Sechai

Basically, It's Over

2010-07-12T21:37:00.000+08:00

Basically, It's Over

A parable about how one nation came to financial ruin.

By Charles Munger

In the early 1700s, Europeans discovered in the Pacific Ocean a large, unpopulated island with a temperate climate, rich in all nature's bounty except coal, oil, and natural gas. Reflecting its lack of civilization, they named this island "Basicland."

The Europeans rapidly repopulated Basicland, creating a new nation. They installed a system of government like that of the early United States. There was much encouragement of trade, and no internal tariff or other impediment to such trade. Property rights were greatly respected and strongly enforced. The banking system was simple. It adapted to a national ethos that sought to provide a sound currency, efficient trade, and ample loans for credit-worthy businesses while strongly discouraging loans to the incompetent or for ordinary daily purchases.

Moreover, almost no debt was used to purchase or carry securities or other investments, including real estate and tangible personal property. The one exception was the widespread presence of secured, high-down-payment, fully amortizing, fixed-rate loans on sound houses, other real estate, vehicles, and appliances, to be used by industrious persons who lived within their means. Speculation in Basicland's security and commodity markets was always rigorously discouraged and remained small. There was no trading in options on securities or in derivatives other than "plain vanilla" commodity contracts cleared through responsible exchanges under laws that greatly limited use of financial leverage.

In its first 150 years, the government of Basicland spent no more than 7 percent of its gross domestic product in providing its citizens with essential services such as fire protection, water, sewage and garbage removal, some education, defense forces, courts, and immigration control. A strong family-oriented culture emphasizing duty to relatives, plus considerable private charity, provided the only social safety net.

The tax system was also simple. In the early years, governmental revenues came almost entirely from import duties, and taxes received matched government expenditures. There was never much debt outstanding in the form of government bonds.

As Adam Smith would have expected, GDP per person grew steadily. Indeed, in the modern area it grew in real terms at 3 percent per year, decade after decade, until Basicland led the world in GDP per person. As this happened, taxes on sales, income, property, and payrolls were introduced. Eventually total taxes, matched by total government expenditures, amounted to 35 percent of GDP. The revenue from increased taxes was spent on more government-run education and a substantial government-run social safety net, including medical care and pensions.

A regular increase in such tax-financed government spending, under systems hard to "game" by the unworthy, was considered a moral imperative—a sort of egality-promoting national dividend—so long as growth of such spending was kept well below the growth rate of the country's GDP per person.

Basicland also sought to avoid trouble through a policy that kept imports and exports in near balance, with each amounting to about 25 percent of GDP. Some citizens were initially nervous because 60 percent of imports consisted of absolutely essential coal and oil. But, as the years rolled by with no terrible consequences from this dependency, such worry melted away.

Basicland was exceptionally creditworthy, with no significant deficit ever allowed. And the present value of large "off-book" promises to provide future medical care and pensions appeared unlikely to cause problems, given Basicland's steady 3 percent growth in GDP per person and restraint in making unfunded promises. Basicland seemed to have a system that would long assure its felicity and long induce other nations to follow its example—thus improving the welfare of all humanity.

But even a country as cautious, sound, and generous as Basicland could come to ruin if it failed to address the dangers that can be caused by the ordinary accidents of life. These dangers were significant by 2012, when the extreme prosperity of Basicland had created a peculiar outcome: As their affluence and leisure time grew, Basicland's citizens more and more whiled away their time in the excitement of casino gambling. Most casino revenue now came from bets on security prices under a system used in the 1920s in the United States and called "the bucket shop system."

The winnings of the casinos eventually amounted to 25 percent of Basicland's GDP, while 22 percent of all employee earnings in Basicland were paid to persons employed by the casinos (many of whom were engineers needed elsewhere). So much time was spent at casinos that it amounted to an average of five hours per day for every citizen of Basicland, including newborn babies and the comatose elderly. Many of the gamblers were highly talented engineers attracted partly by casino poker but mostly by bets available in the bucket shop systems, with the bets now called "financial derivatives."

Many people, particularly foreigners with savings to invest, regarded this situation as disgraceful. After all, they reasoned, it was just common sense for lenders to avoid gambling addicts. As a result, almost all foreigners avoided holding Basicland's currency or owning its bonds. They feared big trouble if the gambling-addicted citizens of Basicland were suddenly faced with hardship.

And then came the twin shocks. Hydrocarbon prices rose to new highs. And in Basicland's export markets there was a dramatic increase in low-cost competition from developing countries. It was soon obvious that the same exports that had formerly amounted to 25 percent of Basicland's GDP would now only amount to 10 percent. Meanwhile, hydrocarbon imports would amount to 30 percent of GDP, instead of 15 percent. Suddenly Basicland had to come up with 30 percent of its GDP every year, in foreign currency, to pay its creditors.

How was Basicland to adjust to this brutal new reality? This problem so stumped Basicland's politicians that they asked for advice from Benfranklin Leekwanyou Vokker, an old man who was considered so virtuous and wise that he was often called the "Good Father." Such consultations were rare. Politicians usually ignored the Good Father because he made no campaign contributions.

