ERICOPOLY

I don't know Bronco, so far this day trading your idea is thrilling. GOOG calls up right away and MSFT calls down 17%. So I got the MSFT calls back today :-). Keeping the GOOG.

How much was ORH worth if you strip out the fabulous returns of HWIC? You then only have underwriting profits and growth in float to value it. Is it still worth 1.3x, or much more than that? I know people were valuing it based on the 20% growth, but I think HWIC's hand had a lot to do with that growth. The more gains they make investing, the more insurance they can write. Strip out the outsized investment gains, and then you only have underwriting profit to juice the rate at which you can build capital to grow.

I entered the workforce straight into Microsoft back in 1997 (with employee options at 50x earnings) and today I'm just astonished by the prices for large caps GOOG at 12x forward AAPL at 12x forward MSFT at 9x forward CSCO at 9.x forward INTC at 9.x forward DELL at 9x forward HPQ at 7x forward Then KO at 15x forward JNJ at 12x forward WMT at 11x forward The list just goes on an on. Especially getting into the big financials. Then you have people fearing the market is going to crash. It feels like it already did if you look at those numbers!

Does the lack of the goodwill on the other 80% of ORH imply that it's inferior to the richly valued 20%? I really don't mean to imply anything by writing off the goodwill. I just want to put apples-to-apples. You could be accused of undervaluing the first 80% of ORH by not demanding to upvalue the goodwill by 5x. The goodwill is just a balance sheet tombstone: "Here lies the premium to book paid for 20% of ORH. RIP." It tells me nothing of the value there... just as the lack of goodwill on the first 80% of ORH tells me nothing about the value. Only the earnings power tells me that, and insurers get their earnings power from their tangible assets. Let's put it this way -- the cash premium paid reduced potential statutory capital. Can we agree on that? When the hard market hits, intangible asset cannot be used to grow premiums. Therefore, the combined companies can write less business than they could before... so keeping that intangible asset around at full value as if it were still cash is hard for me to swallow.

Because... The day after the ORH minority buyout transaction hit the FFH books it looked like this: roughly 80% of ORH is still valued at tangible book value roughly 20% of ORH is now valued at roughly 130% of tangible book value. So I ask... WTF??? Why is 20% of ORH worth 1.3x but 80% of it is only worth 1x? Did they like buy the best part of it or something? It's nonsense. So why don't you value the goodwill for ORH at 5x in YOUR book value assessment? Why not? After all, they've undervalued the goodwill by 80% by having grown the majority stake organically rather than buying it at a premium. Put it this way... had they not owned any of ORH prior to the transaction, then the goodwill from the ORH purchase would be roughly 5x what it is today. So why not just pound the table that book value is really $400 instead of $350? Moving on to another example: 1) You own a holding company that only holds cash, until it acquires 100% of WFC at $45 per share. 2) Let's say book value today (before the buyout) is stated at 22.50 (including intangibles). Today people are looking at WFC as trading at 1.3x book. So they thing "Wow, WFC is really cheap at 1.3x book". 3) After the purchase, your holding company has no more cash and only owns 100% of WFC. 4) Assume your holdco trades at book value -- and that book value is including the new goodwill from your buyout at $45. 5) Now people say... OH MY GOSH. This holdco is effectively just a terrific bank trading at book value! Get it? Your holding company is so great because it trades at book value (even though it's effectively just WFC at $45), even though it's a far worse value than when WFC traded at 1.3x book (including intangibles before your purchase). 1x at $45 is better than 1.3x at $30? Now, that's why I think the goodwill is basically rubbish. I'm just scratching my head. My point is that book value just starts becoming relatively meaningless when it's stuffed with this kind of takeover induced goodwill. You wind up with the new entity having a sum of the parts book value IDENTICAL to what the two parts were worth before the takeover... except minus a good chunk of the cash (turned into goodwill). The combined company no longer has that cash -- the selling shareholders do now. Are you guys trying to tell me that having less cash between the two companies didn't destroy any value? They don't have that cash anymore -- gone, out the door. It's like the cash looked at Medusa and just turned to stone. The lifeless stone has the same mass, but is it as valuable as the previously living being? The stone is the goodwill (I hope it was clear).

