announced and began construction on the first-ever data center to use renewable energy as its primary power source. And through PayPal, we processed more than $3.6 billion in funds in 2012 for charitable organizations."-2012 shareholders letter

 

VALUATION (MARGIN OF SAFETY)

I saw the chart of eBay looking like a year long sideways channel from 50 to as high as 58...just a bit over Town valuation default settings of $57 Sticker based on $2 EPS and 14% future GR.  [The price today closed at $52 -- PT] If that EPS becomes $2.50 the sticker becomes $72 and MOS is $35.  Is $2.50 EPS outrageous to imagine?  They did it in FY2011 and I believe they can achieve that again and more.  

 

[NOTE FROM PHIL: The valuation consideration is less complete than I would want before I put a Sticker on this.  We never just run the Valuation on the Tools and assume its right.  I'd look at Payback Time and Zombie.  I'd look at Free Cash Flow and compare it to earnings to see if the PBT is better or worse.  I'd make a case for a specific growth rate and PE.  And I'd make sure I was starting from a reasonable TTM EPS.  Maybe you all can fill in the blanks here.  Is it possible that Ebay is on sale?  If not, why not and if not then why is an investor as astute about value as Julian Robertson buying in at $53?

The Ebay moat is Brand, Switching, Toll and Price.  Brand is self-evident.  Switching is difficult because of the Ebay rating system.  It is a Toll Bridge moat there being few other real choices for dumping your stuff on line effectively.  And Price is the whole point - the ability to get something cheaper than in a store.

 

No question, this is a wonderful company.  I think it does have a durable moat.  But price is everything and it appears to be expensive.  So, again, why is Robertson buying?

 

NOW GO PLAY

December 09, 2013

MUST READ: BILL BARTMANN'S "BOUNCING BACK"

Have I got a story for you.  A friend of mine has written the most unusual book you will read this year--or will read maybe ever.  It's really more of an adventure than a book. Let me explain. 

I'm guessing that at some point when you were growing up, there was some point in time when you were pretty down. It was then that your mom probably said something like:  "No matter how bad you feel right now, someone's had it worse."  At other times when you felt on top of the world, someone might have warned you: "No matter how  well you do, someone else has done it better."

We've all heard that sort of thing. Here's the really unusual part: What if the highest highs and the lowest lows actually happened to the same person?  My friend, Bill Bartmann, is living that life and its a great story. Get this:

• As a teenager, he was a homeless gang member, eating out of dumpsters.

• Later, his best job was working at a pig slaughterhouse.

• He was an alcoholic at age 18, and became a paraplegic after falling down stairs drunk

• Yet he walked out of the hospital...

• Got married (and stayed married)

• And put himself through college... and law school.

• And became an entrepreneur in the oil patch, a millionaire and then lost it all

• And with about 2 cents started a new business ...

• And Bill became a billionaire and entrepreneur of the year

• Then the Feds (nice job John Ashcroft) moved in on him for all the wrong reasons, destroyed his company and he lost it all in 72 hours and faced 600 years of jail ...

• But he refused to plea bargain and was found not guilty....

• And now he's on the road to getting it all back.

If you've ever wished that fiction thrillers were more true, and that true stories were more interesting, then you're gonna love this book; "Bouncing Back" by Bill Bartmann.

Full Disclosure: I don't make a single penny if you buy this book. I just want you to know about Bill's amazing book for three reasons:
1. It's just a fascinating story to read and to realize that it all happened to a real person who's alive today; and
2. It's full of important principles about failure and success, betrayal and honor, despair and resolve.

3.  I couldn't put it down. 

You know I get asked to blurb books all the time.  Among authors its almost a tribal requirement to blurb other's books.  But I rarely do it and only when I really like the book and I really like the author and I think you guys will benefit from it in some immediate way.  I've blurbed Happy for No Reason by Marci Shimoff, 4-Hr Workweek by Tim Ferriss and now this one.

You can get the eBook at Amazon.  "Bouncing Back".  It's only $5.95 on Kindle. Here's a link to the book or go to Amazon.com and type in "Bouncing Back by Bill Bartmann".

I can tell you one thing for sure: If you start reading this book, you will not be able to resist telling others about it. It's one hell of a story.

Now go play

November 26, 2013

RULE ONE VIRTUAL INTERVIEW WITH WARREN BUFFETT

This post is a virtual interview with Mr. Warren Buffett that I created by framing questions to match answers from his annual letters.  Its not a long interview so I strongly urge you to read each answer closely.  Really give it an effort to understand what he's saying.  This is distilled investing knowledge of a lifetime.  It wouldn't hurt to memorize it:

 

Q.  Mr. Buffett, you’ve taught us to look for a good business at a good price.  Could you give us an example of a good business that all of our Rule One students can easily understand?

A.  They ought to be confident if they buy a farm....  [T]hey ought to look at what the farm produces, how many bushels an acre do they get out of their corn or soybeans and what prices do they bring.  If you decide to buy a farm and you pay the right price for it, you don’t need to lose faith in American agriculture, you know, because the prices of farms go down.

 

Q.  So you don’t worry at all about being able to buy this farm or business cheaper tomorrow.  What if the economy and stock market are melting down?  Do you still step in there and buy?

A.  If you tell me the economy is going to be terrible for 12 months, pick a number, and then if I find something that is attractive today, I am going to buy it today.  I am not going to wait and hope that it sells cheaper six months from now.  Because who knows when stocks will hit a low or a high?  Nobody knows that.  All you know is whether you’re getting enough for your money or not.

