New Buy: Carnival Cruise Lines (NYSE: CCL)

November 9, 2009 by HWWProject Leave a Comment

Picked up Carnival Cruise Lines at $31.29 today. Carnival has steadily grown free cash flow over the last decade. My Intrinsic Value calcs place a value at about $58, so I’m getting it at a significant discount. Still, this was a tough decision. Here was a few things weighing on me:

-CCL has already nearly doubled since its Bear market low. Yet that’s no reason to avoid. (Price does not equal Value)
-I’m not in the mood to buy stocks. I’ve been expecting the market to take a breather (or worse) and present better prices. Mr. Market just doesn’t want to comply.
-Certain bondholders have a right to convert to common stock at higher prices. This will act as a negative as prices rise.
-Carnival is not an Energy or Healthcare stock, which my portfolio is full of and they’ve done so well for me this year. Maybe some diversification is a good thing.

Despite any reservations, I went into CCL with my normal 3% of portfolio in this position.

In other news, my holding Dish Network (NYSE: DISH), the No. 2 U.S. satellite TV provider, beat Wall Street forecasts by posting a gain of 241,000 subscribers in the third quarter and surprised investors with a plan to pay shareholders a special dividend of $2 a share. DISH hit a 52-week high today on the news.

Rx For Success!

November 5, 2009 by HWWProject 1 Comment

Now this is healthcare reform I can agree with!

My holding IMS Health, Inc. (NYSE: RX) entered into a definitive agreement today to be acquired for $4 billion by Texas private equity firm TPG Capital and CPP Investment Board of Toronto. TPG (formerly Texas Pacific Group) has roughly $45 billion in capital under management, according to its website. CPP Investment Board invests assets on behalf of the Canadian Pension Plan.

The deal is the largest leveraged buyout of 2009. IMS Health, based in Norwalk, Conn., provides business and information-technology services to pharmaceutical and health care firms. The company, which reported sales of $2.3 billion last year, has operations in more than 100 countries around the world.

Under the agreement, IMS stockholders will receive $22 cash for each share of IMS common stock they own, representing a 30% premium over yesterday’s closing price, and 70% gain since my purchase on August 10th at $12.93. The deal is expected to close during the first quarter of 2010.

Here’s what’s really special about the deal. Back in August I had calculated IMS’ Intrinsic Value at $21.70. That’s the price I’ve been waiting for to let go of the stock. I’m pleased to get confirmation from the private investors (TPG and CPP) that my analysis was correct (even though someone over at TheStreet.com thinks IMS is worth much more).

Wasn’t expecting another stock to reach its Intrinsic Value this soon, though I’m very happy to oblige.

This weekend I got more confirmation that my Intrinsic Value calculations are correct. I was reading an Outstanding Investors Digest interview with Bruce Berkowitz of Fairholme fund. In it Bruce gave his estimates of 2009 owner earnings (free cash flow) for Pfizer and Forest Labs, two of my other holdings. My own estimates are in line with his. Makes me feel I do have a ‘prescription for success’, knowing how good of a stockpicker Bruce Berkowitz is.

So Long Southern Copper (PCU)

October 28, 2009 by HWWProject Leave a Comment

Let go of Southern Copper today. A tough decision as it had not yet reached it’s Intrinsic Value as I had calculated it back in March. This past week I went back and reviewed my future growth assumptions. Southern has grown its free cash flow by 29% in the last decade, a truly remarkable feat. But perhaps a bit too optimistic to start the next decade. A slight downward revision resulted in a new, lower intrinsic value target of $35 per share. And if I’d sold just a few weeks ago I would have caught 35 instead of the $31.53 I did today. Normally I would wait ’til Southern reached my target, however a few things motivated me to sell early.