Bronco was chattering on about GOOG again today so I looked up the expectation on them and was sort of astonished that it's down to about 12x forward estimates. So I moved a large bit of my MSFT 2013 at-the-money calls into GOOG 2013 calls. I just figure the way people behave over growth and multiples, 12x is way too cheap. This is just speculative money of course -- but that's a given since we're talking calls here. I just see the odds at this point of a 40% run in MSFT much less likely than a 40% run in GOOG.

For a short term trade I think you are correct that it will decline. But I think investors will not lose money if bought and held.

Quarterly earnings announced today. EPS only up 24.4% (or if you include the .05 tax benefit, it's up 36%). For a AAA company loaded with cash and trading at 11.4x trailing, this is a very disheartening performance. Shareholders should just slit their wrists.

Stated differently, the goodwill is a relic of what happened to them. Had they never IPO'd NB and ORH in the first place (in a parallel universe), then they never would have needed to buy them back above book value and thus there would be no goodwill. They would have a cash asset instead of the intangible asset. I can't argue that the cash from that parallel world is worth as much as the goodwill from our real world. I think the cash is worth full value and the goodwill can be ignored. In that parallel world, the goodwill is implicitly there (in addition to the cash!) just as in today's world the previously consolidated majority positions have goodwill that is implicitly there (but not explicitly stated as a component of book value).

So what does the goodwill really signify? After all, it is only attributed to the minority positions that were taken private. I suppose if one wants to defend the goodwill, then you should also argue there isn't enough goodwill on the balance sheet. They had (rough numbers) 80% of ORH before the takeout and 60% of NB before the takeout. If goodwill is to be believed, then the ORH goodwill is understated by 80% and the NB goodwill is understated by 60%. My methodology simply means this: treat the value of the minority position exactly the same as we treat the previously owned majority positions. To do that you either need to bump up the goodwill or throw it out entirely! The good news is one can perhaps then argue that book value is back up near $400 already! Perhaps even more than $400. After all, that's a 2.5x increase in NB's goodwill and a 5x increase in ORH's goodwill.

It's a small world. When I quit/retired from Microsoft I had a picnic with an old coworker/friend (Rob) who left the company a few years ahead of me. He asked me how in the hell I pulled it off and I explained to him the Fairfax calls. Unknown to me, he had not only heard of Fairfax and Prem, but had actually met Prem at a company headquarters visit. It turns out that back around 1998 or so Rob was an intern for Mark Ram and worked on programming some underwriting software for him. At the time Rob was still a student at University of Waterloo. Imagine the chances of that.

I have to do things that way. Otherwise WFC is really trading at a 33% discount to book value right now (because it's worth $45 in a buyout).

No need to check. I had notional 100% of my net worth into ORH calls 2 months before the buyout -- after they telegraphed the move. (much thanks to Cardboard) We used to talk about ORH's book value. When we did so, we didn't inflate it by 20% or 30% to account for the goodwill that wasn't there. Likewise, when I think about FFH with ORH integrated, I like to think of it consistently just as I used to think of ORH.

Which cancels out the goodwill.

The KO $85 strike calls cost less than 0.5% of notional annualized -- plus you can deduct the expenses when they expire worthless if our fears of dollar Armageddon are disappointed.. This is cheaper than the management fees on some of these physical gold funds -- if you were to view the KO calls as just a hedge on your notional net worth. So you'd lose maybe 20% of value in a complete dollar disaster -- compared to today's stock price. However, that's no so bad if you look at how gold has outpaced KO in the past two or three years. That 20% gap from the options is smaller than the gap between gold and KO. The settlement date is in 2013 and the intrinsic value of KO will probably be at least 5% higher or something. So it wouldn't even be a 20% loss -- something less than that, depending on the growth of KO over the next 2 years.