Among the suggestions of the Good Father were the following. First, he suggested that Basicland change its laws. It should strongly discourage casino gambling, partly through a complete ban on the trading in financial derivatives, and it should encourage former casino employees—and former casino patrons—to produce and sell items that foreigners were willing to buy. Second, as this change was sure to be painful, he suggested that Basicland's citizens cheerfully embrace their fate. After all, he observed, a man diagnosed with lung cancer is willing to quit smoking and undergo surgery because it is likely to prolong his life.

The views of the Good Father drew some approval, mostly from people who admired the fiscal virtue of the Romans during the Punic Wars. But others, including many of Basicland's prominent economists, had strong objections. These economists had intense faith that any outcome at all in a free market—even wild growth in casino gambling—is constructive. Indeed, these economists were so committed to their basic faith that they looked forward to the day when Basicland would expand real securities trading, as a percentage of securities outstanding, by a factor of 100, so that it could match the speculation level present in the United States just before onslaught of the Great Recession that began in 2008.

The strong faith of these Basicland economists in the beneficence of hypergambling in both securities and financial derivatives stemmed from their utter rejection of the ideas of the great and long-dead economist who had known the most about hyperspeculation, John Maynard Keynes. Keynes had famously said, "When the capital development of a country is the byproduct of the operations of a casino, the job is likely to be ill done." It was easy for these economists to dismiss such a sentence because securities had been so long associated with respectable wealth, and financial derivatives seemed so similar to securities.

Basicland's investment and commercial bankers were hostile to change. Like the objecting economists, the bankers wanted change exactly opposite to change wanted by the Good Father. Such bankers provided constructive services to Basicland. But they had only moderate earnings, which they deeply resented because Basicland's casinos—which provided no such constructive services—reported immoderate earnings from their bucket-shop systems. Moreover, foreign investment bankers had also reported immoderate earnings after building their own bucket-shop systems—and carefully obscuring this fact with ingenious twaddle, including claims that rational risk-management systems were in place, supervised by perfect regulators. Naturally, the ambitious Basicland bankers desired to prosper like the foreign bankers. And so they came to believe that the Good Father lacked any understanding of important and eternal causes of human progress that the bankers were trying to serve by creating more bucket shops in Basicland.

Of course, the most effective political opposition to change came from the gambling casinos themselves. This was not surprising, as at least one casino was located in each legislative district. The casinos resented being compared with cancer when they saw themselves as part of a long-established industry that provided harmless pleasure while improving the thinking skills of its customers.

As it worked out, the politicians ignored the Good Father one more time, and the Basicland banks were allowed to open bucket shops and to finance the purchase and carry of real securities with extreme financial leverage. A couple of economic messes followed, during which every constituency tried to avoid hardship by deflecting it to others. Much counterproductive governmental action was taken, and the country's credit was reduced to tatters. Basicland is now under new management, using a new governmental system. It also has a new nickname: Sorrowland.

Charles Munger is vice chairman of Berkshire Hathaway.

Article URL: http://www.slate.com/id/2245328/

Thoughts on Horses by Henry Ford, 1908

2010-05-08T23:04:00.002+08:00

EVEN BEFORE THAT TIME I HAD THE IDEA of making some kind of a light stream car that would take the place of horses - more especially, however, as a tractor to attend to the excessively hard labour of ploughing. It occurred to me, as I remember somewhat vaguely, that precisely the same idea might be applied to a carriage of a wagon on the road. A horseless carriage was a common idea. People had been talking about carriages without horses for many years back - in fact, ever since the steam engine was invented - but the idea of the carriage at first did not seem so practical to me as the idea of an engine to do the harder farm work, and of all the work on the farm from ploughing was the hardest. Our roads were poor and we had not the habit of getting around. One of the most remarkable features of the automobile on the farm is the way that it has broadened the farmer's life. We simply took for granted that unless the errand were urgent we would not go to town, and I think we rarely made more than a trip a week. In bad weather we did not go even that often. Being a full-fledged machinist and with a very fair workshop on the farm it was not difficult for use to build a stream wagon or tractor. In the building of it came the idea that perhaps it might be made for road use. I felt perfectly certain that horses, considering all the bother of attending them and the expense of feeding, did not earn their keep. The obvious thing to do was to design and build a steam engine that would be light enough to run an ordinary wagon or to pull a plough. I thought it more important first to develop the tractor. To lift farm drudgery off flesh and blood and lay it on steel and motors has been my most constant ambition. It was circumstances that took me first into the actual manufacture of road cars. I found eventually that people were more interested in something that would travel on the road than in something that would do the work on the farms.

But I did not give up the idea of a horseless carriage. The work with the Westinghouse representative only served to confirm the opinion I had formed that steam was not suitable for light vehicles. That is why I stayed only a year with that company. There was nothing more that the big steam tractors and engines could teach me and I did not want to waste time on something that would lead nowhere. A few years before - it was while I was an apprentice - I read in the World of Science, an English publication, of the "silent gas engine" which was then coming out in England. I think it was the Otto engine. It ran with illuminating gas, had a single large cylinder, and the power impulses being thus intermittent required an extremely heavy fly-wheel. As far as weight was concerned it gave nothing like the power per pound of metal that a steam engine gave, and the use of illuminating gas seemed to dismiss it as even a possibility for road use. It was interesting to me only as all machinery was interesting. I followed in the English and American magazines which we got in the shop the development of the engine and most particularly the hints of the possible replacement of the illuminating gas fuel by a gas formed by the vaporization of gasoline. The idea of gas engines was by no means new, but this was the first time that a really serious effort had been made to put them on the market. They were received with interest rather than enthusiasm and I do not recall any one who thought that the internal combustion engine could ever had more than a limited use. All the wise people demonstrated conclusively that the engine could not compete with steam. They never thought that it might carve out a career for itself. That is the way with wise people - they are so wise and practical that they always know to a dot just why something cannot be done; they always know the limitations.

