giofranchi

December 2012 Gary Shilling's Insight. giofranchi insight-1212ab.pdf

ASTA, thank you for your answer and welcome to the board! :) giofranchi

“John Templeton was once asked what had made the greatest difference to the quality of his investment decision making. He replied, “Every mile I moved away from New York.” As we have seen, this is borne out by the evidence; the margin by which his fund beat the market went from zero to 6 percent per annum when he moved to the Bahamas and started to work on his own. Investment analysis is, or should be, a contemplative and peaceful task. It is unlikely to be successful in an environment where the telephone never stops ringing and the analyst is distracted by multiple screens of data, all changing in real time, on the desk in front of him. … As we have seen, initially working alone in the Bahamas, Sir John was able to produce a track record that is unlikely ever to be bettered. He had no Internet and no fax machine. His information was out of date by the time it arrived. All he had was access to historic financial statements, the contacts he had built up over many years, and the scope for extensive travel. It was the depth and clarity of his thought that determined his results, not the volume of information or the speed with which it was delivered.” TEMPLETON’S Way with Money I was wondering, just curious, how many investors on the board have already managed to successfully arrange life habits and job tasks, so that their investment analysis actually is a “contemplative and peaceful task”? In other words, how many of you already succeeded in breaking free from the daily frenetic routine most people have to constantly endure? giofranchi

Biaggio, obtuse_investor, thank you for posting! giofranchi

“Yes! 50 Scientifically Proven Ways to Be Persuasive” is also interesting, and I would recommend it. It is not a 3 page resume of “Influence”, but to each way Mr. Cialdini dedicates just a few pages, so you can jump from one chapter to another, because they are uncorrelated. And you can choose to read only the ones that grab your attention the most. It is enjoyable and very easy to read (not time consuming at all!). giofranchi

Frank, I really think that your feelings about near term returns on equity are inevitable. In a secular bear market “lumpy results” are the only results possible. That’s what the market hates and that’s the cause of your near term feelings. But: June 6, 1933 It is my conclusion that the successful investor must cultivate the habit of "patience". He must be able to hold his money and wait until it is really the time to buy. In this panic it meant waiting over 3 years until stocks were really at rock bottom and selling at less than 1/10 of their normal value. I suppose the real investor would then have the patience and courage to wait until normal times returned before selling. Patience to wait for the right moment - courage to buy or sell when the time arrives - and liquid capital - these are the 3 essentials as I see it now. The Great Depression, A Diary - Benjamin Roth Who has more patience, courage, and liquid capital than FFH? When the right moment comes, FFH equity will rise again very fast! And don’t ask me how much will it take: remember, we have to cultivate the habit of “patience”!! ;D I bought more FFH today. :) giofranchi

Which is why, Eric, that when you say you are headed to the sidelines (clipping dividends from high quality, low risk stocks) after the next wave of wealth, I don't believe you! :) There is a lot of truth in the old cliche: "It is the journey, not the destination." I see it time and again including my personal experience. When I first started working I dreamed of making six figures annually and felt that a after a few years at that level I could walk away and live on easy street. Two years later I had reached that goal at the age of 27. I took me about a week to get accustom to my new "wealth" and realize there was more, much more, if I wanted to stay the course. I ended up working for another 20 years. And my income went up exponentially with over the years. By any objective measure I could have walked away anytime, but I couldn't break away from opportunity. It was just too exciting and fun. I stopped working for others five years ago at 47. I thought I would play lots of golf, travel on Netjets, and spend lots of time relaxing poolside in my new mansion as that is all easily in my budget. What actually happened? I live in a modest home, travel coach, and spend my time reading financial reports. I commit more energy to wealth creation now than ever before but enjoy every minute of it. It's just too fun and to walk away would be a setback to my level of life satisfaction. Right now you see it as a stressful rollercoaster and you want to get off, and sit on the sidelines in the shade. But as time passes you will remember the thrill and forget the anxiety which makes it very hard to stay away from a significant allocation of assets to the next "inevitable". I hope BAC rallies like crazy, and that you at least have a chance to prove me wrong, but until then I'm betting against because I believe wealth doesn't change our fundamental approach to life. onyx1, I am very impressed by what you have just written! It is just amazing how many fabulously accomplished people can be met on this wonderful board!! :) giofranchi