 

Q.  So what are the key things you look for to determine whether you are getting enough for your money?

A.  If you’re going to buy a stock in some business that’s been around for a 100 years and will be around for 100 more years and it’s not a leveraged company and it sells some important product and it’s got a strong competitive position and you buy it at a reasonable multiple of earnings, you don’t have to worry about crooks, you’re going to do fine.

 

Q.  What’s your view of a ‘reasonable’ multiple of earnings?  Is there a number?

A.  We acquired a company recently and the owner quoted me as saying that I like to buy a PE of 10.  I’ll leave it at that.

 

Q.  We’re not supposed to worry about the business’s market price declining, right?  Is there a percentage decline beyond which you’d be very concerned?

A.  Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market.

 

Q.  That brings up the question of diversification.  You are famously not diversified across the broad market.  Why is that better than spreading it around to a lot of good companies?

A. Wide diversification is only required when investors do not understand what they are doing.  Never invest in a business you cannot understand.  Risk can be greatly reduced by concentrating on only a few holdings in businesses you understand well. 

 

Q.  Which takes us to my last question:  What’s the most critical thing for our Rule One students to focus on? 

A.  The critical investment factor is determining the intrinsic value of a business and paying a fair or bargain price.  [And] lethargy bordering on sloth should remain the cornerstone of [their] investment style.

 

Q.  Thank you very much, Mr. Buffett.  Everything makes total sense.  Its so weird so few people follow these principles.  I always wondered why.

A.  I asked [Ben]Graham the same question. Everyone took his class at Columbia Business School. 90% of the people that took his class ended up doing something else.

 

Now go play.

November 11, 2013

ANGELA (guest post) ON SILVER WHEATON

I am putting up the following post as a training exercise.  I am not giving you my opinion on the quality of the analysis except to tell Angela that she's definitely trying to do the work and that's the most important thing at this point.  The more you do on your own, the faster you learn.  So let's take a good look at what she wrote and do some solid critiques.  Focus on MOAT and the value of the business.  Is this a 'Just One'?  Would you put even 25% of your money into this?  If not, why are we looking at it?  If so, then make a good, rational case for it.  

And have fun!

 

Angela W. 

Silver Wheaton

 

I. Meaning: Silver Wheaton (SLW) is the world’s largest silver streaming company. It does not own or operate any mines. By providing upfront payment, it secures long time/lifetime agreements to buy all or portion of silver and gold production at a predetermined fixed cost, generally around $4/oz and $400/oz respectively, from mining companies located in politically stable regions around the world. Streaming companies provide venture capital for mining companies in exchange for an interest in mine production. Streaming is considered to be mutually beneficial. In today’s environment where funding is hard/expensive to obtain and the fact that mining is a very capital intensive business, mining companies could get upfront capital injection at no/very low cost, from their non-core by- product sale, to fund their core product business. SLW’s peers include Royal Gold (RGLD), Franco-Nevada (FNV) and Sandstorm (SAND), primarily gold streaming companies versus SLW a primarily silver streaming player (80% silver +20% gold). SLW has streaming rights to 19 operating mines and 4 development projects. Corner stone assets including Penasquito mine in Mexico with Gold Corp, Pacua-Lama project in Chile/Argentine with Barrick Gold, San Dimas mine in Mexico with Primero, Constancia silver/gold mines in Peru with Hudbay,777 gold mine in Canada with Hudbay and the recent acquisition of Salobo/Sudbury gold mine in Brazil with Vale. Durability and Predictability • Durable mining industry as economic growth demands metals. Thomson Reuters GFMS estimates that 72% of 2012 global silver production was produced as a by-product from copper, lead, zinc or gold mines. As a result, silver will be mined anyway together with other metals. In addition to being an investment vehicle, silver (50% of its production) has been widely used for industrial use, primarily in hi-tech sector, such as in cell phones/electronics/equipment. o SLW owns estimated reserves of 1.12B silver equivalent oz. At 33.5M silver equivalent oz production per year pace, the existing reserve could last them 25-30 years, without counting future acquisitions. In addition, SLW now has only 5.8% of the world’s total silver production, thus still has considerable amount of growth potential. •Predictability o Very low. Precious metals are very price volatile, and there is inherent exploration/development risk associated with the projects SLW has a meaning for me. With concerns of central banks creating fiat money and eventual high inflation/wealth transfer, I have invested in both physical bullions and ETFs in my retirement account. I have followed commodity veterans Jim Sinclair, Jim Rogers, Doug Casey, David Morgan since 2002. I see SLW as a unique business model as it has a more diversified portfolio than regular mining companies, no risk with direct exploration/development/production, fixed capital and purchase cost, and a potential to capture price upside.

 

II. Moat: Numbers look good, consistent and growing Moat: Compound Growth Rate 10 Years 7 Years 5 Years 3 Years 1 Year RATING BVPS+Dividend Growth Rate - 30.5% 21.5% 22.7% 20.9% 100 EPS Growth - 41.0% 32.3% 62.1% 6.4% 100 OCPS Growth - 43.8% 30.8% 61.7% 14.7% 100 Sales Growth - 28.3% 24.9% 45.4% 15.9% 100 Rule One Moat Score 100 • Switching moat: SLW, through its streaming agreement, owns, in most cases, lifetime silver/gold production from its mining partners. • Why they are better than competitors: SLW believes they have redefined how mining industry use their non-core silver byproduct. SLW has the first mover advantage, and have quickly amassed consideration amount of funding in the beginning, and later on solid cash flows from operations. The cash on hand helps to position them in a unique time like now • Chart View: all 4 lines are in a consistent and parallel upward trend, except for EPS growth dip in 2008, due to $65M loss on mark-to-market long term investment, which looks like the company’s warrants. • Gurufocus: no Phil’s gurus activity