1) We are in an ‘all cash’ safety environment with the momentum portfolio.
2) Just released 3rd Quarter profits are down 25%, though I hesitate to give much weight to one quarter. Indeed there was some good news – sales up and costs down. Southern blamed the poor showing on a terrible pricing environment.
3) Short-term technicals turned lower from an overbought position. (I was a few days late catching this)
4) Copper has reached some overhead resistance at current levels ($300 per lb.) In this economic environment I think it reacts lower before inflation pressures catch on and carry it away.

I was also practicing one of Warren Buffet’s rules of knowing when to sell:

“Look at each stock you own and ask yourself if you’d rather see it rise in price so you can sell… or fall in price so you can buy more. If you’d rather see it rise in price, you should consider trimming the position or selling it out entirely.”

I was hoping PCU would rise back to $35 for a quick sale. Hope is not a good investment strategy. So I decided to lock in the profits now. I’m quite pleased with the 105% gain since purchase 7 months ago, and may buy in again for another ride if things truly “go south” for Southern.

You can follow my real-time stock trades on the Portfolio page.

Cash Signal 10/19/09

October 20, 2009 by HWWProject Leave a Comment

We’ve reached a cash signal for the Momentum model as of October 19th. Note though that we were already in cash because of our 26% profit signal on EWZ (Brazil) just a few days ago. So we’ll remain in cash for 40% of the portfolio until the signal gives an all-clear.

To read more about the overbought conditions in the market, see John Hussman’s weekly market commentary.

Decision Moose Works On An Update To The Model

September 20, 2009 by HWWProject Leave a Comment

I’ve gotten a few emails, mostly from new readers, inquiring why the Moose missed most of the recent stock rally. The answer, of course is that it is an intermediate term framework. It is weighted toward slower-reacting nine to fifteen month technical trends, which are traditionally considered the most efficient way to time markets over the long haul. In “normal times” a longer hold and fewer transactions eventually make for a higher return. In abnormal times, however– when stocks fall 60% in six months and then rise 50% in five months, for example– an intermediate term construct seems out to lunch.

It’s always difficult to determine whether what was previously considered “abnormal” is now actually the “new normal”. What is “normal” over the last hundred years or so may not be normal over the last year, or even the last decade. The Moose was conceived in the late 80’s and perfected in the early 90’s, pre-dating both the 2000-03 and the 2008 market crashes, both of which were “abnormally” severe compared to the “average” 20th century bear market. In both cases, the model exited stocks in time, but got back in late.

The “Encyclopedia of Technical Market Indicators” (first edition, 1988) was my primary reference in building the model. It back-tested all the popular indicators to the early 1900’s and sorted out the wheat from the chaff. Years later, I bought the second edition (2003) which aspired to more of the same, but because the back-test now included the 1987 crash, and the 2000-02 crash, the wheat and chaff had changed. The optimal trend was no longer intermediate term, but a shorter, sub-intermediate trend.

So if you’re building and testing your own models, the lesson is that any back-test period will skew your observations. My guess is that a lifetime (or one Kondratieff cycle) of 65-75 years is probably optimal. Longer than that and you run the risk of including two great crashes, as the second edition of the encyclopedia did. Shorter than that and you risk not including at least one “worst case” scenario. Cyclically, I equate 2000-03 crash to 1929-32, and the 2008 crash to 1937, which followed the ’29 crash by eight years too. Ultimately, ’29-’37 proved to be an abnormal time compared to the rest of the century.

So I doubt that the “new normal” insures wildly volatile and seriously manic-depressive U.S. financial markets. Although our government, for the last half-century, has been doing everything it can to destroy the Dollar by replacing private initiative with public largess, we are still a potent economic force. We may be descending toward banana republicdom with all the vigor of a boatload of chimpanzees, but we aren’t there quite yet. At this rate, we’ll get there soon enough, but the first stop would appear to be Japanization, arguably a more respectable (and less volatile) form of failure. Consider it a preliminary (and doomed) effort to save face.