Thank you Farnam! Great video! And I always check your blog early in the morning, as soon as I get to my office, to find many others interesting articles and ideas! :) giofranchi

Thank you! It is actually what I am doing. My worries rest much more on “the man at the helm leaving” risk, than some black swan kind of event that could make the company blow up. But the result is almost the same: a portfolio of 7 to 10 (maybe even some more, if I can find high quality) owner-operators. giofranchi

txitxo, you always bring the scientist’s and the statistician’s point of view into the discussion, and for this I thank you, because every time it is very interesting! ;) You said the absolute minimum is at least 4 companies, and I am curious: take, for instance, twacowfca’s portfolio of BRK, LRE, and FFH. Though presently not that much concentrated, I am sure I would sleep very soundly at night with such a portfolio! 3 stocks, not 4… How do you look at such a portfolio? Of course, my point of view is that BRK is a collection of 70 plus businesses, with a very large and diversified portfolio of stocks; the same is true for FFH, which is a collection of many insurance companies and possesses a diversified, very well protected, portfolio of stocks. So, intuitively I judge twacowfca’s portfolio to be much more diversified than it appears to be at first glance. Now, to my question: do you think that my intuitive judgement has statistical relevance, or that it is statistically flawed? twacowfca, I know from your posts that you are much versed in statistics, what’s your thought on the subject? Thank you, giofranchi

wisdom, I tend to think about a business in terms of “platform”. In my view a high quality platform combines two things together: 1) a machine that generate lots of reliable free cash, 2) a machine that reliably compounds that free cash at satisfactory rates of return. For instance, I view my firm’s platform as follows: 1) civil engineering services and for profit education generate free cash: not very good, because margins are low and predictability is low :( 2) I allocate my firm’s free cash as best as I can: not very good, but, believe me, my partners would most probably do an even worse job! So, not many other choices… ;D If 1) is not very good and 2) is not very good, imo it follows that the platform is not very good. Now, what about SHLD? Well, my idea is that SHLD has a wonderful 2), but a not very good 1). Average “wonderful” and “not very good” and what you get is “fair” at least, “good” at best. But I would be hard pressed to say “great”. Of course, you may say I misjudged the quantity and the reliability of the free cash generated by 1) in SHLD. And I admit I have never dug deep into SHLD, so you might very well be right! giofranchi

BeerBaron, fortunately, I always try to keep in mind the diagram in attachment (which probably most of you already know), and I always try to “find lessons and inspiration in the success of others”, rather than “feel threatened by the success of others”. I have discovered that, compelling me to behave like the diagram suggests, helps me very much to avoid easily falling victim of envy. I do not envy ERICOPOLY, even when he says he is up 15,000% over the past 10 years (ok, I know what you must be thinking now: that is a monstrous lie!!! ;D ;D ;D). Instead, I greatly admire him for his achievement and I have the utmost respect for him! I will go on reading every idea he posts, and I will try to learn from him as much as I can. Today I will be buying more FFH! ;) twacowfca, thank you very much! Your wisdom, counsel, and support are always precious and very much appreciated! giofranchi mindset_diagram.pdf

hellsten, just one simple thought: I like owner-operators, because first of all I want to partner with outstanding managers. An Mr. Lampert is an outstanding manger, no doubt about it. But I also want to be in a business that I like. For instance, I like insurance (FFH, LRE), I like the media sector (LMCA), and I like the money management business (OAK). But I don’t like retail. So, though I certainly seek to partner with managers as good as Mr. Lampert, that’s not enough for me… These requirements must BOTH be met, for me to pull the trigger: 1) A great manager / capital allocator 2) A business that I like Of course, also requirement 3) is most important: a good price. But without 1) AND 2) I almost never invest. giofranchi

biaggio, I wish I were humble… unfortunately, I am just a realist!! ;D Whoever has the patience to hold a significant amount of cash today, and whoever has the discipline to follow BeerBaron quote on position sizing, I judge him/her to be a great investor. ;) giofranchi