Thoughts on Flash by Steve Jobs, April 2010

2010-05-08T23:02:00.001+08:00

Apple has a long relationship with Adobe. In fact, we met Adobe’s founders when they were in their proverbial garage. Apple was their first big customer, adopting their Postscript language for our new Laserwriter printer. Apple invested in Adobe and owned around 20% of the company for many years. The two companies worked closely together to pioneer desktop publishing and there were many good times. Since that golden era, the companies have grown apart. Apple went through its near death experience, and Adobe was drawn to the corporate market with their Acrobat products. Today the two companies still work together to serve their joint creative customers – Mac users buy around half of Adobe’s Creative Suite products – but beyond that there are few joint interests.

I wanted to jot down some of our thoughts on Adobe’s Flash products so that customers and critics may better understand why we do not allow Flash on iPhones, iPods and iPads. Adobe has characterized our decision as being primarily business driven – they say we want to protect our App Store – but in reality it is based on technology issues. Adobe claims that we are a closed system, and that Flash is open, but in fact the opposite is true. Let me explain.

First, there’s “Open”.

Adobe’s Flash products are 100% proprietary. They are only available from Adobe, and Adobe has sole authority as to their future enhancement, pricing, etc. While Adobe’s Flash products are widely available, this does not mean they are open, since they are controlled entirely by Adobe and available only from Adobe. By almost any definition, Flash is a closed system.

Apple has many proprietary products too. Though the operating system for the iPhone, iPod and iPad is proprietary, we strongly believe that all standards pertaining to the web should be open. Rather than use Flash, Apple has adopted HTML5, CSS and JavaScript – all open standards. Apple’s mobile devices all ship with high performance, low power implementations of these open standards. HTML5, the new web standard that has been adopted by Apple, Google and many others, lets web developers create advanced graphics, typography, animations and transitions without relying on third party browser plug-ins (like Flash). HTML5 is completely open and controlled by a standards committee, of which Apple is a member.

Apple even creates open standards for the web. For example, Apple began with a small open source project and created WebKit, a complete open-source HTML5 rendering engine that is the heart of the Safari web browser used in all our products. WebKit has been widely adopted. Google uses it for Android’s browser, Palm uses it, Nokia uses it, and RIM (Blackberry) has announced they will use it too. Almost every smartphone web browser other than Microsoft’s uses WebKit. By making its WebKit technology open, Apple has set the standard for mobile web browsers.

Second, there’s the “full web”.

Adobe has repeatedly said that Apple mobile devices cannot access “the full web” because 75% of video on the web is in Flash. What they don’t say is that almost all this video is also available in a more modern format, H.264, and viewable on iPhones, iPods and iPads. YouTube, with an estimated 40% of the web’s video, shines in an app bundled on all Apple mobile devices, with the iPad offering perhaps the best YouTube discovery and viewing experience ever. Add to this video from Vimeo, Netflix, Facebook, ABC, CBS, CNN, MSNBC, Fox News, ESPN, NPR, Time, The New York Times, The Wall Street Journal, Sports Illustrated, People, National Geographic, and many, many others. iPhone, iPod and iPad users aren’t missing much video.

Another Adobe claim is that Apple devices cannot play Flash games. This is true. Fortunately, there are over 50,000 games and entertainment titles on the App Store, and many of them are free. There are more games and entertainment titles available for iPhone, iPod and iPad than for any other platform in the world.

Third, there’s reliability, security and performance.

Symantec recently highlighted Flash for having one of the worst security records in 2009. We also know first hand that Flash is the number one reason Macs crash. We have been working with Adobe to fix these problems, but they have persisted for several years now. We don’t want to reduce the reliability and security of our iPhones, iPods and iPads by adding Flash.

In addition, Flash has not performed well on mobile devices. We have routinely asked Adobe to show us Flash performing well on a mobile device, any mobile device, for a few years now. We have never seen it. Adobe publicly said that Flash would ship on a smartphone in early 2009, then the second half of 2009, then the first half of 2010, and now they say the second half of 2010. We think it will eventually ship, but we’re glad we didn’t hold our breath. Who knows how it will perform?

Fourth, there’s battery life.

To achieve long battery life when playing video, mobile devices must decode the video in hardware; decoding it in software uses too much power. Many of the chips used in modern mobile devices contain a decoder called H.264 – an industry standard that is used in every Blu-ray DVD player and has been adopted by Apple, Google (YouTube), Vimeo, Netflix and many other companies.

Although Flash has recently added support for H.264, the video on almost all Flash websites currently requires an older generation decoder that is not implemented in mobile chips and must be run in software. The difference is striking: on an iPhone, for example, H.264 videos play for up to 10 hours, while videos decoded in software play for less than 5 hours before the battery is fully drained.