I may be wrong about volatility eventually reverting to the mean. Perhaps the Greenspan Fed did indeed mark the beginning of a new era of monetary and economic instability leading to market chaos. Of course, cultural changes could also be a factor in shortening the optimal technical time frame, increasing volatility, and leading to a “new normal”. Technology has made it much easier to trade and do research, for example. While this democratization of the markets is a good thing, it is worth remembering that democracy is generally messy.

On the off-chance that the intermediate term is indeed a dinosaur, I’ve spent the greater part of this quarter trying to figure out how the model could be made more responsive to near term events. In that regard, I’ve been working on a more temporally balanced technical approach, on incorporating volatility into the mix, and on changing the way the model treats cash. (You might not think it, but cash is by far the most volatile asset in the model during a crisis. Price, the inverse of yield, can rise or fall by huge percentages in a short time. It can take months to mathematically eliminate the distortion, delaying the switch to other assets.)

So far, so good. The revision appears promising, but I haven’t done a long enough look-back to be consummately confident. My findings are not unexpected– more transactions, lower overall accuracy rate– but during the most recent period, at least, considerably higher return. Clearly, added turnover makes the revision better for tax-deferred than taxable portfolios. And clearly you never want to base your methodology on an abnormal set of circumstances. So more investigation is required.

from the September 18, 2009 Weekly Update

September-October Stock Market Performance

September 20, 2009 by HWWProject Leave a Comment

from John Hussman, 9/20/09 Weekly Market Commentary:

The fact is that yes, on average, the combined September-October period has historically produced slight declines for the S&P 500 whether you look back since 1870, 1900, 1940 or 1970. But the variance around that slightly negative return is large enough that it’s really misguided, in my view, to base predictions on it. All you can say is that maybe in a repeated game of 20 or 30 years, you might find that avoiding stocks in September and October slightly reduces risk without surrendering long-term returns.

Saying “September and October are the worst months for stocks” simply isn’t all that scary, because again, the average change in the S&P 500 is just slightly below zero, and the average total return including dividends is still slightly positive (though generally less than T-bills).

While a two-month period with an average historical return of zero is interesting, what is more interesting is the variation in those returns. Investors rarely operate in a vacuum, so a given piece of data really matters only in the context of other pieces. As investors, we are very much interested in “conditional return,” which requires that we base our analysis on a wider context than a single indicator.

With regard to September-October performance, Jim Stack of Investech points out that if you restrict the set of Sep-Oct periods to only those that followed the end of a bear market, the returns for the S&P 500 during that subset have been positive by a couple of percent, on average. The difficulty, from my perspective, is that the close of a bear market isn’t an observable variable, except with the benefit of hindsight. Better to use “conditioning variables” that can be measured directly.

For example, at any point in time, we can observe directly where the S&P 500 Index is in relation to its 6-month moving average. Using this variable to measure the recency of a market weakness or strength, we find that Jim is still right, but he’s right in an interesting way. Specifically, if you look at the set of periods where, at the end of August, the S&P 500 was more than 10% below its 6-month average, it turns out that the S&P 500 has indeed advanced by an average of about +2.5% during the subsequent September-October period.

On the other hand, if you look at the set of periods where the S&P 500 was more than 10% above its 6-month average (as it was at the end of August this year), we find that the September-October returns have been clearly negative, averaging a -5.6% decline for the S&P 500.

The lesson here really is much broader than September-October seasonality, which is interesting in the same way horoscopes are interesting, but not something I consider useful for investment management. The important point is that what investors believe are “average” tendencies for the stock market are actually very dependent on the prevailing context, be it valuation, market action, overbought/oversold conditions, sentiment, economic considerations, or other factors. The implications of September-October seasonality are largely dependent on the position of the market at the end of August. So knowing only that September-October has arrived is not particularly helpful information taken by itself. Similarly, it is not helpful to say, look, we think this is a recovery, and in a recovery stocks do “X” – without coupling that analysis with a whole set of other conditioning variables that shape the outcome (or call the recovery itself into question).