Shalab, sorry! I don’t know how, but I missed this thread of yours! I find it extremely interesting… but you made me laugh!! I am really not a good investor!! Surely, I am not in the league of Sanjeev, twacowfca, valuecfa, Moore, uccmal, tariq, racemize, PlanMaestro, ERICOPOLY, Beerbaron, biaggio, berkshiremystery, yourself, and others who constantly write on this wonderful board! This is what I have written in a personal message to Bart this morning: Just a few words about the way I invest my firm’s free cash: I tend to stick with a bunch of owner-operators that I think I understand well enough, just because it fits my personality and I feel quite comfortable with it. I am also very risk averse: right now I am keeping a lot of cash in usd and gold, I also want to be market neutral, so I am shorting the indexes. Results, unfortunately, simply don’t care what I am comfortable with…! 2012 has been a terrible year: speculative stocks went up a lot, so I am losing money on my shorts, owner-operators went sideways at best, with FFH (by far my largest holding) that was down significantly from $410 to $350, so I am also losing money on my long positions, gold went nowhere and the euro appreciated on the usd, so I am losing money on fx as well… It really seems I got it completely wrong!! Viceversa, a lot of traders on the board are booking spectacular returns: I remember ERICOPOLY who said a month ago he was up 100% for the year! So, you see, on the board I just write about what I know, but that doesn’t mean it is the way to go, or even it has any usefulness at all… :( No, really, if you have the patience to bear with me, I’d really like to go on posting some thoughts on the board, because I enjoy the company of great investors!! But surely I am not one… not even a “do no harm” investor… “First, do no harm”: I am not even able to follow this basic and most important precept! :( But I will get better very quickly, learning from all of you! ;) Thank you, giofranchi

Understood (at least, I hope! :) ). You are saying that there are not many funds, which are selling for more than their NAV. Even among the best performing funds. Am I right? I agree and I can understand why: both the mutual and the hedge fund business models have weaknesses that the FFH business model doesn’t have (among them no permanent capital and a much higher cost of money). I consider them to be fundamentally riskier than FFH and I have never invested in a fund. That’s probably one of the reasons why no fund command a significant premium to NAV. giofranchi

I attach a brief article I read some days ago on the subject. Hope it helps! giofranchi reflections-on-complacency-valuations-bearmarkettroughs-patience.pdf

Viking, thank you for your very clear answer! I understand what you are saying very well. My point of view is a little bit different, though. Because I don’t trade. I am an entrepreneur (at least, I try to be one!), not a finance guy. And sincerely I find trading to be quite risky… maybe just because I am so bad at it! ;D Instead, I find much easier to identify outstanding mangers, who are at the helm of compounding machines, and partner with them. I invest in owner-operators and almost never sell. Price should really be out of whack on the upside, to induce me to sell. Historically, if you take away the returns generated by owner-operators, you find that the performance of the S&P500 is quite unsatisfactory. Right now there are more or less 100 owner-operators. I have put together a portfolio of 10 owner-operators, that I think I understand quite well, and that are trading close to book value. The S&P500, on the contrary, according to the iShare Core S&P500 ETF (IVV), is trading at 3.75 x BV. It seems to me a no-brainer market beating strategy. :) giofranchi