When websites re-encode their videos using H.264, they can offer them without using Flash at all. They play perfectly in browsers like Apple’s Safari and Google’s Chrome without any plugins whatsoever, and look great on iPhones, iPods and iPads.

Fifth, there’s Touch.

Flash was designed for PCs using mice, not for touch screens using fingers. For example, many Flash websites rely on “rollovers”, which pop up menus or other elements when the mouse arrow hovers over a specific spot. Apple’s revolutionary multi-touch interface doesn’t use a mouse, and there is no concept of a rollover. Most Flash websites will need to be rewritten to support touch-based devices. If developers need to rewrite their Flash websites, why not use modern technologies like HTML5, CSS and JavaScript?

Even if iPhones, iPods and iPads ran Flash, it would not solve the problem that most Flash websites need to be rewritten to support touch-based devices.

Sixth, the most important reason.

Besides the fact that Flash is closed and proprietary, has major technical drawbacks, and doesn’t support touch based devices, there is an even more important reason we do not allow Flash on iPhones, iPods and iPads. We have discussed the downsides of using Flash to play video and interactive content from websites, but Adobe also wants developers to adopt Flash to create apps that run on our mobile devices.

We know from painful experience that letting a third party layer of software come between the platform and the developer ultimately results in sub-standard apps and hinders the enhancement and progress of the platform. If developers grow dependent on third party development libraries and tools, they can only take advantage of platform enhancements if and when the third party chooses to adopt the new features. We cannot be at the mercy of a third party deciding if and when they will make our enhancements available to our developers.

This becomes even worse if the third party is supplying a cross platform development tool. The third party may not adopt enhancements from one platform unless they are available on all of their supported platforms. Hence developers only have access to the lowest common denominator set of features. Again, we cannot accept an outcome where developers are blocked from using our innovations and enhancements because they are not available on our competitor’s platforms.

Flash is a cross platform development tool. It is not Adobe’s goal to help developers write the best iPhone, iPod and iPad apps. It is their goal to help developers write cross platform apps. And Adobe has been painfully slow to adopt enhancements to Apple’s platforms. For example, although Mac OS X has been shipping for almost 10 years now, Adobe just adopted it fully (Cocoa) two weeks ago when they shipped CS5. Adobe was the last major third party developer to fully adopt Mac OS X.

Our motivation is simple – we want to provide the most advanced and innovative platform to our developers, and we want them to stand directly on the shoulders of this platform and create the best apps the world has ever seen. We want to continually enhance the platform so developers can create even more amazing, powerful, fun and useful applications. Everyone wins – we sell more devices because we have the best apps, developers reach a wider and wider audience and customer base, and users are continually delighted by the best and broadest selection of apps on any platform.

Conclusions.

Flash was created during the PC era – for PCs and mice. Flash is a successful business for Adobe, and we can understand why they want to push it beyond PCs. But the mobile era is about low power devices, touch interfaces and open web standards – all areas where Flash falls short.

The avalanche of media outlets offering their content for Apple’s mobile devices demonstrates that Flash is no longer necessary to watch video or consume any kind of web content. And the 200,000 apps on Apple’s App Store proves that Flash isn’t necessary for tens of thousands of developers to create graphically rich applications, including games.

New open standards created in the mobile era, such as HTML5, will win on mobile devices (and PCs too). Perhaps Adobe should focus more on creating great HTML5 tools for the future, and less on criticizing Apple for leaving the past behind.

Steve Jobs
April, 2010

Mr. Distress - Wilbur Ross

2010-03-18T13:51:00.002+08:00

The relationship between information and decision making is a challenge. Everyone gets the same information at basically the same time, so the value of information has gone to zero. And there has not been proportionate growth in the investment community's ability to to sort through it all. People spend so much time absorbing that they don't have time to understand what it means. This creates volatility.

For example, people suddenly decide Greece is the problem, and whack, the market is down 10%. If weeks from now people decide California is the problem, markets will move again. Everyone has known for over a year that both places are troubled. Why do we care now? How do we know that the problems of Greece or rescuing that country will make a difference in the economic landscape one way or the other?

That's why the value of expertise and the ability to interpret information will someday go to infinity.

2010-02-28T14:25:00.000+08:00

Why Warren Buffett Loves Wells Fargo

2009-11-16T23:56:00.001+08:00

I am in the process of putting together a detailed presentation on Wells Fargo (WFC), but I thought it would be useful to understand why Warren Buffett loves Wells Fargo. Wells is the most diversified financial services firm with a leading position in US banking stores, small business lending, mortgage origination, middle market commercial banking, agriculture lending among US banks, commercial real estate brokerage, bank-owned insurance brokerage, banking deposits in the US, debit card issuers, foreign exchange sales, retail brokerage, and wealth management. Wells Fargo has the highest net interest margin, return on assets, and return on equity of all large-cap US banks YTD 2009. Their efficiency ratio is third best in the industry behind only U.S. Bank (USB) and JPMorgan (JPM) (both great banks and great stocks to own as well). Growth opportunities for Wells include investment banking, international growth, and expansion of their business model within the US.