The Best Thing Jim Rogers Ever Said…

September 15, 2009 by HWWProject Leave a Comment

“I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up. I do nothing in the meantime.”

Of all the brilliant things Jim Rogers has ever said, I believe this one is head-and-shoulders above the rest.

Rogers is one of the most successful money managers in history. He made so much money investing and trading during the 1970s, he left the conventional side of work to travel and run his own money. You can read more about him in the greatest trading book ever, Market Wizards.

In that short quote above, Rogers nails one of the most important factors to trading and investment success: Don’t spend your time and energy chasing mediocre trades and investment opportunities. Only move when the odds are overwhelmingly in your favor.

Jim Rogers: 10 Tips For A Successful Life

September 14, 2009 by HWWProject Leave a Comment

Called the “Indiana Jones of finance” by Time magazine, Jim Rogers is one of the world’s most successful investors. He co-founded the Quantum Fund before he was thirty and retired at thirty-seven. Since then, he has served as a sometime professor of finance at Columbia University’s business school, and as a media commentator worldwide. But ask Jim Rogers about his most important venture and he will answer without hesitation: fatherhood.

A Gift to My Children: A Father’s Lessons for Life and Investing (Random House, 85 pages, $16) is Jim Rogers’ love letter to his daughters, Happy and Baby Bee. Reminiscent of The Autobiography of Benjamin Franklin, which was also written by a father to his child, Rogers’ book is full of no-nonsense, unsentimental fatherly advice.

This charming volume captures a father’s voice – loving, direct, and sometimes stern – and amplifies his message for all to hear.

Among Jim Rogers’ best advice:

Conduct your own research and trust your own judgment.
Focus on what you yourself love.
Be persistent.
Broaden your horizons and see as much of the world as you can.
The most important thing you can learn is how to think and question everything you hear.
Study and learn from history.
Master more than one language – and make sure one of them is Mandarin.
Don’t panic.
Take care of yourself and don’t neglect the sunscreen.
Remember that boys need girls more than girls need boys.

Entertaining and principled, Jim Rogers’ A Gift to My Children should take pride of place among such staples of family reading as William Bennett’s The Book of Virtues, Conn Iggulden’s Dangerous Book for Boys, and parents’ personally cherished books of inspiration and wisdom.

Jim Rogers has taught finance at Columbia University’s business school and is a media commentator worldwide. He is the author of Adventure Capitalist, Investment Biker, Hot Commodities, A Gift to My Children, and A Bull in China.

Rick Rule’s Latest Natural Resources Advice..

September 14, 2009 by HWWProject Leave a Comment

From 1998 to 2006, Rick Rule turned $15 million into roughly $460 million (before fees) for his customers.

Earlier this week, Rick explained what you should do with your money now. One thing that distinguishes Rick from his competition is this: He’ll tell you when it’s NOT a good time to invest. On the call this week, Rick told us that now is one of those times…

Rick thinks the overall markets will start to falter. And he believes a fall in the overall markets will bring down natural-resource stocks, too. That fall will bring the opportunity he’s waiting for.

Rick’s area of expertise is natural resources – like energy and metals. He says resource stocks are overvalued now and will follow the market lower. Eventually, the overall market and resource stocks will “bifurcate.” Then, resource stocks will soar while the rest of the market lags.

In previous conversations with Rick, he’s told me that’s why he’s still working… While his track record from 1998 to 2006 will be difficult to repeat, Rick thinks there’s an extraordinary bull market in natural resource stocks just around the corner… one worth delaying retirement. We’re just not there yet.

Looking five years ahead, Rick is “extremely bullish on energy prices.” He says the rise will be triggered by a fall in oil production from major producers. Oil production in countries like Venezuela, Mexico, and Iran will drop rapidly in the next five years. The opportunity is coming… but we’re not there yet.