As to whether it's worth more than 1.5BV if a 'Kaboom' moment is coming, Mr. Gundlach's fund can be invested in without any premium to book value whatsoever. The market is having trouble valuing FFH at a high premium to book value because the market itself is the one setting the value of the underlying portfolio investments -- it would be truly bizarre for it to say that JNJ is worth more in FFH's portfolio than outside of it. Thus it's down to the operating income and growth assumptions of the insurance operations for the market to use as it's input for setting a PB multiple on the stock. ERICOPOLY, I think the market is extremely allergic to those “lumpy results” Mr. Watsa is used to referring to. FFH has not meaningfully increased BV per share for some time now. That’s why, in my humble opinion, the market is completely mispricing FFH today. Because lumpy results in a secular bear for stocks are the only sustainable results possible. My best guess is the market sooner or later will recognize that Mr. Watsa & Company are right, and that will be the moment when BV per share starts to rise again very quickly. Until then the market might not have patience, but FFH shareholders must have it. giofranchi Yes, BV will no doubt rise quickly when their investments rise quickly. But that isn't in itself in any way warranting a high book value multiple. It merely results in very high rates of compounding over time, which is just dandy anyhow. There are no investment funds compounding at a high rate that command a high multiple to their underlying portfolio investments. FFH by definition should always trade below intrinsic value, otherwise it would be overvalued. That's the nature of gaining much of your intrinsic value by making shrewed equity investments. The place where they do command some kind of BV multiple would come from evaluating their insurance operations and their wholly owned non-insurance subs. Figure out some sort of value of what the float+floatgrowth+underwriting results brings to the table, and then add that to the BV to get some sort of BV multiple. But the lumpy capital gains... I don't see them worth anything more than portfolio mark-to-market value. ERICOPOLY, I am well aware of the fact that almost nobody wants to hear about discounted valuations on this board… And I agree that they are not very useful. But let’s just make a simple exercise, and calculate the discounted value of equity (VOE) of FFH 20 years from now. To do it, I will use Professor Penman’s formula from his book “Accounting for Value”, page 68, Columbia Business School Publishing: Present value of equity = B0 + [(ROE1 – r) * B0] / (1 + r) + [(ROE2 – r) * B1] / (1 + r)2 +[(ROE3 – r) * B2] / (1 + r)3 + … + [(ROE20 – r) * B19] / (1 + r)20. Assumptions: B0 = book value today = $360, ROE1 = return on equity in year 1 ROE2 = return on equity in year 2 … ROE20 = return on equity in year 20 r = interest rate Let’s say our required minimum return is 9%, so r = 9%. Let’s assume that ROE in year 1 and 2 will be equal to their stated goal of 15%, and then, from year 3 to year 20, it falls to 10% (just above the minimum required return). Under these assumptions we get to a present value of equity: VOE = $570.24, or 1.584 x B0. If we assume that a ROE = 15% will be sustained for the next 20 years, we get to a present value of equity: VOE = $1,112.39, or 3.09 x B0. If, instead of using our required minimum return, we choose to use FFH’s cost of capital as interest rate, so that r = 2,8% (until year end 2011 the weighted average cost of float for FFH since inception has been 2,8%), future ROEs just have to average 6,5% for the next 20 years, to get to a present value of equity that is 2 x B0. My intention here is not to put a precise number on VOE, but simply to argue that the market always has a very hard time valuing properly a machine that can compound capital at high rates of return for a very long time. That’s why I think that, even if FFH might not look “statistically” very cheap, right now it is, like Sir John Templeton was used to saying, a “true bargain”. Something that’s trading below book value is worth more dead than alive… Now, please read how Mr. Watsa answered to Mr. Shezad, when he asked if FFH shareholders had to expect other 7 lean years (Q3 2012 results conference call): “Yes, that was -- Shezad, that's a good question. And so the first thing, just to say you is we've always focused on the long-term and when we went through our 7 lean years, Shezad, we were turning around our company. We were turning around Crum & Forster and the -- take reinsurance and all of that, and that took sometime to turn it around. Today, our companies are in excellent position, they're underwriting-focused, they are well reserved, they've cut back in the soft markets and they are well- positioned to expand significantly at the right time. And then as we are expanding today, you're seeing that in Zenith, and you're seeing it in Crum & Forster, you're seeing it on Odyssey. And the Canadian market's always lag -- have lagged in the past and you'll see it in time in Canada. So underwriting operations are very well-positioned, and our investment philosophy and position -- they're always long term. So when we had credit default swaps in the past, it took a few years for it to work out and as you know, we made a lot of money. And so right now, it's very important not to reach for yield because if you do reach for yield, if you put money into the stock market at these prices, you could suffer permanent losses. We'll take temporary losses but we don't like taking permanent losses. So I don't think we'll be at a position where our results will be poor for a long period of time but you're right for the last year and a half, it hasn't been good. But our results for year ending 2011, for the 5 years, is among the best in the business and of course, for the 26 years ending 2011, it's better than anyone else in our industry. So we're focused on the long-term and we continue, we've always been focused on the long-term, and continue to be focused on doing well for our shareholders always.” It really doesn’t sound to me as something worth more dead than alive! :) giofranchi