 

III. Management Management: Average Growth Rates 10 Years 7 Years 5 Years 3 Years 1 Year RATING ROE - 12.3% 12.2% 17.5% 18.9% 100 ROIC - 11.4% 11.7% 17.2% 18.7% 100 Debt 0.04 years earnings 99 Rule One Management Score 99 • A very capital efficient business model/management team. 28 full time employees, with $7.5B market cap and $845M 2012 revenue. • CEO/President Randy Smallwood is one of SLW’s founding members. He is an industry veteran, with a geological engineering background and has been in a number of mining companies, including Gold Corp. He has mainly been in corporate development role, basically a deal maker. • Management team performance is solid. They have in depth knowledge of the mining industry. They target mining companies based on these criteria. • Low leveraged balance sheet: companies need to have the extra cash to sit out the tough times. Gold Corp as an example. • Low cost, high efficiency: 85% of SLW production comes from the companies in the low quartile of their cost curves • Junior mining companies that need alternative ways of funding and are willing to make deals. Hudbay/Vale as example. They have also been smart to put contingency clauses in the contract to protect their interest, in case the deal goes sour. Concerns: • Haytham Hodaly, Senior Vice President, Corporate Development, joined SLW in 2012. Before, he is a mining analyst in RBC capital and has 16+ years of experience in North America security market. Not sure how effective he is, as a long time security analyst, to be a deal maker in the real world. • CEO’s 2011 compensation of $2.9M, with only 23% in salary, the rest from restricted stocks/options. Gives incentive to drive for short/mid term stock performance. From Insider Trading, he got 150K stock options exercised at $17/share on the most recent June and sold half of it on the same day for $24. See other management team mostly sell, instead of buying company stocks • Don’t see personally passionate BAG

 

Evaluation Pros: • Predictable upfront cost, fixed purchase cost • High margin with GM>50%. SLW pays around $4/oz and $400/oz for silver and gold respectively. As a reference, Gold Corp’s all-in cost is $874/oz and Barrick $945/oz of gold production. • Do not have to deal with exploration/development/environmental risks

 

Cons: • no control over operation/production • Mining partners might go underwater and thus goes the upfront investment and future growth • Extremely volatile PM prices • Declining margin/earnings this year due to lower metal price and higher cost resulting from product mix (more gold into the mix, with lower margin)

 

SLW future growth depends on two factors: production volume and metal prices. Production Volume: SLW management comments that they have been extremely busy with corporate development projects. They are treading very carefully during volatile time, looking for “green flag’ among the red. Additional acquisitions is highly likely. Randy and his team is almost like our Ruler, looking for events to happen so that they could capitalize Price: Jim Rogers/Doug Casey think gold/silver price will go up in the long run. Jim says that there will probably be more corrections in near term, but “gold price should go up much higher in the next decade”. Mainly due to central banks’ money printing Events

 

• Mining sector: The traditionally European financiers have backed away from the mining sector, due to increased mining cost, cash flow being eaten by increased capital investment, the availability of ETFs and the general economy. The mining sector has been hammered in the last several years and it has become very difficult and expensive, especially for junior miners to find funding. However, great opportunity for SLW

 

• SLW: Barrick announced construction suspension of Pascua-Lama mine on Oct 31 and its CEO is forced to step down 11/8. Major setback for SLW as the mine is projected to be 15-20% of its total sales by 2017. However, I think this is temporary. Pascua-Lama is a $8.5B capital investment project and once finished, is said to be the world’s best silver mine with the most deposits and low cost. Under grave cost concern, this project is probably being put on care & maintenance and Barrick is waiting to resolve high cost issue, environmental issues but impossible to walk away from a good mine. There will be delay in project completion but not eventual shut down. Meanwhile, SLW is entitled to get the short fall volume from Barrick’s 3 other mines and could get back its upfront $625M investment if project goes sour. SLW is protected from the downside, however, the temporary impact to upside growth in near term is real.

 

IV. Margin of Safety • Growth rate: Analyst projection 20%. Based on SLW’s recent updated forecast, annual compound production growth rate to 2017 will be 6.1%. I did two scenarios, assuming 10% production growth (with additional acquisitions) afterward with and without Pascua-Lama reopening in 2018. Price wise, assuming price will double in the next decade to $40/oz. The projected growth rate comes out about 15% • TTM: $1.29 (updated after Q3 13 earnings). I feel the margin erosion from increased gold weight has been almost counted in now. • P/E: 30 • Sticker $38, MOS $19. • Analyst long term P/E 20, then MOS $13 • Seems price is in a channel, with $24 high and $15 low. Option candidate? 1 month put with $15 and $17 strike yield $.3 to $.11 per. • Current observation: Does not fit into “Just One” category but might be a candidate for 2nd tier positions. How about buy 1H at $18 and sell puts around $16 strike

November 06, 2013

HOW WE USE PE FOR RULE #1 INVESTING

There has been a flurry of comments discussing PE and Rule #1 and a lot of questions have arisen that have been answered with various degrees of accuracy regarding how we use PE.

Many so-called 'value' investors try to buy companies based on low PE's and high PE's.  The idea is that if today the PE is a 5 and a 5 PE is at the low end of the relative range of the business's PE, the business is a 'value' and is on sale.  That's not a Rule #1 Investing principle nor is it even necessarily correct.  