I think it's important to realize that the economy is improving, even though it is a result of easy monetary policies and fiscal stimulus. With unemployment at 10.2% and capacity utilization around 70%, the Federal Reserve will probably not increase interest rates for another six to twelve months. With credit losses peaking for the major commercial banks in 2010, they are set for incredible earnings growth in 2011 and 2012. There is a reason why Warren Buffett owns Wells Fargo, U.S. Bank, and Suntrust (STI) and John Paulson (who has been right throughout the entire financial crisis) is now long Bank of America (BAC), Citi (C), JPMorgan, Suntrust, etc.

All the large-banks capital reserves are much higher than before the financial crisis started. Wells Fargo's stockholders' equity of $122 billion, up $23 billion since year-end 2008 and up $50 billion since pre-Wachovia position at 9/30/08, excluding the U.S. Treasury's $25 billion Capital Purchase Program Investment. Wells Fargo's Tier 1 Capital has increased from 7.8% in 4Q08 to 10.6% in 3Q09 and Tier 1 Common Equity has increased from 3.13% in 4Q08 to 5.18% in 3Q09. Also, Wells Tier 1 Capital and Tier 1 Common Equity ratios would be significantly higher if they did not eliminate $20.1 billion of Wachovia nonaccrual loans at 12/31/2008 through purchase accounting. Wells estimated $40.9 billion losses in their purchased credit-impaired loan portfolio and YTD 3Q09 have taken $13.3 billion in losses, leaving the firm with $27.6 billion in reserves still available (in their credit-impaired loan portfolio). In addition, as the economy improves and these banks earn more money, their capital ratios are increasing. As a result, all large-cap banks are overcapitalized today, especially if you include the government's preferred stock investment.

World's Greatest Investor

2009-10-26T22:49:00.000+08:00

The World's Greatest Money Maker: Evan Davis meets Warren Buffett

Watch:

Next on:

Today, 21:00 on BBC Two (except Northern Ireland (Analogue), Wales (Analogue))

Synopsis

Warren Buffett is the greatest investor of all time. His decisions about buying shares and companies have beaten the stock market year after year and made him the richest person in the world - thought to be worth 37 billion dollars.

Yet Buffett lives modestly in his native Omaha, in America's mid-West, and runs his 150 billion dollar business with a staff of just twenty. Evan Davis meets him to find out about his unique investment strategy and his eccentric lifestyle. He talks to Buffett's family, friends and colleagues about the man they call the Sage of Omaha, and Buffett's friend Bill Gates praises his philosophy of life.

As the greed of the super-wealthy is widely criticised in the current financial crisis, Davis asks whether Warren Buffett is the acceptable face of the filthy rich.

Credits

Presenter: Evan Davis
Producer: Charles Miller
Executive Producer: Dominic Crossley-Holland

Broadcasts

Mon 26 Oct 2009
21:00
BBC Two (except Northern Ireland (Analogue), Wales (Analogue))
Tue 27 Oct 2009
23:20
BBC Two (England, Wales only)
Tue 27 Oct 2009
23:50
BBC Two (Northern Ireland only)
Wed 28 Oct 2009
00:20
BBC Two (Scotland only)

Economy, Psychology and the Market

2009-10-26T20:34:00.001+08:00

What affects the Mr. market?
Mass psychology.

Currently, we believe there will have inflation in the U.S. as a result of greenback emission and there will be no double dip recession.

Meanwhile, the U.S. market performance is currently lagging behind all other countries. Additionally, USD has weakened significantly.

What do you think will happen to the earnings?
It should recover slowly but since most of the S&P and Dow Jones companies are MNCs, a weak USD will lead to higher than expected earnings. Aggressive cost cutting also has it impact.

What if the current interest rate is being held at such low level for too long?
We are not going to put money in the bank, let’s go and buy some property or stocks to hedge inflations. So, money is chasing asset. Just another bubble.

What will be the short term impact to the market?
WE SIMPLY DON’T KNOW. However, if we assume that people becomes over optimistic due to good earnings reported or they just chasing asset to fend off inflation, CHANCES are U.S. market will overshoot.

Many fund managers have missed up the recent bull run of the stocks market, What would they do?
If we try to read their mind… they are likely to be fearful because they have underperformed, and they are also fearful that the stock market would collapse once they get in. So they might wait for a little bit longer, chances are they will jump in with both feet because they don’t want to look fool if the U.S continues to shoot up.

Lastly, What so special about U.S.?
The U.S. has a free market system, excellent legal structure.
"Our economic system has worked extraordinarily well over time. It has unleashed human potential as no other system has, and it will continue to do so.” Warren Buffett

So what if I am wrong?
Don’t worry, we are value investor, we only buy quality companies at undervalued price or mediocre companies at dirt cheap price, therefore, chances are we would do well in the long term.

If I am wrong, this would be a good news to those who still has some pocket money, Prada and Wells Fargo don’t often have DISCOUNT.

Magic word in investing?
MARGIN OF SAGETY.

-THE END-

Susan Thompson Buffett

2009-10-09T22:02:00.001+08:00

"Rose’s interview with Buffett’s wife, Susie — three months before her
unexpected death in 2004 — was both authentic and touching. It was the
only TV interview of her life; she gave a glimpse of why Warren
treasured her and how they made an unconventional marriage work. It
was one of Rose’s least affected, most nuanced performances; mention
it to [Buffett friend Bill] Gates and you can hear him well up a
little."

