Saturday, November 24, 2007
Yellow BRK'er Party Information:
2008 Meet & Greet Happy Hour
Date: Friday, May 2, 2008Time: 4:00 pm - 7:00 pm Place: DoubleTree Hotel, Omaha
Berkshire Hathaway shareholders from all online communities are welcome.
If you feel most comfortable wearing a suit, go for it. With that said, it's Omaha; please feel under no such obligation. This is a casual atmosphere, with light snacks available. It's a "happy hour" type of gathering - not a formal dinner or anything of that sort.
The DoubleTree is located on 16th and Dodge. There may be some street parking, otherwise, one can use the parking garage with an entrance from the South at 16th & Dodge street, just east of the First National Bank.
To RSVP: http://www.yellowbrkers.com/
Directions to venue:http://tinyurl.com/ystqqb
About Yellow BRK'ers:http://tinyurl.com/2fqajh
2008 Official Berkshire Hathaway Annual Meeting Press Release:http://www.berkshirehathaway.com/meet01/2008meetpre.pdf
Friday, November 2, 2007
John Bogle’s Thoughts on the Black Swan: Black Monday and Black Swans
"We produce thirty year projections for social security deficits and oil prices without even realizing that we can’t predict these for the next summer."
How can a Beta measure risk when the securities price is determined by factors that have no correlation with past events. We come up with pretty theory’s that will tell us what will happen in the future or what securities price should be, without realizing that much of what happens in the future is totally unpredictable and small deviations can mushroom into very large differences over time.
We focus on a small section of what we see and generalize from it to the unseen. This is called confirmation bias in psychology. We look for patterns in random information. The narrative fallacy states that we have a limited ability to look at a series of facts without weaving an explanation into it. Expressing facts as a pattern makes it easier to remember and we naturally do it.
We can always find evidence that will validate our thoughts. In science a hypothesis is made and the scientist looks for ways to prove it wrong. We will become smarter by coming up with a conjecture and then looking for disconfirming evidence.
What we can learn from it
Avoid dependance on large scale predictions (macro economic, analyst estimates, growth rates far into the future etc.)
People are ashamed of losses so they look for investments with low volatility but don’t realize that it still contains an equal chance of large losses.
Look for positive Black Swans (those where the surprises will be positive and the downside is limited). -Same as Mohnish Pabrai’s low risk high reward strategy (heads I win tails I don’t lose anything)
Understand that we don’t know what we don’t know.
Avoid the majority of forecasters
Sunday, October 14, 2007
Roger Ibbotson, Professor in the Practice of Finance at Yale School of Management and President of Ibbotson Associates, Inc., a consulting firm specializing in economics, investments and finance, in Decile Portfolios of the New York Stock Exchange, 1967 - 1984, Working Paper, Yale School of Management, 1986, studied the relationship between stock price as a percentage of book value and investment returns. He split all the stocks traded on the NYSE into ten deciles. Decile one contained the bottom tenth of the stocks with the lowest P/B ratios and decile 10 contained the top tenth of the stocks with the highest P/B ratios. The test was run once a year for 18 years and decile one returned 14.4% and decile 10 returned 6%.
Piotroski took the idea that a large portfolio of the lowest P/B stocks would outperform the market and added to it. Piotroski knew that many of these stocks were financially distressed and would turn out to be duds and that they deserved to be trading far below book value.
So he developed nine criteria that when combined with a large number of low P/B stocks, would help eliminate the financially distressed companies and would keep the strong ones. He reports that his screen produced a return of 23%.
Here are his criteria that he applies to the low P/B stocks:
Operating cash flow: Piotroski considers cash flow the real earnings gauge. Passes if full-year cash flow is positive.
Return on assets: Piotroski wants to see increasing profitability. Passes if full-year ROA exceeds prior-year ROA.
Quality of earnings: Cash flow usually exceeds net income because income is typically reduced by non-cash charges such as depreciation. If it's not Piotroski says that's a
bad signal about future profitability and returns. Passes if full-year operating cash flow exceeds net income.
Long-term debt vs. assets: Piotroski prefers companies that are cutting debt. Passes if the full-year ratio of long-term debt to assets is down from year-ago.
Current ratio: Piotroski sees CR as a way to gauge if liquidity is improving which is a good signal about the companies ability to service its debt. Passes if the CR increases from the prior year.
Shares outstanding: Piotroski penalizes companies that sell stock to raise cash.
