ERICOPOLY

Indeed, since 1996, the repurchase of shares has increased the amount of real estate owned per share by over 50%, which is no small matter. I don't want to belittle the author's point, but a commercial REIT yielding 7% does the same thing for the investor who purchases more shares with the distribution. So it does seem to be a relatively small matter. What am I missing? EDIT: Although the author wrote 1996 I presume he meant 2006

Never say never I suppose. Perhaps he'll manage money virtually for free via SHLD thus effectively losing the ESL fees. A hedge fund manager that no longer wants to make money off of his partners' money is a rare breed.

ESL is the Berkshire. Not SHLD. ESL has passive investments. ESL has operating companies (via SHLD). Buffett had all passive investments and operating companies done via Berkshire.

Okay, I got that part wrong. As for the other half, what businesses has Eddie bought for diversifying the earnings streams of ESL? None.

Interesting. With the NOLs that equates to earning $1.30 for next year and $1.95 for 2015. Therefore, I recommend "Hold" rating on the stock.

It isn't. When SHLD has cash, it returns it to shareholders. BRK never did that. BRK was built by retaining cash and using it to fund new income streams. Completely different trajectory at SHLD. Moons apart.

It's going to be a function, in part, of where interest rates are. NIMs are getting squeezed now and that's not anyone's fault. If we are still in a ZIRP environment over the next few years those numbers are going to be potentially very tough to come by. Moynihan though has stated that they can do 13% to 15% return on tangible book without getting any improvement from interest rates. In other words, he is saying they are making 13% to 15% already, right now, as long as you can look through the elevated expenses. Fair enough. Although note that a 13-15% on tangible book is (off the top of my head) around a 7-9% return on book. So doing 10% will still require something else along the way. Don't get me wrong. My point isn't that they're not doing well or that they won't do well in the future. I think they are doing everything right. My point was just that they shouldn't (and in my view, won't) get fired if they can't achieve a 10% ROE. That's a tall order in the current environment. It's better than 7-9%. It's actually 8.6%-9.9%. 15% return on current tangible book value is $2.02 per share. Current tangible book is $13.48 per share. $2.02 is 9.9% return on current $20.40 of book value per share. So let's just round the 9.9% and call it 10% ROE. 13% return on tangible book is 8.6% ROE. PS: I also don't think they should get fired -- unless they are lying.

It's going to be a function, in part, of where interest rates are. NIMs are getting squeezed now and that's not anyone's fault. If we are still in a ZIRP environment over the next few years those numbers are going to be potentially very tough to come by. Moynihan though has stated that they can do 13% to 15% return on tangible book without getting any improvement from interest rates. In other words, he is saying they are making 13% to 15% already, right now, as long as you can look through the elevated expenses.

I have a lot of flexibility in that roughly 50% of my holding is in RothIRA where I can trade without tax consequences. I want to diversify out of BAC when I can trade it for a roughly equivalent amount of distributable earnings in other high caliber businesses. Right now the gap is just so wide. Maybe that happens at $20, maybe the rest of the market will crash and it will happen at $13. I don't know.

The other banks were employing a strategy of paying dividends while still needing to build capital. BofA's strategy has been to rebuild capital first, then return everything in excess of that. So a 75% payout is conservative in that it's not 100%. Moynihan has stated that as some loans runoff they'll be able to put that money back to work in new loans, so therefore they don't need to retain anything at all for the business right now.

That is about my expectation too. 5+10.

90 cents in 2015 is what I'm talking about -- Moynihan will tell the analysts that by 2015 the company will begin earning 13% to 15% on tangible equity which is at least $1.80 per share. So they turn around and make up this 90 cent number.

Their B3 number was already at 9% at the end of Q3 and Moynihan doesn't plan on letting that number creep any higher. This is the estimated 8.5% that they are required by regulators to maintain (in 2019), and on top of that a 50 bps buffer for things like legal settlements. That comes straight out of Moynihan's mouth less than a month ago. So it's pretty solid evidence of what they plan to do, even though the analysts seemingly choose to believe something entirely different. In other words, any time it exceeds 9% it's either time to make more loans or return the capital to investors via dividend or buyback. The good news is that in the next 4 months we'll finally find out how much they plan on returning in 2013 -- thus analysts will be forced to pay attention to Moynihan finally.