Valuation of IT company (Part 2) - 37Signals @ $100 Billion

2009-09-26T02:06:00.002+08:00

PRESS RELEASE: 37SIGNALS VALUATION TOPS $100 BILLION AFTER BOLD VC INVESTMENT Jason F. Sep 24

CHICAGO—September 24, 2009—37signals is now a $100 billion dollar company, according to a group of investors who have agreed to purchase 0.000000001% of the company in exchange for $1.

Founder Jason Fried informed his employees about the new deal at a recent company-wide meeting. The financing round was led by Yardstick Capital and Institutionalized Venture Partners.

In order to increase the value of the company, 37signals has decided to stop generating revenues. “When it comes to valuation, making money is a real obstacle. Our profitability has been a real drag on our valuation,” said Mr. Fried. “Once you have profits, it’s impossible to just make stuff up. That’s why we’re switching to a ‘freeconomics’ model. We’ll give away everything for free and let the market speculate about how much money we could make if we wanted to make money. That way, the sky’s the limit!”

Proof that 37signals is now a $100 billion dollar company.

A $100 billion value for 37signals is “not outlandish,” says Aanandamayee Bhatnagar, a finance professor and valuation guru at Grenada State’s Schnook School of Business. Bhatnagar points to a leaked, confidential corporate strategy plan that projects 37signals will attract twelve billion users by the end of 2013.

How will the company overcome the fact that there are only 6.8 billion people alive today? “Why limit users to people?” said Bhatnagar.

In order to determine the valuation of companies, Bhatnagar typically applies the following formula: [(Twitter followers x Facebook fans) + (# of employees x 1000)] x (RSS subscribers + daily page views) + (monthly burn rate x Google’s stock price)2 and then doubles if it they use Ruby on Rails or if the CEO has run a business into the ground before. Bhatnagar admits the math is mostly a guess but points out that “the press eats it up.”

To help handle the burdens of an increased valuation, 37signals hired former YouTube exec Craig Mirage as Chief Operating Officer earlier this month. Mirage hopes to replicate YouTube’s valuation success at 37signals. “Of course, the investment comes with great expectations. But you should see the spreadsheet models we’re making up. Really breakthrough stuff,” said Mirage.

“37signals will lead the new global movement filled with imaginary assumptions on growth and monetization potential,” he continued. “We’re excited to roll out a list of unconfirmed revenue possibilities that involve crowdsourcing, a robust set of widget creation tools, 3G, augmented reality, social stuff, and an app store. Also, everything we make will include a compass.”

37Signals.com

Valuation of IT company (Part 1) - Twitter @ $1 Billion

2009-09-26T01:45:00.004+08:00

September 25, 2009
Twitter Appears Set to Raise $100 Million, Valuing It at $1 Billion

By BRAD STONE
SAN FRANCISCO — Twitter has trained people to compress their thoughts into 140 characters and given a public stage to both dissidents in Iran and voluble stars like Shaquille O’Neal.

Now the start-up appears to have chalked up another achievement. Twitter, which has no discernible revenue, is set to raise about $100 million of new funding that would value the company at around $1 billion, a person briefed on the company’s plans said Thursday.

For context, that is almost double the market capitalization of Domino’s Pizza, which has 10,500 employees and had $1.4 billion in sales last year. Twitter has some 60 employees, and although it is experimenting with running advertisements on its Web site, Biz Stone, a Twitter founder, said this week at an industry conference that the company had no plans to begin widely running ads until 2010.

But Twitter’s cash infusion and exospheric valuation are not easily reduced to the level of the blind bets of past dot-com bubbles. In its three and a half years, Twitter has become a magnet for media attention, and its Web site now attracts 54 million visitors a month, according to comScore, the tracking firm. Along with Facebook, it is helping to remake the Web as a forum for the perpetual sharing of even the most trivial bits of information about people’s lives.

“There have probably been less than five examples of companies that have grown like Twitter has,” said John Borthwick, the chief executive of Betaworks, which created the link-shortening service Bit.ly. (Betaworks also invested in Summize, a Twitter search engine that Twitter acquired last year, and it now owns a small stake in the company.)

Mr. Borthwick lists Google and Facebook as other examples. Twitter “represents a next layer of innovation on the Internet,” he said. “This investment is happening because it represents a shift.”

The new investors include Insight Venture Partners, a venture capital firm based in New York; T. Rowe Price, the mutual fund company, which is not normally known for placing such bets; and the current Twitter backers Spark Capital and Institutional Venture Partners.

The investment is likely to kick off more discussion about the heady valuations investors are assigning to some Internet start-ups, even as the United States economy struggles to emerge from a deep recession and the window for initial public offerings remains weak.

Twitter is what insiders charitably describe as pre-revenue, and the service has become known for going down periodically, although its reliability record has been improving lately.

To some, Twitter’s new valuation makes sense. Facebook, Google and Microsoft have all reportedly made entreaties to acquire the company, and its desirability to the Internet giants elevates its value.

Then there is the nonstop media attention, with everyone from Oprah Winfrey to local radio stations increasingly using the service to communicate with fans. “There is so much media hype around them, it was probably easy to go to mainstream investors and find someone who would be interested,” said Jeremiah Owyang, a social media analyst at the Altimeter Group.