A company is not necessarily 'on-sale' by virtue of its PE being relatively low.  The relative PE provides no information about what earnings are going to be in the future, how those fit into the overall historical picture or how the TTM EPS is related to the future earnings of the company.  If you could buy wonderful businesses on sale just by doing a relative PE analysis, you wouldn't need to understand the business at all.  Life would be simple.  But low PE's can be deceptive.

A company can have a relatively high PE if Mr. Market thinks the TTM EPS is unrealistically low.  Or a relatively low PE if Mr. Market thinks the earnings are unusually high.  

And if the business is on its way to bankruptcy or a long recovery or a broken moat you could be looking at a relatively low PE and no kind of margin of safety at all.

You gotta know the business.  You gotta know the moat.  You gotta know the absolute value, not the relative value.

The only place we use PE is as a multiple of the earnings in our Rule #1 MOS valuation formula. While that might seem like a distinction without a difference at first look, its a very different use of PE than relative valuation use.  We are not determining whether the business is on sale based on a relative view of what 'low' is with regard to this company.  I use it solely as one of four inputs into the MOS analysis.  It is just a multiple of the future earnings and its necessary because no good company is going to sell for one year of earnings. Its going to sell for multiple years worth of earnings.  The right multiple reflects a good market and a solid grip on the long-term growth rate ten years into the future.  For Rule #1 investors the PE is derived more from a projection of future growth than historical PE data.

Note that we don't use the PE to figure Payback Time.  We don't use PE in figuring Zombie value. And, to reiterate, we don't use relative PE to decide something is 'cheap'.  

[NOTE: A brief reminder to those of you who are taking advanced courses that this is not the place to discuss the content of those programs nor are you authorized to discuss intellectual property publicly.  That information is for you to use, not for you to teach.  Thank you.]

Now go play.

October 29, 2013

TRANSITIONAL INVESTING WORKSHOP SUMMARY

The auditorium at the Wyndham was packed; standing room only for 3 days.  Our sincere thanks to Michelle, Jeff, JP, Earl and Nancy, Michael D, Greg and Kirk for all of their help and also a big thanks to all the many long-time students who volunteered to help the novice Rulers during the small-group lab sessions.  And a very special "thank you" to Stephen Haller who joined us from Germany with his amazing insights (for staff) into economics.  

We're already looking forward to the next time we can do this with those who've never had a chance or the money to learn how to invest the way the best investors in the world do it. 

Here's a summary of the three days:

The key to successful investing is to buy companies (stocks) as if each one is the only stock you will buy the rest of your life. 

You must buy only 5 to 10 companies.  To get great results, you must load up, not nibble.

You must truly understand the business and the industry in order to 'load up the truck' when you have the opportunity.

The historical view of the business is only the first step.  Knowing where its going in the future is what's critical and what its worth as a business.

How to know the value 3 different ways: MOS, Payback Time and Zombie.

Why you must have a huge margin of safety when you buy and how to know if you really have one.

Why your mutual fund manager can not and will not invest like Warren Buffett with a MOS and a focus on only a few great companies that are on sale.

Why its critical to calculate Owner's Cash to nail the true PBT.

Why coat-tailing is the easiest and best way to find stocks to research.

The best hedge fund managers to coat-tail and why 'shorting' stocks creates a problem for coat-tailers.

What 'shorting' means.

Portfolio management: How much stock to buy and how often to buy it.

Why its critical to hope the stock goes down after you buy it and how (and why) you'll profit more if it does.

How to use specific free websites for analysis, back-testing, charting and derivatives analysis.

What's a short put and what's a short call.

Rule One Puts (ROPs) and Rule One Calls (ROCs) and why, how and when to use them.

STO-BTC, BTO-STC: Combinations to correctly enter and exit ROPs and ROCs.

How to know which price to choose, bid or ask, for any option trade.

Why basis reduction is the key to a great portfolio

How basis reduction creates amazingly high 'equity bond' yields from dividends

Support and resistance, floors and ceilings

Key indicators for market-wide projections

Bringing it all together: How to repeatedly write/short/sell specific derivatives to reduce basis on your 'just one' company, particularly when the stock price is dropping like a brick...and how that can reduce basis by as much as 80% in a year.

How to use rule #1 basis reduction tactics to remove market risk, inflation risk and deflation risk virtually forever.

How to hedge a ROP to get more capital working with good leverage than otherwise possible in a small account.

 

Now go play.

 

October 06, 2013

WHY STOCKPILE INSTEAD OF LOADING UP ALL AT ONCE

One of our most conscientious commenters, Shuki, has raised some issues around the ideas of Stockpiling and selling puts to enter positions so I thought I’d try to clarify my point of view here for y’all.

 

To understand the concept of Stockpiling you only have to remember that Mr. Market doesn’t put things on sale for no reason.  There is almost always a reason that a wonderful business is on sale.  I call that reason an ‘Event’.  Events can be specific to a company or an industry.  The Macondo well disaster drove down prices on BP and Noble. Gildan got hammered when cotton prices doubled during the Arab Spring.  Cameco saw its stock price get halved after Fukushima.  Events are cool because its pretty easy to see why Mr. Market is dumping the stock.  If I don’t know why, I usually feel there is something going on I should know but don’t so buying even at what seems to be a really low price usually seems too risky for me simply because I know Mr. Market isn’t stupid.  If Mr. Market is getting out of the stock because who knows if the company will recover in a year or maybe 3 years, or because the CEO said he’s going to have a really bad year, or because the industry is going to be down for a couple of years and if my time horizon for the stock to recover is longer than the period Mr. Market fears, then I can be a buyer while really smart guys are selling.  The only problem is, I don’t know how long they are going to be selling or how far down this price will go.  Which brings us to stockpiling.