"Financially distressed firms that raise external capital could be signaling their inability to
generate sufficient internal funds to service future obligations." Passes if the current number of shares outstanding is no greater than the year-ago figure.
Gross margin: Increasing gross margins often signal that a company's costs are decreasing or product selling prices are increasing. Passes if full-year GM exceeds the prior-year GM.
"An improvement in asset turnover signifies greater productivity from the asset base. Such an improvement can arise from more efficient operations (fewer assets generating the same levels of sales) or an increase in sales (which could also signify improved market conditions for the firm’s products)." Passes if current year asset turnover ratio is greater then last year's asset turnover ratio.
Value Investing: The Use of Historical Financial Statement Information
to Separate Winners from Losers By Joseph Piotroski
Sunday, October 7, 2007
Link to Interview
Wednesday, September 19, 2007
"The Company will not sacrifice credit quality, its purchasing criteria or prudent business practices in order to meet the competition." - Page 10 of 2007 10-K
Competitors use credit scores as the main indicator of credit risk, allowing their central offices to process large volumes of loan applications and approvals to keep costs low. Nicholas feels credit scoring alone isn’t the most accurate indicator of individual borrowers risk. Two clients with identical credit ratings can offer much different risk levels. Nicholas administers phone interviews with each client. NICK places a high value on impressions made during the interview process. Nicholas primarily measures risk through factors other than raw credit scores, such as income level, stability, type of vehicle and previous credit history.
The Investment Opportunity
If we take the average net portfolio yield over the last 11 years, which is interest income - interest expense and provisions for credit losses as a percent of net finance receivables, which is 20.5%. Then subtract 10.5% for expenses and subtract a 38% tax rate and the result is net income of 6.2% of net finance receivables. 6.2% multiplied by 184 million (net finance receivables) =’s net income of 11.4 Million. So this is a company trading for less then 8 times earnings that will benefit from the current credit crisis, has management that has proven that they do what’s best for shareholders and with a growth rate that should continue at over 20% a year as it has for the last 5 years.
Friday, August 17, 2007
EPA sees continued "solid" freight car demand
"Despite a slowing momentum in orders during the current traffic downturn, Economic Planning Associates in a newly revised forecast says there are signs that "demand for rail cars will remain on solid footing for a number of years to come." EPA cited "replacement pressures and technological advances as well as legislative measures" as reasons for optimism. EPA expects builders to deliver 66,500 cars this year and 63,000 in 2008. Meanwhile, actual figures from the Railway Car Institute Committee of the Railway Supply Institute said builders delivered 16,643 new freight cars in the second quarter, down from 19,466 in the corresponding period last year. New orders were placed in the first quarter for 11,595 cars, compared with 19,190 in the 2006 quarter. The backlog of new cars on order but undelivered slipped to 73,921 on July 1, compared with 85,692 on July 1, 2006 . First-quarter 2007 orders included 4,236 tank cars, 2,706 open top hoppers, 2,200 inter modal platforms, 831 non-inter modal flat cars, 632 covered hoppers, and 500 boxcars."
The figure above are for rail cars in general not specifically coal cars. Nonetheless, coal car figures generally follow total rail car figures.
A recent Fortune article titled Going nuclear discussed the merits of nuclear power. As many as 150 coal power plants were in the planning stages as of this summer. But, political opposition has caused many of the utilities to abandon plans for new coal power plants. Despite this many of the plants did get approval and are currently being built or are in the planning stages. Just like nuclear power, coal is being questioned because of its negative environmental effects. Nuclear power has many of the same issues as well. Utilities and scientists are working on ways to decrease the amount of CO2 emissions that coal power plants generate. The amount of coal deposits in the U.S. has oftentimes been compared to the amount of oil in Saudi Arabia. I continue to believe that coal will fill a larger part of our energy needs in the future.
In my first post on RAIL I calculated that the company will be able to earn 67 million in normalized earnings. Another interesting way to think about this situation is to calculate what the company has to earn to maintain the current price.
Market cap is 533 million - 200 million in cash = enterprise value of 333 million. So, if RAIL earned just $33 million and traded at only 10 times earnings the current price would be maintained. So, therefore if I am extremely off on my calculations and RAIL makes half of what I calculated it will make, I will break even. In other words, I have a strong margin of safety if I am wrong on my calculations or something negative happens to the company.