I suspect that the reason is that not everybody wishes to hold FFH for a decade like you and me. Some people are more active investors and want to pick up a 50-cent dollar and then turn around and sell it for 80-cents in a year or two. People who are able to do that reliably can have a better return than just holding FFH or BRK for lengthy periods. I suspect that people are now looking at FFH as an opportunity to buy very cheap and sell a little bit less cheap sometime during 2013 for a quick 20%. As an observation, back when ORH was still publicly traded, many of us made good money by flipping back and forth between FFH and ORH depending on which looked more attractive. For whatever reason, the relative valuation of the parent and subsidiary would swing perhaps 30% back and forth a couple of times per year so you could play the relative valuation while retaining a long-term exposure to the basic P&C business and to the investing prowess of Prem et al. Too bad we can't do that anymore! SJ Thank you SJ! And yes! I was suspecting the same reason. But, let’s say that FFH is worth 1,5BV (it is worth much more, especially if the ‘Kaboom’ moment Mr. Gundlach talked about is really in our future, but let’s keep it simple!): when people buy FFH at $370, they are buying $1 bill for 68.5 cents; on the other hand, when they buy FFH at $350, they are buying $1 bill for 64.8 cents. Again, not such a dramatic difference! Anyway, it was just a passing thought of mine… by no means an interesting remark! giofranchi Gio, I am afraid the 'Kaboom' moment Mr. Gundlach mentioned doesn't necessarily mean that will benefit FFH If I was reading correctly, he was worrying about sovereign debt explosion and high inflation, will that necessarily lead to market crash ? Or deflation first and then high inflation later ? If the later case, FFH will benefit Plato1976, it seems to me that markets at this point are very fragile… I think any scare could make them decrease significantly. Don’t know when or why, but it is a danger we’d better be very well aware of. And yes, I still see a deflation threat, before high inflation might become a problem. From 1932 to 1937 a lot of money was printed and the dollar was devalued many times. Talks about very high inflation were the order of the day… we all know what actually happened from 1938 until WWII. Japan during the last 20 years printed a ton of money, yet it is still in chronic deflation. And I think that the US in the ‘30s and the last 20 years in Japan are the most relevant periods for what we are living through today. giofranchi

As to whether it's worth more than 1.5BV if a 'Kaboom' moment is coming, Mr. Gundlach's fund can be invested in without any premium to book value whatsoever. The market is having trouble valuing FFH at a high premium to book value because the market itself is the one setting the value of the underlying portfolio investments -- it would be truly bizarre for it to say that JNJ is worth more in FFH's portfolio than outside of it. Thus it's down to the operating income and growth assumptions of the insurance operations for the market to use as it's input for setting a PB multiple on the stock. ERICOPOLY, I think the market is extremely allergic to those “lumpy results” Mr. Watsa is used to referring to. FFH has not meaningfully increased BV per share for some time now. That’s why, in my humble opinion, the market is completely mispricing FFH today. Because lumpy results in a secular bear for stocks are the only sustainable results possible. My best guess is the market sooner or later will recognize that Mr. Watsa & Company are right, and that will be the moment when BV per share starts to rise again very quickly. Until then the market might not have patience, but FFH shareholders must have it. giofranchi