 

I come by Stockpiling honestly.  Its in the Rule #1 tradition.  Buffett is an inveterate Stockpiler.  He has to be now because it’s nearly impossible for him to take a full position in a company all at once.  He’s just too big.  He started Stockpiling BNI in 2007 and finished in late 2009.  He started Stockpiling IBM in 2011 and was still buying in 2013.  But he’s always been like that.  Here’s a quote from his 1958 partnership letter about Stockpiling (my term for it) into a small bank:

 

“So that you may better understand our method of operation, I think it would be well to review a specific activity of 1958.  Last year I referred to our largest holding which comprised 10% to 20% of the assets of the various partnerships.  I pointed out that it was to our interest to have this stock decline or remain relatively steady, so that we could acquire an even larger position....  Over a period of a year or so, we were successful in obtaining about 12% of the bank at a price averaging about $51 per share....” (http://www.rbcpa.com/WEB_letters/1959.02.11.pdf)

 

Shuki prefers to buy her whole position as soon as the stock reaches an attractive price and there is nothing wrong with that point of view.  Small investors can get away with it.  But it is also not wrong for a small investor to Stockpile into a position, particularly if the price seems bent on continuing on down.  Our most recent experience with this was with CCJ: I began acquiring it at $28 after it dropped from $44 and I continued to Stockpile it down to $18.  Which brings me to using puts.

 

The main reason we sell OTM puts is to either reduce our basis or increase our position or both.  I do it because its often free money and I’m often small enough to get away with it.  Buffett also does this on occasion when the opportunity arises as he has recently with both Coke and BNI but at his level the options market is small potatoes on most stocks he is trying to acquire. 

 

Even at my level, I can easily move the premium prices on many stocks I want to acquire by taking too large a position on a specific strike price and expiration.  In general, though, on large stocks like CF or IBM, I can effectively use options to get another tranche at a great price or lower the basis of the tranche I already own with virtually no extra risk over buying another tranche. 

 

I recently took a position in CF Industries (CF) at about $190 and lowered the basis by selling way out of the money LEAPS puts down into the $160s that I can now buy back cheaply to lock in the reduced basis.  I mention this as an example but its not unique.  I did the same thing with Gildan, BP, CCJ, Noble, Coke, Walmart, Coach, Western Union and Oaktree in the last couple of years.  The main idea here is to take advantage of the increase in Implied Volatility created by the uncertainty of the outcome of the ‘Event’ to increase the premium of puts that have strike prices so low I’d be jumping for joy to own the business at that price. 

 

In effect, the only downside of selling the puts instead of buying another tranche or two is not getting more of the business but done judiciously I can have my cake and eat it, too.  I can buy all of the business I want right now with the expectation that I’ll be in position to buy more in a year when the puts expire.  Of course, I have to be willing to overload that company in my portfolio if I get it put to me at that great price right away.  Like Buffett, I’m willing to be quite overloaded on one company if the probability of a successful outcome is large and the probability of a loss is quite small.  If that is difficult for you to determine, just buy 10% of your portfolio into what you think are great companies at attractive prices and be done with it.  But you do give up the possibility of being able to drop the basis and thereby reduce your market risk and vastly increase your return on basis.  Imagine buying BP at $27 to $41 yet through judicious use of puts have a basis of $20 with dividends of $2 per share after only 3 years.  Each year from now on the increasing dividends reduce the basis (say from $20 to $18) and, as BP raises the dividend back to $5 over the next few years the dividend yield on basis goes through the roof.  I like to target a dividend yield of 20% cash on basis within 5 to 10 years of ownership with a basis of about 25% of the projected price at that time.  This is pretty much nirvana for investors: low market risk combined with double-digit cash on cash yields.

 

In addition, another beautiful aspect of Stockpiling and selling puts is that we protect our emotions from ERI (the Emotional Rule of Investing which states that if I buy it it will go down and if I sell it it will go up).  I love to buy something and hope it goes down.  That is so much more fun than buying it and hoping it goes up because no matter what happens its all good.  If it goes down, I get to buy more.  If it stays the same, I get to reduce basis.  If it goes up I get to reduce basis and my ‘marked to market’ profits look lovely for my investors. 

 

 

Are there problems with this approach?  Sure.   If I buy too little and it runs up, I should have bought more but my mistakes tend to be not buying enough at some price rather than buying too much at too high a price and feeling later that I should have waited until the stock stopped dropping.  Nailing the bottom, of course, requires a crystal ball.  Buffett started buying BNI at $80, continued buying down into the $50’s and then wrapped it up at $100.  Crystal balls are hard to come by which is why being comfortable about not getting enough of a good thing seems to me to be much preferred emotionally to agonizing about getting too much of a good thing too soon.

 

But in truth, this discussion is about maximizing profit.  We’re all in agreement that we should focus on not losing money by buying wonderful businesses at attractive prices.

 

(And lest I forget: CONGRATULATIONS TO THE WINNERS OF THE FREE TICKETS TO THE ATLANTA 'TRANSFORMATIONAL INVESTING' WORKSHOP!!!!!!   We received so many essays that were wonderful and heartfelt.  I'm sorry we couldn't take everyone this time but we'll try to do this again next year.  Thank you to every one of you who participated and to everyone who is coming to the Workshop, I'll see you there!)

Now go play.

 

 

 

 

September 12, 2013

ARE YOU STILL INTERESTED IN LEARNING RULE #1 INVESTING FOR FREE?