Thursday, August 16, 2007
Stanford Prison Experiment: "A Simulation Study of the Psychology of Imprisonment Conducted at Stanford University: What happens when you put good people in an evil place? Does humanity win over evil, or does evil triumph? These are some of the questions we posed in this dramatic simulation of prison life conducted in the summer of 1971 at Stanford University."
Born Suckers: The greatest Wall Street danger of all: you. by By Henry Blodget
"Human beings, it turns out, are wired to make dumb investing mistakes. What's more, we are wired not to learn from them, but to make them again and again. If there is consolation, it is that it's not our fault. We are born suckers."
Influence: The Psychology of Persuasion by Robert B. Cialdini
Psychology of Intelligence Analysis
THE PSYCHOLOGY OF HUMAN MISJUDGMENT by Charlie Munger
The Expert Mind
"Studies of the mental processes of chess grandmasters have revealed clues to how people become experts in other fields as well."
Wednesday, August 15, 2007
Maui Land & Pineapple Co: MLP has prime acreage in Hawaii. It's down 25% in the past few months.
Moody's Corporation: Down over 60% during the past few months. Growing concern on Wall Street over the ratings MCO made on sub prime debt has pushed shares lower.
Wal-Mart Stores Inc: Down around 13 percent this past month. WMT is expanding into India. The company also announced that they will be repurchasing shares.
American Eagle Outfitters: Down over 30% in 6 months. I'm a strong believer in this brand.
USA Mobility, Inc: Down nearly 35% the past month. Held by many value managers.
CryptoLogic Limited: CRYP's stock price has suffered recently because of the ban on internet gambling in the United States. Mohnish Pabrai acquired shares at around $25 and CRYP is trading at $21 currently.
M&T Bank Corporation: Down around 20% in 6 months. Berkshire Hathaway has owned shares for a long time.
Lexmark International, Inc: Down 40% in 6 months. Berkshire Hathaway owns shares.
Sears Holdings Corporation: Eddie Lampert's company is down nearly 30% in 6 months.
Tyco Electronics Ltd: TEL just spun off from Tyco. It's down 15% since it first started trading about a month ago.
AutoNation, Inc: AN is down about 20% in 6 months.
Bank of America Corporation: Down about 10% in 6 months. Berkshire Hathaway recently disclosed it owned shares.
Walter Industries, Inc: Recently spun off Mueller Water Products. Down about 10% since it spun-off MWA.
Mueller Water Products, Inc: Down about 15% in a month. Recent spin-off from WLT as mentioned above.
USG Inc: Down 33% in 6 months. I recently researched this company. At the time it was trading at about $45 and now its at $36. I really like the company and if it falls further I will most likely make an investment.
Nicholas Financial, Inc: Down around 20% in 6 months.
Sunday, July 29, 2007
First Industrial Realty Trust, Inc. operates as a real estate investment trust (REIT). As of September 30, 1999, the Company owned 950 properties located in 25 states, containing approximately 65.2 million square feet. This makes First Industrial one of the largest industrial property owners in the country. As a REIT the company is not subject to federal income tax, provided it distributes 90% of its taxable income to its shareholders every year.
The industrial reit sector has some very interesting characteristics. Industrial properties include distribution centers, warehouses, service centers, light-manufacturing facilities, research and development facilities and small office space for sales and administrative functions. Compared to other reit sectors, industrial reits maintain longer relationships with tenets because of the nature of the properties. Tenets renew leases at a rate greater then 80% and vacancy rates are very low usually around 7%, according to the book Investing in Reits by Ralph Block. The sector is much less prone to overbuilding because most properties are "built to suit" for specific customers and it takes considerably less time to construct and lease an industrial property so there is a much faster reaction time when demand weakens. Because of these factors, the ownership of industrial reits provides for consistent and high returns. Also, because industrial reits are less cyclical then other reits they are relatively recession resistant. Another advantage of industrial reits is unlike office, apartment or retail sectors, this sector has less of a need for ongoing capital expenditures to keep the building in good repair. Despite the interesting characteristics of industrial reits I doubt the reason Buffett bought was necessarily because of these characteristics. I think the reason was mostly because it was just extremely cheap.
The reit industry was doing fine in December 1999 but, share prices continued to fall. Investors ignored reits as they focused on the tech sector even though reits continued to report growing earnings. According to NAREIT, the price of all equity reits from January 1st 1998 to November 30th 1999 fell nearly 40%. Also, as stocks were trading at somewhere around 40 times earnings, reits were trading for only 8 times FFO! Currently reits are trading at 15 times FFO. Reits were yielding 9% at the time and now they yield just 4%.