Don't forget that the cost of supporting legacy platforms and products is considered R&D. Apple doesn't play that game.

Has the dollar really been cut down by 60%- 70% over the last 10 years? The world beverage market has a value, no matter what currency it is priced in (sea shells, dollars, gold, oil). But the price of KO hasn't followed the same path as gold in the past few years -- this despite the fact that KO was fairly priced a few years ago and the global beverage market has only grown since then. So if this gold and commodities rally is for real and it's truly monetary inflation driving it, then it would stand to reason that a hedge with KO calls should achieve the desired result of protection your ass if the dollar really is going to be worthless tomorrow morning. But it should do even better than gold because gold already has such a head start on KO.

I wound up using some margin to get both MSFT at-the-money $25 strike 2013 calls and WFC 2013 calls. Deferring the sale of SSW for a while -- it won't be until after July that it's all long-term tax status anyhow. So I'm doubled up notional leverage for a bit. Should MSFT run up enough I can write some covered calls to recover the volatility premium. I expect SSW to pay out enough in dividends to largely repay my margin loan by the time those calls expire -- then I can repeat the exercise if needs be. Trying very hard not to repeat the 2009 tax experience of short-term capital gains at 35%.

What made you give that up? Fear of striking out. I think an unleveraged MSFT bet has a shot at delivering 40% over the next 12 months. It simply needs to trade at 13x average 2012 estimates. That's considerably lower than current S&P500 P/E.

Eric, please give your evaluation of MSFT. It's our second largest holding right now, partly because it seems to be a good value, but also because of the much higher proportion of the QQQ's that will be allocated to MSFT in two weeks with the unusual rebalancing of that index. I didn't see your post until now. There are a couple of reason why I like it, but they are rather general. And they are not based on whether AAPL is eating their lunch or whatnot: 1) I worry about the USD, and MSFT's expenses are largely denominated in USD, yet the revenues are collected in all sorts of currencies. Given that revenues are much higher than expenses, you can kind of see where I'm going here. It is somewhat of a favorable trend to have your revenues rise in relative value to your expenses. 2) Then there is how they make their money -- they aren't just taking on lots of debt in order to make a big return. On a risk-adjusted basis, I think MSFT is an incredible value versus the SSWs of the world. SSW is what I'm selling (reducing the position size). Just looking at the Morningstar website, and looking at the 10 yr financials for MSFT. It's rather impressive. They barely had a hiccup during the financial crisis. It's just solid growth and profitability all the way through. There was never any solvency risk or whatnot -- so much cash and profitability it is truly AAA. People aren't happy with the stock performance, but now that it is getting into the single digit P/E range on a forward basis, I'm sort of amazed. I'm not trying to hit the ball out of the park anymore. I think MSFT is at a price to value where that could be quite a reasonable expectation but without having to reach for too much risk. That was pretty much my thoughts on JNJ as well. I think these are AAA companies that are trading down close to single digit P/E. Kind of scared about risk spreads exploding again -- will hurt the SSWs of the world much more than the JNJ or MSFT of the world. Yet there is not that much difference in forward earnings prospects between MSFT and SSW.

Due to my foot surgery on the 4th, I've been on pretty heavy dosages of oxycontin & oxycodone. I've spent all of this time lying on my back in bed thinking of reducing risk in my portfolio and moving at least a third into higher quality blue chips. I would rather be in MSFT or JNJ than cash.