YUP.  WE'RE GOING TO DO IT AGAIN.

Last spring we offered our blog readers 3 days with me for free and a bunch of y’all took us up on it ... so many that we had to do two courses and we still had to turn a number of you away for lack of space.  About 500 people showed up between the two courses.  Students came from Brazil, Poland, Israel, Hong Kong, Singapore, Australia, Mexico, Canada and even from Alabama. 

How did it go?  Well, we asked the students who attended to rate the 3-day workshop on one question (we got this simple but profoundly important survey question from Stanford University and Intuit): On a scale of 1 to 10, would you recommend this workshop to your family and friends?

The average score between the two courses for almost 500 people was a 9.3, an almost unheard of positive response to the quality of the training.  To put that in perspective, when Intuit Corporation asked its customers that same question about Quicken, the world’s leading tax and accounting software, they scored a 7.4.

Well, y’all, we’re going to try this again and try to get it perfect this time.  This time we’re going to try to score 10.0.

And why not get a ten?  AAII just published the results of their 'guru' portfolios and Rule #1 in in thrid place for 2013 with an ROI of over 40%.  And we're in the top 8 of 77 screens for the last 3 years and the last 5 years with CAGRs far in excess of the S&P 500.  Here's the screen:

AAII #3

Maybe its time you took 3 days to learn how to do this in your own portfolio.  After all, if you'd just followed this screen for the last five years you would have more than doubled your money with less risk than you're taking by putting your money in a mutual fund or EFT.

We're going to do another special FREE 3-Day course for our most interested, most involved students here on the blog and in our database of readers.  The course will be held near our horse farm south of Atlanta, GA beginning on Friday, October 25th at 9 am through Sunday, October 27th, 2013 at 3 pm.  This is a $4,995 course and it’s going to be the best thing you ever did when it comes to making money and becoming financially independent.

THAT'S 3-DAYS WITH ME, MELISSA, JEFF, DR. PAUL PRICE (more on Paul below) AND OTHER RULE #1 FACULTY ABSOLUTELY FREE.  YOU WILL SAVE $4,995.

It’s free but it’s only for those of you who haven’t been to the previous two free courses.  We’d love to have you all back again for more but our most important priority is to educate those of you who haven’t yet been to the workshop. 

I’m calling this course the Rule #1 Transformational Investing Course.  And by ‘transformational’, I mean these 3-days will change your whole life.  This course is going to be the best course I’ve ever taught.

To make sure that happens we’re going to keep the course small and intimate so we can teach you well.  We're going to do this for just 100 of you (and your significant other).

You read that right: 100 of y'all are going to be our guests in this 3-day course plus your significant other if you want to bring him/her.  

In this transformational course I'm going to personally teach you about how I pick the right business to own, how I buy the business with a huge discount to its current price and how I use dividends, derivatives and buybacks to get my money out of the business in as fast as 4 years so my market risk is very low and my yield on basis is very high.  What I teach is so unique in the world of investing that no one else in the world teaches anything remotely like it.  This is how the best investors in the world do it, how I do it in my own Rule One Capital hedge fund and we can and will teach you to do it every bit as successfully.

This class is going to be incredible.  I'm leading the course along with my brother, Jeff Town, our Rule #1 faculty and I’m excited to introduce you to a guy who turned his $2000 IRA into millions of dollars using Rule #1 option strategy, Dr. Paul Price.  Paul is a top contributor to TheStreet.com and Gurufocus and is now teaching our live-trades class.  If you want to meet Jeff, Paul, Melissa and me along with several of our top students and bloggers, here's your chance.  

Last time we did something to help us all get to know each other even better – we had a barbeque out here at Starting Point Farm – our horse farm south of Atlanta.   We had such a good time getting to know some of you in a social setting that we’re doing another party for y'all. Chicken and pulled pork southern style in a big smoker (and some great veggie burgers for all of us vegetarians).  That’s Saturday night and you won’t want to miss it.  And if you like horses, you might even meet our almost-Olympian, Can’t Fire Me (aka ‘Teddy’), and our national champion (and now preggo) mare, Sienna.  And maybe we can get someone to demo some cross country jumping and a bit of dressage.  (Last time, one of our friends gave us a retreiver demo during the party and our lab, Dewey, fell in love with a very attractive bitch who left him cold and never came back so this time we're using our horses so Dewey won't be hurt again.)

If you haven't done anything like this with us before, ask around the blog and you'll find out we do everything we can to make your experience life changing.  Jeff, Paul, Rule #1 faculty and some of our top students will be doing 1:1 coaching during the course for anyone who is feeling a bit overwhelmed by the pace but don't worry, for those of you who are accepted to the course, I’m going to give you a $995 set of On-Demand Tutorials, also for free, that will take you about 3 hours to go through.  This ‘Intro to Rule #1’ course is the perfect preparation for the 3-Day Transformational Workshop.

Once you’re at the Workshop, here's just a few things you can count on learning:

-How to buy wonderful companies and drive your basis down with derivatives, dividends and buybacks so your market risk goes to zip.

-How to create a 20% cash on basis DIVIDEND annual cash return on your portfolio that grows bigger every year, is inflation-proof and will last your whole life without worrying about it.

-How we create ROP’s and ROSS’s (Rule One Puts and Rule One Short Strangles) to lower market risk and create cash flow.  (And Paul will show you how he used ROP’s and ROSS’s to turn a $2000 IRA into $3,000,000.)

-How a couple of young guys made over $100 million in 5 years using Rule #1 strategy with leverage.