For the year ended 1998 First Industrial had FFO of $133 million and was trading for $941 million. Giving the company a price to FFO of 7. Also, the company was trading at 88% of book value as of September 30, 1999. The company had a dividend yield of nearly 10%. Two months from now the company will report that for the year ended 1999 the company had FFO of 151 million giving the company a price to FFO of 6! After reading the 1998 annual report and the three 10Qs leading up to December 1999 I can detect no problems the company is going through. First Industrial wasn’t the only reit that Buffett invested in at the time. MGI Properties, Tanger Factory Outlet, Town and Country Trust, Baker Fentress & Co., Aegis realty, JDN Realty, PMC Capital, HRPT Properties Trust, Burnham Pacific Properties and Laser Mortgage Management all were held in Buffett’s personal portfolio around 1999. I will probably research some of these companies at some time in the future.
How it turned out
Buffett said at the 2004 Berkshire annual meeting that he sold off all his reit investments. So, I’ll assume he sold First Industrial at around the same time. He ended up doubling his money in 4 years. This proves that those with their eyes open can still find undervalued stocks in today’s market.
Thursday, July 5, 2007
The company is the leading North American manufacturer of coal-carrying rail cars. They manufactured 81% of the coal carrying rail cars delivered over the three years ended December 31, 2006 in the North American market. The company has been producing rail cars for over 100 years.
The majority of the company's business is to it's top 10 customers. These included many of the major railroad shippers (Norfolk Southern, BNSF, Canadian Pacific, CSX and Union Pacific), financing companies and the remainder are major utilities. The company maintains long range customer relationships with these companies and the chances of one of their customers moving their business to a competitor is low because of the high costs of switching manufacturers.
Coal-carrying rail cars need to be replaced about once every 25 years so most shippers buy infrequently. Combine that with the fact that the company has only about 10 customers that make up about 70% of its sales and you get a company with very choppy earnings.
The company's prospectus from 2005 has good information to help investors learn about the industry.
A Company facing a temporary obstacle
The company delivered 18,764 coal cars last year compared to 13,031 in 2005 and 7,484 in 2004. As you can see the company had a huge spike in deliveries last year and that corresponded to a huge gain in earnings. There are two reasons for the large number of deliveries last year: First, this is a very cyclical industry and it happens to be a time when the industry is doing well. Second, many of their large customers made very large purchases.
Since their customers loaded up last year, the company's deliveries will be considerably lower this year compared to last year's record. Investors dumping the shares in anticipation have caused the share price to fall below intrinsic value. At the end of the first quarter backlog of unfilled orders was at 6,006 compared to 17,794 in the comparable period last year. Earnings and car deliveries for the first quarter were about the same as last year. But, the results in the coming quarters will be much lower then last year.
Why it's cheap
The company's results will suffer for the next few quarters but they will return back to normal soon. The companies results have varied widely from year to year in the past so last year's spike is nothing new. What would make most sense is this situation is to calculate normalized earnings. Normalized earnings is an average earnings figure that helps the investor to see past Freightcar's lumpy results.
First I'll start with a normalized order rate which includes the replacement rate of current fleets and the growth factor. There are 250k coal cars in the North America. Coal cars have a useful life of about 25 years. So that yields a replacement rate of 4%. Besides replacement, there is also a growth component for the normalized order rate. Energy demand in the US is expected to grow by about 2% a year and much of this will be met by coal. So with the growth factor of 2% and the replacement rate of 4%, 6% of the total coal car fleet or 15,000 coal cars will need to be manufactured every year. Since the company will most likely maintain its 80% market share, 12,000 of those cars will be produced by the company. Also, historically 15% of the company's orders were from non coal-cars. That would add 2,000 cars to the company's yearly production. In all, the company's normalized order rate is 14,000 rail cars. This will be used to calculate normalized earnings.
The replacement rate and growth factor assumptions are very conservative and I believe that for reasons mentioned in the catalyst section below that they will be a few percentage points higher. But nonetheless the company is cheap anyway and because of my extremely basic knowledge of the industry, it's probably intelligent to err on the conservative side.