I was the one who lost 18lbs in a few weeks. I haven't read that 4hour body book, so I can't comment on that. I started my diet in January and have lost a total of 36lbs as of this morning. I have about 20-30lbs to go before I am the weight I was when I graduated high school. In December I went for a routine check-up and bloodwork and was pretty upset about the results. Not only was I obviously obese, but my good cholesterol was low, my LDL was high, my triglycerides where through the roof, my blood sugar was high and A1C was in the diabetic range. On a recommendation I read "Good Calories, Bad Calories" then "Why We Get Fat" both by Gary Taubes. I thought I'd give it a try. I went on the diet completely, I haven't cheated a single time since going on it the first week in January. I do about 20g of net carbs/day. (Net carbs) = (total carbs) - (fiber). As I said I've lost 36lbs on the scale, I went from a size 38pants (they were tight) to a size 34 which are getting too loose now to wear without a belt. I had bloodwork done at the end of March and it was amazing. My triglycerides was 94 (under 100 is very good, they were almost 150 in December), my HDL (Good cholesterol) was way up into the high 40's and my LDL was still a little high, but almost normal. The LDL doesn't bother me anymore because of my triglycerides level being under 100, read this. And best of all my A1C level was 5.6 (it was almost 6.8 before) which is well under the diabetic level and well into the normal range. I'm done debating people. I don't really care if you buy the food pyramid eat lots of grains BS. Everyone else seems to be getting fatter and fatter and my results speak for themselves. People have been coming up to me almost daily in my office asking me how on earth I've lost so much weight in so little time. I point them towards Taubes' books. --Eric I too have come down roughly 18 lbs now -- although it has taken me 3 months. Just taking Gary Taubes advice.

He made dumb moves but he is still holding the bag -- ethically, this is no Mozillo.

Another viewpoint is that the contract specifies that the banks need to pay up, yet they refuse to do so. The courts now need to make them live up to the terms of the contract. Let's say for example that a reinsurer with the ability to pay a claim refuses to do so. Should the insurer just write down the reinsurance recoverable to zero while litigation is pending? Or would it instead be fair to leave it as an asset while litigation is pending, given that the contract states that they claim must be paid? Perhaps impair it somewhat, to discount the possibility that the courts won't enforce the contract, and that perhaps the reinsurer won't be able to pay? My complaint has more to do with the beneficial impact to management of a negative shareholder event rather than with the accounting treatment. Management does discount the possibility of payer insolvency and time value, but they currently anticipate 100% recovery of par related to losses incurred (which includes to be incurred amounts). I do view the discount to loss and lae as a red flag, however, given that such information communicates management's estimation capabilities, as well as the progress of existing policies. Selecting and weighting information appropriate to the insurance decision is well within management purview. If management provided a separate line item on the income statement resulting in a complete movement of putback recoveries to "insurance loss recoverables" on the balance sheet, then the shareholders can consider the two events (misrepresentation and malcoverage), and the effects of one on the other. Current accounting practices imply some agreement that the incurred losses were pretty much all the issuers fault. But why oh why does management get to use this factor to increase their bonuses? For reinsurers, wouldn't a misread of reinsurer character or capacity strike against management performance? Similarly, shouldn't a misread of issuer character, aided by subsequently lower standards of due diligence on the part of management, also represent a negative? It seems that the implied philosophy is "Ok, we screwed up, but if you want us to fight for you, you better pay up." I wouldn't purchase the company if management character were a necessary component of the long thesis. Their compensation doesn't concern me that much. I doubt it will make a huge dent on per share value, nor do I think Jay Brown is going to lie down and twiddle his thumbs with so much of his personal money in the company. Personally I feel like it would be worse if they were paid based on GAAP book increases.

Another viewpoint is that the contract specifies that the banks need to pay up, yet they refuse to do so. The courts now need to make them live up to the terms of the contract. Let's say for example that a reinsurer with the ability to pay a claim refuses to do so. Should the insurer just write down the reinsurance recoverable to zero while litigation is pending? Or would it instead be fair to leave it as an asset while litigation is pending, given that the contract states that they claim must be paid? Perhaps impair it somewhat, to discount the possibility that the courts won't enforce the contract, and that perhaps the reinsurer won't be able to pay?