-How a Rule #1 student built a $160 million options trading fund with these basic principles.

... and a whole lot more.  Truth is, if you just learned just one of these things it would make this course worth every cent of the $5000 we normally charge for it.

Now lets talk about how you get to the course.

The course is free if you win.  You invest in getting to Atlanta, your food, your hotel room.   The Wydham gives us a break on the conference room charges if enough of you guys stay there at a discount rate of $129.  Obviously its very convenient to have a room right where we're having the class but as an additinoal incentive to stay there we're going to have a drawing for the 1st 50 essay winners who book rooms at the Wyndham Peachtree Hotel.  If you're in the first 50 who book (but first you have to a winning essay) your name will be placed in a drawing for one month's free access to Phil’s Tues & Thurs night 1 ½ hour live webinars where he opens up one of his own trading accounts for discussion and teaching on which companies he is currently looking at).  We'll pick up the training room, the Internet, instructor's travel/hotels/food/cars, the instructors fees and the barbeque party. Lest you think this is trivial on our part, I'll tell you what it costs us: We estimate it’s going to be near $50,000.

So you gotta be asking yourself why we would we spend $50,000 just to give away a $4,995 course.  Are we altruists?  Do we just love people?  Are we nuts?

Well, if you don't know us yet you'll learn that one of our favorite books is Atlas Shrugged so probably the altruistic motive is out.  And we love you guys but loving y'all's got nothing to do with it.  And no we're not crazy. I'll tell you why we're doing this: Same reason I wrote both books and spent over $1 million on publicity to promote them - we want to change the world we live in and the only way to do it is to change one person at a time (well, 100-200 at a time is okay too).  And we've found that if we show you that what we teach you can learn, many of you will go on to become great Rule #1 students and investors.

Our courses change lives.  That's why we do them.  

Okay so back to you.  What's it going to take to get you to get off your butt and do this?  Are you skeptical and that gives you an excuse to procrastinate your way along in life?  The first time we offered a few free seats we had a concerned father of a young woman calling us to demand to know what the catch was.  He said he was sure we were going to be selling her something at the course.  We said no, we aren't.  Just like last time, there is no selling allowed. Just pure education, as best as we know how to do it.  This dad was very perplexed.  He couldn't think how we were going to take advantage of his daughter but he just knew we were somehow.  We didn’t.  He was amazed.  And she sent all our staff nice gifts afterwards. 

Sometimes free is really free.  Here’s my promise to you: There will not be one single word spoken about selling you anything nor anything sold.  There won’t be a form to fill out.  There won’t be a special 1:1 session to go to.  We just plain don’t do that seminar crap.  We teach.  You learn.  It’s that simple.  You can't buy something at this workshop if you wanted to.

The reason we do that is to earn your trust the hard way - by doing what we say we are going to do.  We have thousands of students who without exception have told us this course is worth every penny of the $4,995 that they paid.  We start teaching at 9 am on Day One and don’t stop until y’all leave on Day Three. Our staff has been known to stay until 2AM in the morning helping students.

So don’t be too concerned about being a bit skeptical but also don't let your inner cynic keep you from an experience of a lifetime and from what virtually all of our students say is a life-changing experience. 

Now, how to win this course.  

Simple enough.  Just write about 200-400 words from your heart.  Maximum 400. Some of you learned last time that we are not going bother trying to teach you how to invest if can't follow simple instructions. Do not write more than 400 words or we will toss your entry into the round-file.  (We let super blogger Garrett get away with breaking the 400 word rule in the first contest and he's been writing 2000 word essays on the blog ever since.) 

What should you write about? Just imagine for a second that you knew you had a $5 million trust fund waiting for you at age 65. What in your life would you have done different?  What would you do different now?

But only 400 words.

And don't worry about the grammar or the way you say it.  Just say it from the heart.  Tell it like we're standing there talking.  All we care about is that you're telling us your dream.

The DEADLINE for all entries is 12:00 midnight EST, SUNDAY, SEPTEMBER 22, 2013.  You've got 12 days. Get to it.  

Here's who wins:  The first 100 good ones win 1 free seat PLUS one seat for your significant other, each one of which is worth $4,995.  When the seats are gone, they're gone. After that you get wait-listed.

SEND YOUR ENTRY TO registration@ruleoneinvesting.com.  Be sure to put your full name and your correct contact information on your entry.  We will need to contact you if you are a winner. And keep it under 400 words.

WINNERS WILL BE ANNOUNCED VIA EMAIL ON MONDAY, SEPTEMBER 23rd, 2013.

If you win a seat, be ready for 3 incredible days of the best investing training on the planet and should you think I'm exaggerating, ask around on the blog and the people who've been to the previous version of this training will tell you what they think.

By the way, this message is going out to 140,000 people in our database from our books and blog and speaking engagements.  First entries in get first priority with the judges.  First 100 good ones win.  Early counts.

There will be 100 winners and there will be a wait-list.  Some of the winners are likely to not be able to make it to the course so the people on the top of the wait-list will also be notified that they are on the wait-list and that they will be contacted the minute a seat opens up.  And if we can accommodate more than 200, the wait-list group will be the first to be invited in.

If you've already attended the Rule #1 Cash Flow course, either the 3-Day or the CR-280, we’d love to see you again but we are probably not going to have room.  However, since we're making some changes to the old Cash Flow course, we'd love to have you there if we can find the space. You guys are our best students and anything we can do to help you get to this course, we'll do if we can.  You don't need to write anything. Just let us know you want to re-take the course and we’ll let you know on a first-come first-served basis if there is room.  We’ll notify you as quickly as possible after September 23rd.