Rick also says we could see a “once-in-a-decade” opportunity in the next 12 months in investing in natural gas. But once again, we’re not there yet.

Rick Rule is great at what he does. I have even more respect for him when he DOESN’T invest my money, which has been the case recently. During these times, I know he earns no commission or sales fee… but he’s doing the right thing, waiting for the right time.

Right now, Rick believes the overall market could fall and bring natural-resources stocks with it. So play defense. Take your tax losses, take profits, and set trailing stops on big stocks you want to own.

Then get ready. The big opportunities are coming in natural resources, possibly within the next 12 months. Rick could be wrong, of course. But his track record is hard to argue with.

Excerpted from Dr. Steve Sjuggerud, DailyWealth.com

Buffett Definition of “Owner Earnings”

September 12, 2009 by HWWProject 2 Comments

This article is via a now-defunct website written by a young man who was just getting into finance. I consider it the best analysis of Warren Buffett’s 1986 Letter to Shareholders wherein he defined “Owner Earnings” I have ever seen. This is how I understand and calculate Owner Earnings for my own stock selection.

I am posting the entire article below. I claim no copyright.

First, you will want to download the pdf which you can by clicking on the link here:

Analysis of Warren Buffett’s 1986 Letter to Shareholders App. A “Owner Earnings”

The pdf from the link above includes the Appendix to Buffet’s 1986 Shareholder Letter in which he defines Owner Earnings. Keep this attachment open as you read the analysis below.

Buffet’s 1986 Letter to Shareholders – Owner Earnings Demystified

As I have mentioned before, Buffett did us all a huge favor by explaining, in depth, one of the key measurements that he uses in his valuation process, in his 1986’s Letter to Shareholders that comes annually together with Berkshire Hathaway’s financial reports.

For years I have read dozens of different interpretations to what’s written there, and now I would like to take the time to explain, in plain English, what I consider to be one of the cornerstones of valuation: Owner Earnings.

In order to understand Owner Earnings (or simply, OE) we must delve, deep into Buffett’s explanation. It may seem like a lot, but if you want to understand it fully, that’s the only way to go.

If you haven’t before, grab yourself a cup of coffee and put some John Mayer songs to relax yourself and get ready for some in depth analysis. This is going to be a long one.

Let’s begin.

In the beginning of the note, Buffett gives us two seemingly different income statements, and later informs us that they both belong to the same company, Scott Fetzer, one before it was bought by Berkshire (Company O) and the other the day after (Company N).

He emphasizes four different key figures, which ultimately make Company N’s show considerably smaller income. Those figures are:

A Special non-cash inventory cost of $4.979mil.
An increase in Depreciation of $5.054mil.
A $595k Amortization cost.
A non-cash inter-period allocation adjustment of $998k.

First of all, you should understand why any difference exists at all. When a company buys another company, it often pays more for the company than it’s reported ‘net worth’, meaning the sum of assets minus the sum of liabilities, or book value. The reason for this is that companies pay for intangible assets that are often not listed on the balance sheet, such as a brand name, patents, etc. As well as pay for appreciation in tangible assets that is also not listed on the balance sheet.[1]

Following the transaction, the premium paid has to be displayed on the acquired company’s balance sheet. So, in Scott Fetzer’s case, Berkshire paid a premium of $142.6mil, that now has to be listed on the balance sheet. You can treat this as some sort of update of the company’s balance sheet to current value.

So, going one by one, I’ll explain the accounting in each of the figures:

A Special non-cash inventory cost of $4.979mil:

Starting with adjusting the value of the current assets, the accounting practice is to check whether or not any of them are carried at less than current value. Because items like receivables and cash (DA. -_-) are always carried at current value, the big change comes in inventory, where an inventory that was acquired just one year ago can change dramatically in value, a change that is not presented on the balance sheet (think of last year’s computers, phones, cars).

Unless you had some training in accounting, the next part may seem complicated, so feel free to go straight to figure number 2 if needed.