In 2005 the company delivered 13,031 cars. The margins will most likely be similar if the the company delivers 14,000 cars, so this can be the basis for calculating the company's normalized earnings. The company earned 45 million in 2005 but that includes 11 million in interest expense and all this debt has since been paid off. So 11 million will be added to this figure which yields earnings of 56 million. 150 million in cash has since been added to the balance sheet and if the cash returns 5% that would add 7.5 million to earnings. Now we're at 64 million in earnings. Since the company delivered 13 thousand cars in 2005 and not the 14 thousand figure that were looking for it's safe to assume that with this extra 1,000 cars and the added efficiencies that have been realized since 2005 Freightcar America should be easily able to make 67 million a year in normalized earnings. With a market cap of 610 million the company trades at about 9 times normalized earnings. But, there are still a few significant pluses that haven't been added in.
1. Mohnish Pabrai invested in the company.
2. There will be a surge in the number of coal power plants scheduled to open beginning around the first quarter 2009. The utilities that own these plants will begin to order cars for these plants about 6-9 months before they are scheduled to open. Thus we’d expect to see a surge in new coal car shipments beginning in the second half of 2008. Here is a article in the Washington Post about this boom in plant construction. The article focuses around MidAmerican Energy's activities and David Sokol is quoted often.
The Washington Post:
"At this bend in the Missouri River, with Omaha visible in the distance, the new MidAmerican plant is the leading edge of what many people are calling the "coal rush." Due to start up this spring, it will probably be the next coal-fired generating station to come online in the United States. A dozen more are under construction, and about 40 others are likely to start up within five years -- the biggest wave of coal plant construction since the 1970s."
3. The current fleets of coal cars are at the higher end of their useful lives. The average age of the 250,000 coal cars in North America is about 17 years old and coal cars typically need to be replaced at 25 years of age. Shippers looking to replace older fleets will be a significant plus for Freightcar America. This is already the case with Norfolk Southern. They announced last year that they will replace their 33,000 coal cars over the next ten years.
4. The company has a significant cash hoard. Over 30% of their market cap is cash. The company could expand their share repurchase program, increase dividend, make an acquisition or expand their operations overseas.
5. The company is repurchasing shares. They repurchased 1/8 of the shares outstanding in the first quarter. They can repurchase a further 1/8 of shares with the current program.6. The company returned nearly 100% on capital last year. If my calculation of normalized earnings is used the company returns about 60% on capital (after taxes are added back in). Because of this the company is on the magic formula list. The company has no debt on its balance sheet!
Note: The author has an investment in Freightcar America.
Monday, July 2, 2007
Merger price------ $34
Potential return-- 15%
Annualized return- 36% assuming the transaction is completed by the end of the year
The transaction comprises of two steps first, the tender offer, which has already been completed and second, the merger in which the shares will be purchased for $34 per share. The transaction is expected to be completed by the fourth quarter. If the Merger does not close by January 1, 2008, this amount will be increased at an annualized rate of 8% from January 1, 2008 to the closing.
The preliminary proxy is out but completion of the deal rests on FCC approval and then when the definitive proxy is out, the shareholder vote. The reason for the wide spread is probably caused by the declining operating results at Tribune. It looks like Sam Zell (the acquirer) and the company are to far into the deal for them to easily walk away from the table. The merger looks fine but the risk is that if the merger is canceled the stock could fall because of the softening operating results at Tribune.
Note: The author has an investment in Tribune.
At about age 10 I began reading about the stock market. At that time, I had a small amount of money saved up and because I had no interest in spending it, I put it in the stock market. I invested some of the money in Wal-Mart because I was familiar with the company. The rest of the money was invested in various other companies.
As I made more money with my golf ball business I would send the money to my brokerage account. I would look for companies to invest the money in but I grew frustrated because I had no idea what to look for to determine what companies to invest in. I went to the library to check-out books on investing but most of the books were on technical analysis and that made no sense to me. Somehow I found a book title How to Pick Stocks Like Warren Buffett by Timothy Vick. The book made sense to me. For the last three years since I read that book I've been a voracious reader of anything I can get my hands on that pertains to investing. I've read well over 50 books on investing. The stock market is the greatest game in the world. It is unbelievable how small sums of money can grow into spectacular amounts over time because of compounding. Example: $100,000 compounded at 12% a year for 50 years becomes almost $30 million.
I'm currently studying many of the most successful investors such as Joel Greenblatt, Monish Pabrai, Warren Buffett, Charlie Munger, Edward Lampert etc. I hope that by following their methods I can do well also. Since I enjoy reading about the stock market and researching companies so much, it is my dream to someday run my own investment fund. In this blog I will discuss my portfolio and I will post about various things that have to do with the stock market.