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 You could look at how closed-end funds are priced if you want to see the premium (or more likely discount) to how captive capital is trading. One of the great things about a mutual fund is when you ask for your pro-rate share of book value back, you are guaranteed to get it right away. A closed-end fund this is not the case -- you can get back only what Mr. Market is willing to pay you, and often that can be less than what the book value is. Now if you paid a big premium to book value and you sell it below book value -- double ouch! So, I'm just saying that it's not all a dreamboat ride when you get into captive capital.

There is also the "cart before the horse" analogy if that helps to see things clearer: A large portion of the future 15% return will come from the future recognition of IV from the underlying portfolio investments when the market actually prices them at IV. Your discounting method is asking the market to realize that appreciation right now -- before it is willing to do so! Thus, you are putting that cart before the horse when you use discounting method that ignores the mechanics of how that 15% is achieved.

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 It feels like you are talking past my point. I was separating out the operating components and you are still fully valuing the investment returns as operations. I haven't read their annual report for a couple of years, but I remember a few years ago they were putting up numbers of around 17% annualized compounding returns on their equity investments. Let's say they shut everything down and put all of their capital into equities. And further let's project that they make 15% compounding returns going forward. You now have a 100% equities fund that has no operations. Are you still going to discount it the way you are doing? My answer right now is that the 100% equities fund is worth book value... even if we all project that it will keep compounding at 15%. You could rightly argue that "it's worth just as much dead as alive". True, but that's the nature of most funds I know of. Ironically, if they were 100% an equities investment fund making 15% returns their results would be MORE LUMPY than they are. They have a lot of leverage with lower yielding bonds and that helps them to achieve a smoother 15%.

That's exactly right. In 2002 I had an Audi S4 parked in my driveway at my home in West Seattle. I got up in the morning to go to work, and once I looked at my car it took me a second to figure out what didn't look quite right. All four wheels were stolen and the car was on blocks. That's cost over $2,000 to "fix". I called the police and reported the crime. They just made a report and that was all. They never even sent anyone out to the home to investigate! Now, if I instead had reported a $10 million worth of artwork stolen they might have shown more interest -- perhaps even sending an officer to the house to investigate.

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.

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.

Smart, but isn't it a little alarming that the FBI can access Google search terms? Not these days post-Patriot Act.

The doubts I'm having with the "this can't end well" thesis is that there is still a large amount of debt out there. So it's not like borrowing will come roaring back. Without borrowing roaring back, I'm not sure where they run into trouble.

This is somewhat of a contrast to your prior statement of: "it's not hard to figure out if you're an old fogie". if you are an old fogie you can figure out the source, or inspiration of the name. but in the end it has no particular meaning, good or bad. nor does a it imply a malevolent context concerning my favorite company. :) I sense a Neil Young fan in our midst. The only time I've seen Neil Young in person was at the Cow Palace -- he was playing as part of Bill Graham's Earthquake Benefit (the quake was in October '89 so it has been a while). I remember thinking he looked like an aging dinosaur dragged out of retirement. This was a heck of a long time ago, I'm surprised he is still playing based on my prior assessment :)

This is somewhat of a contrast to your prior statement of: "it's not hard to figure out if you're an old fogie".

So you are living in Waterloo, Canada then? Not that I care where you live, but this comment you made is a little strange saying that you are not from Canada but that you like to put up little flags saying that you are.

no. but it isn't hard to figure out if you're an old fogie. :) https://www.youtube.com/watch?v=l7E6kQ2aLHo Yourself, you wrote "it's better to burn out, than it is to rust.". Rimm itself is constantly degrading our society, just as rust constantly acts upon iron? I'm not sure I get what you want it to mean at all.