Buffett allocated $37.3mil of the $142.6mil premium to increasing inventory because of an existing LIFO reserve. A LIFO reserve is the difference in the value of the inventory between FIFO accounting and LIFO accounting:

LIFO Reserve = FIFO Valuation – LIFO Valuation

So basically, Buffett adjusted the value of the inventory to the higher end of the valuation spectrum. The effect on the income statement is a little bit different – Because the income statement measures only costs that affect the same year, of the inventory increase in the balance sheet, only $4.979mil is applicable to that fiscal year.

An increase in Depreciation of $5.054mil:

Next move: Adjust fixed assets. Fixed assets are increased by $68.0mil (update to current value, as measured by the acquisition price), and that sum is depreciated in a way to reflect the real use of assets.

Another $13.0mil is deducted from deferred taxes as a tax shield – Explained later.

A $595k Amortization cost:

After all the other costs are made, the residual $24.3mil is amortized over the normal 40 years period. Which comes out at a regular cost of $607.5k, and slightly less for the mentioned year, because Scott Fetzer was acquired on January 6, resulting in a slightly lower cost for this fiscal year.

Amortization is basically depreciation for purchased companies.

A non-cash inter-period allocation adjustment of $998k:

I know Buffett lists this as too complicated, but sue me, I love complicated stuff. Again, feel free to skip it.

When an asset is purchased, the company lists a ‘tax shield’, so it won’t have to pay taxes in a case where it sells the asset in the future. The same thing happens in the case of an acquisition, because a tax shield is created on the premium the acquirer paid for the acquired assets.

Of the $13.0mil change in the balance sheet, $998k is accounted for the fiscal year (and twelve similar charges will follow in the upcoming years).

A problem, is it?

So, a problem arises. How can a company have considerably less income just because it was acquired, where there’s no economic difference? And even more, how do we overcome this?

Buffett suggests Owner Earnings as the solution. The idea is to replace the Net Income with a figure that will be more guarded from non-economic changes.

Owner Earnings = Net Income plus Depreciation, Depletion, Amortization and Certain other non-cash charges such as Company N’s items (1) and (4) minus the average annual amount of capitalized expenditures for plant and equipment that the business requires to fully maintain its long-term competitive position and its unit volume.

Let’s go one by one:

Net income – Straight from the income statement.

Depreciation, Depletion and Amortization – This change is critical, because 95% of accounting fallacies happen with the DD&A aid.

Certain other non-cash charges, such as Company N’s items (1) and (4) – I don’t think one can determine some sort of specific rule that would suit 100% of the companies in this case, but if you must, take this as a general statement: Any permanent non-cash charge made to inventory valuation or allocation adjustments relating to tax purposes, in the case of an accounting change, such as in the case of an acquisition, is to be counted in the OE formula.

Capital Expenditures – When looking at this line, one should remember that Buffett wrote these lines before the cash flow statement was mandated in 1987. Back then he estimated the CapEx figure using the average depreciation and amortization figure as a base point, as those usually account for the company’s annual spending on manufacturing fixed assets, and mentioned that in the Scott Fetzer case, the “old” accounting gives a better estimate.

Some people think that you should estimate the maintenance CapEx and the Growth CapEx components differently, using a formula made by Prof. Greenwald of the Columbia MBA program. I think it’s a good concept (although not perfect), and in order to stay on the subject I will not go into details.

One more careful observation should be made on Buffett’s note on ‘additional working capital’. Some people take that for ‘always add changes in working capital, and so they take Free Cash Flow as a perfect substitute for Owner Earnings. I do not agree. If any permanent changes do occur, add them, but it is pretentious to think that all changes in working capital fall within this definition.

Told you it will be a long run.

So there you go, Buffett’s note explained in depth. I just wish there was someone to help me with all the confusion I had with it back when I started.

[1] Think of land – It is always listed at cost, but usually increase significantly in value over time.

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