I suspect that the reason is that not everybody wishes to hold FFH for a decade like you and me. Some people are more active investors and want to pick up a 50-cent dollar and then turn around and sell it for 80-cents in a year or two. People who are able to do that reliably can have a better return than just holding FFH or BRK for lengthy periods. I suspect that people are now looking at FFH as an opportunity to buy very cheap and sell a little bit less cheap sometime during 2013 for a quick 20%. As an observation, back when ORH was still publicly traded, many of us made good money by flipping back and forth between FFH and ORH depending on which looked more attractive. For whatever reason, the relative valuation of the parent and subsidiary would swing perhaps 30% back and forth a couple of times per year so you could play the relative valuation while retaining a long-term exposure to the basic P&C business and to the investing prowess of Prem et al. Too bad we can't do that anymore! SJ Or it could be that FFH at the current price meets these investors' hurdle rates for investing. I can tell you that I don't just go by the rule of thumb that FFH will increase BV by 15% and, therefore, I will get a 15% return over time if I buy at BV. I have my own assessment of when I think FFH is cheap, and it's not dependent on nominal IV (i.e., BV). txlaw, I didn’t want to upset anyone… I am sorry if I did! Certainly not you, because I really enjoy your posts! Anyway, I said 15% annual increase in BV per share just because that is their stated goal. But the math doesn’t change if you use 10%, 5%, or if you use 20%. Personally, I do not have any idea of what their future results will be… But I think I understand what they are doing, why they are doing it, and how they are doing it. And that’s what really matters to me. If I have studied history enough, and I understand the historical period we are living through, so that caution is really warranted here, FFH might turn out to be one of the best investment in north America for the next 10 years. An entry point today at $350, instead of $370, won’t make any meaningful difference. Of course, that’s just my humble idea. And many of you might now think I am nuts! :) giofranchi

I suspect that the reason is that not everybody wishes to hold FFH for a decade like you and me. Some people are more active investors and want to pick up a 50-cent dollar and then turn around and sell it for 80-cents in a year or two. People who are able to do that reliably can have a better return than just holding FFH or BRK for lengthy periods. I suspect that people are now looking at FFH as an opportunity to buy very cheap and sell a little bit less cheap sometime during 2013 for a quick 20%. As an observation, back when ORH was still publicly traded, many of us made good money by flipping back and forth between FFH and ORH depending on which looked more attractive. For whatever reason, the relative valuation of the parent and subsidiary would swing perhaps 30% back and forth a couple of times per year so you could play the relative valuation while retaining a long-term exposure to the basic P&C business and to the investing prowess of Prem et al. Too bad we can't do that anymore! SJ Thank you SJ! And yes! I was suspecting the same reason. But, let’s say that FFH is worth 1,5BV (it is worth much more, especially if the ‘Kaboom’ moment Mr. Gundlach talked about is really in our future, but let’s keep it simple!): when people buy FFH at $370, they are buying $1 bill for 68.5 cents; on the other hand, when they buy FFH at $350, they are buying $1 bill for 64.8 cents. Again, not such a dramatic difference! Anyway, it was just a passing thought of mine… by no means an interesting remark! giofranchi

Sorry, I have read again what I wrote and I now understand that it is not clear. What I meant follows: If you buy FFH today at $370, and FFH increases BV per share at 15% annual for the next 10 years, and in year 10 it trades at BV, you will get a 14.68% CAGR of your investment. On the other hand, if you buy FFH today at $350, you will get a 15.32% CAGR of your investment. I understand that 15,32% is better than 14,68%, but they are not dramatically different! So, I was surprised to find so few people interested in FFH, when it was trading slightly above BV, and so many people who are now buying into it, just because its share price fell slightly below BV… I hope now it is clearer. giofranchi

Thank you for this insight! It is very similar to what I am doing. And yes, it surely is quite hard! giofranchi