Twitter has not yet commented on the investment, so it is not clear how it will use the new cash. The company does not appear to need the capital. It previously raised $55 million and has said it still has $25 million of that in the bank. But it is known to have wide aspirations to ultimately reach one billion users and become “the pulse of the planet,” according to internal documents that were illicitly obtained by a hacker and published on the blog TechCrunch earlier this year.

Twitter could use the investment to build the technology infrastructure required to grow to that scale. It also might use the cash to acquire one or more of the companies that are writing Twitter programs for mobile phones and computer desktops.

Twitter could even find a business model for itself if it were to buy one of the several start-ups devoted to helping companies manage their Twitter presence and monitor how their brands are being discussed.

But close followers of Twitter do not sense that the company is in any great rush to prove itself as a profitable venture.

“It would be trivially easy for them to turn on a revenue source today,” said Steve Broback, founder of the Parnassus Group, which runs conferences on Twitter and other business topics. “I don’t see that they are in a big hurry to start generating revenues, mostly because they want to minimize any sort of negative effect on their community.”

Twitter’s newly lined pockets may have the biggest impact on its chief rival, Facebook. Executives from the two companies often claim that their services do not quite overlap and can peacefully coexist. But both firms are essentially on the same mission: to allow people to share with friends and fans what they are doing now, in real life and on the Web.

Despite their protestations, the companies appear, especially recently, to be taking swipes at each other. Last week, when Facebook announced that it had signed up its 300 millionth member and that its finances were strengthening, executives used the occasion to play down any threat posed by Twitter. Chamath Palihapitiya, a Facebook vice president, told the technology blog VentureBeat that Twitter was now in “the rearview mirror.”

Even more pointedly, earlier this year Facebook redesigned the stream of updates from friends that each user sees to be more of a constant flow of information, similar to Twitter. And earlier this month, Facebook began allowing users to “tag” messages about particular friends with the @ symbol, a familiar convention on Twitter.

For its part, Twitter has previewed a new way to allow people to see when other Twitter users have “retweeted” or relayed their messages. The feature looks eerily similar to the display of friends who have commented on, or indicated that they liked, an update on Facebook.

Twitter’s ascension has clearly clouded Facebook’s aspirations to dominate the market for sharing over the Web, said Keith Rabois, an Internet entrepreneur and vice president of strategy at Slide, a Web social entertainment firm.

“Twitter is so likely to be successful at this point, it is almost impossible to envision a way in which Facebook can truly monopolize online content-sharing,” he said.

http://www.nytimes.com/2009/09/25/technology/internet/25twitter.html?_r=1&ref=business

25 insightful investment sayings from legendary investor Warren Buffett

2009-09-04T22:00:00.000+08:00

In no particular order, here are 25 insightful investment sayings from legendary investor Warren Buffett:

1. "Rule No.1: Never lose money. Rule No.2: Never forget rule No.1"

2. "In a bull market, one must avoid the error of the preening duck that quacks boastfully after a torrential rainstorm, thinking that its paddling skills have caused it to rise in the world. A right-thinking duck would instead compare its position after the downpour to that of the other ducks on the pond."

3. "The fact that people will be full of greed, fear or folly is predictable. The sequence is not predictable."

4. "Be fearful when others are greedy. Be greedy when others are fearful."

5. "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."

6. "When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is usually the reputation of the business that remains intact."

7. “You only find out who is swimming naked when the tide goes out.”

8. "Risk comes from not knowing what you're doing."

9. "If I was running $1 million today, or $10 million for that matter, I'd be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I've ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It's a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that."

10. "Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down."

11. "I try to buy stock in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will."

12. "Price is what you pay. Value is what you get."

13. "I don’t look to jump over 7-foot bars: I look around for 1-foot bars that I can step over."

14. "If a business does well, the stock eventually follows."

15. "Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it."

16. "Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well."

17. "The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities — that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future — will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hands."

18. "Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks."

19. "Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results."

20. "Investors making purchases in an overheated market need to recognize that it may often take an extended period for the value of even an outstanding company to catch up with the price they paid."

21. "I like to go for cinches. I like to shoot fish in a barrel. But I like to do it after the water has run out."

22. "We don’t get paid for activity, just for being right. As to how long we’ll wait, we’ll wait indefinitely."

23. "In the business world, the rearview mirror is always clearer than the windshield."

24. "The investor of today does not profit from yesterday's growth."

25. "Someone's sitting in the shade today because someone planted a tree a long time ago."

Thanks David for the list above.

Warren Buffett Gives Advice to Girl Scouts at Dairy Queen

2009-08-26T16:41:00.001+08:00

Interview of Charles T. Munger with Joseph Grundfest

2009-08-26T16:09:00.001+08:00

Just who is Charlie Munger. To many people he is the other half of Berkshire Hathaway. Buffett's partner, sounding board, confidant, strategist, etc... Charlie has often allowed Warren to hog the limelight, but his contribution has been significant as well. Just read Warren's notes and memoirs.