And if you're a good student and want to come do 1 on 1s during breaks and after each day is over, please let michelle know at support@ruleoneinvesting.com.  We have a lot of volunteers already but we'd like to know who's willing and maybe we'll give you a chance to show us what you can do for others.

Looking forward to hearing from you.

Now Go Play!

Phil

 

August 09, 2013

'ALTERNATIVE' INVESTMENTS V. INDEX INVESTING

This post comes as a comment on Mickey's post today:

Mickey (millermickey7@yahoo.com) has left you a comment:

Interesting reading. http://www.thereformedbroker.com/2013/08/08/confessions-of-an-institutional-investor/

I agree, Mickey.  Interesting reading from an institutional investor who is sick, SICK! of trying to beat the market by putting 60% of his fund into what he (and the industry) calls 'alternative' investments - things like hedge funds and Private Equity (aka PE).  As he sees it, he has to pick lots of hedge funds because going with just one would be too risky.  And he has to pick lots of PEs.  Same logic.  And he suggests that all this complexity and the lack of transparency and the fees ... oh man the fees can be stunning ... are simply not worth it.  He wants everybody to stop wanting all those high returns, returns above market performance, and just go back to the good old days, to what he calls Simple Investing - meaning his clients should pay him to select a basket of ... not stocks, no ... they should pay him to select a basket of indexes and that would be simple and provide the highest return on investment.

Well, his Simple strategy would be simple for him, that's for sure.  Its not particularly challenging investing to select a pile of index ETFs.  And if you get to collect 1% of $10 billion for the trouble, Simple could look very good indeed.  (For the math challenged amonst us, that's $100,000,000 per year.)

But why is he complaining about hedge funds?  Aren't they worth the extra because they do so well? Well, he thinks that, on the average, hedgies don't actually beat the market.  And he may be right.  The problem with his logic is, however, this: Some hedge funds do beat the market.  By a lot.  And over long, long periods of time.

Ironically for him, the one's that do beat the market tend strongly toward one simple strategy - you guessed it -  Rule #1.  The guys (and they are exclusively guys who are doing this for some reason) who beat, even pound, the market do so by not focusing at all on making money.  They just focus on not losing it.

Strange that that works, but it most certainly does.  Buffett, Graham, Ruane, Perlmeter, Einhorn, Berkowitz, Robertson, Ackman, Pabrai and many more including me, focus on not losing our capital and yet the results come in spectacularly.  Most everybody on this list has a long term track record far above the market average.  

The problem for this and most other institutional fund managers is they want their cake and eat it too.  They want the security blanket that excessive diversification brings and yet they desperately desire the alpha returns achieved by a focused Rule #1 portfolio.  Indeed, it should be obvious that it is impossible to diversity your way into a huge return. The more places the money goes, the less you know about where its going, the more likely a mistake will destroy capital and level the gains down to less than a market level of performance.  Diversification is crack for simple minds; it seems like heaven until they wake up one day and discover everyone left.  All of the investors headed out the door and over to those awful hedge funds.

I feel this guy's pain.  He wants what he can't have - money from lots of investors that he can use to make a mediocre return with.  Simple looks so good until its compared to the market destroying results of Rule #1 investing.  It looks good to be able to tell investors "I told you so" about sticking with the index because the market always goes up in the long run - and here he is - 5 years after the market collapse - with a compounded annual return of 3.7%.  Why isn't everyone applauding?  Because of guys like me.  When AAII.com can run a simple objective program using my defined strategy and get 20% CAGR in the same 5-year period, most investors are going to prefer that to 3.7%.  $100,000 invested with an index oriented fund increased it to $120,000 while the Rule #1 Strategy at AAII increased it to $250,000.  

Investors used to believe the academics - that you can't beat the market - until even smarter academics proved that you could and that many hedge fund guys did.  From Buffett's famous 24% per year for 50 years to Robertson's 38% per year for 18 years with dozens of audited long-term CAGRs in between, todays investors know its possible and they want it.  They are not willing to leave their money with an institutional manager who wants to go back to Simple and charge fees for it.  They've discovered that they can get Simple even simpler - just go buy DIA, SPY, QQQ and RUT and you're done.  If they want Simple, they learned that they don't need this guy.  Simple is as simple does.  You want the market ROI, its available for a pittance, no management fees required.

But if you're institutional and you want big alpha returns, diversifying across a pile of hedge funds, paying tons of fees and praying you picked the right mix is probably not going to cut it either.  Rule #1 guys are few and far between.  Most hedgies use a lot of leverage and complexity.  Few of them can hold their institutional clients for more than a few months of sub-market returns.  Where the money goes, the industry follows.  If institutional money goes to the guy  with the hottest track record over the last 6 months, more and more hedge funds are going to lever up and go for the big home runs, all the while trying like crazy to avoid having a bad month.  Its a recipe for disaster.

Rule #1 guys don't do that.  They go long.  They buy when their clients are screaming for them to sell.  They don't worry about making alpha.  They do it all backward.  And, in the long run, they kill the market.

Long term killing the market.  That's not what this blog is about.  This blog is about learning to avoid losing your money and that focus results in killing the market.  Everything we do here should be focused on Rule #1, not on short term complexity and high returns, not on options trades, not on gambles.  Let's stick to our knitting, focus on finding great companies at attractive prices and put the complex trades back in pandora's box where they belong.  Like this institutional investor wishes he could, we keep it simple, focus on the basics, avoid the losses and in the end come out a big winner.

Now go play.

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