Charles T. Munger is a man of many interests, much like his hero Benjamin Franklin. Self-taught in a range of disciplines, he's a strong advocate for interdisciplinary education saying, "If I can do it, many people can." A student of physics and mathematics before entering law school, he left his mark on the legal profession early in his career by co-founding Munger, Tolles & Olson in 1962—a firm that is today consistently ranked at the top of its field. Now an icon of the business world, he joined forces with Warren Buffett in the mid-1960s—leaving law to become vice chairman of Berkshire Hathaway and a partner in one of the most successful firms in the world.

Over the years Munger has gained a reputation as something of a no-nonsense voice for sound investment strategies and responsible business practices—as well as simple common sense. But lately it is the mythical Greek character Cassandra who is much on his mind. After living through the Great Depression, serving in WWII, and entering the business world in an era of restraint and sensible regulation, he is irritated by what he calls "the asininities" of today's government and business leaders that led to the current crisis. He saw the financial train wreck coming and voiced his concerns loudly. But almost no one shared them.

"It is painful to see the tragedy coming, to care about all the people who are going to be clobbered, and not to be able to do one damn thing about it," said Munger, as we prepared for the interview that follows. As the nation navigates through this crisis, entering waters previously uncharted, perhaps the powers that be will be more willing to address issues previously ignored.

Joseph Grundfest is the W. A. Franke Professor of Law and Business is more than familiar with many of Munger's complaints. A former commissioner at the Securities and Exchange Commission (SEC) and counsel to the President's Council of Economic Advisers, Grundfest is today a prominent voice for sense and responsibility in corporate governance. Grundfest founded Stanford's Directors' College, the premier venue for continuing education of directors of publicly traded firms, and also founded the award-winning Stanford Securities Class Action Clearinghouse, which provides detailed, online information about the prosecution, defense, and settlement of federal class action securities fraud litigation. His scholarship focuses on matters related to securities fraud, complex litigation, corporate governance, and statutory interpretation, and his name regularly appears on lists of the nation's most influential attorneys.

GRUNDFEST: I'll begin with two words: Bernie Madoff. What do you think "l'affaire Madoff" teaches us about the operation of our financial system?

MUNGER: One of the reasons the original Ponzi scheme was thrown into the case repertoire of every law school is that the outcome happens again and again. So we shouldn't be surprised that we have constant repetition of Ponzi schemes.

And of course there are mixed schemes that are partly Ponzi just shot through American business. The conglomerate rage of buying companies at 10 times earnings and issuing stock time after time at 30 times earnings to pay for them was a legitimate business operation mixed with a Ponzi scheme. That made it respectable. Nobody called it illegal. But it wasn't all that different from mixing a significant amount of salmonella into the peanut butter.

Harry Markopolos, a hedge fund expert, sent a detailed memo to the Securities and Exchange Commission (SEC) articulating why Madoff must have been a fraud. The SEC did nothing with it. We don't know the reason why, but I'm willing to suggest that the lawyers who received Markopolos's warning simply didn't understand the finance or math that Markopolos relied on.

Lawyers who only know a mass of legal doctrine and very little about the disciplines that are intertwined with that doctrine are a menace to the wider civilization.

Why didn't the SEC understand the warning that was clearly placed at its door?

The SEC is pretty good at going after some little scumbag whom everybody regards as a scumbag. But once a person becomes respectable and has a high position in life, there's a great reticence to act. And Madoff was such a person.

Why aren't our regulators capable of addressing many of the issues that we confront in the market today?

Most of them plan to go back to living off money made in the system they are supposed to regulate. You can argue that financial regulation is so important that no one in such a position should ever be allowed to do as you partially did—serve and then leave to make money in the regulated field. Such considerations led to lifetime appointments for federal judges. And we got better judges with that system.

So government service should be a little like a monastery from which you can never escape?

What you can opt to do is retire, which is pretty much what our judges do.

What about the idea that investors should be able to fend for themselves?

We want the sophisticated investor to protect himself, but we also want a system that identifies crooks and comes down like the wrath of God on them. We need both.

And here I think what's intriguing is we have a failure of both.

Yes.

As we look at the current situation, how much of the responsibility would you lay at the feet of the accounting profession?

I would argue that a majority of the horrors we face would not have happened if the accounting profession developed and enforced better accounting. They are way too liberal in providing the kind of accounting the financial promoters want. They've sold out, and they do not even realize that they've sold out.

Would you give an example of a particular accounting practice you find problematic?

Take derivative trading with mark-to-market accounting, which degenerates into mark-to-model. Two firms make a big derivative trade and the accountants on both sides show a large profit from the same trade.

And they can't both be right. But both of them are following the rules.

Yes, and nobody is even bothered by the folly. It violates the most elemental principles of common sense. And the reasons they do it are: (1) there's a demand for it from the financial promoters, (2) fixing the system is hard work, and (3) they are afraid that a sensible fix might create new responsibilities that cause new litigation risks for accountants.

Can we fix the accounting profession?

Accounting is a big subject and there are huge forces in play. The entire momentum of existing thinking and existing custom is in a direction that allows these terrible follies to happen, and the terrible follies have terrible consequences. The economic crisis that we're in now is, in its triggering circumstances, worse than anything that's ever happened.

Worse than the Great Depression?

The economy hasn't contracted as much as during the Great Depression, but the malfeasance and silliness, the triggering events for today's crisis, were much greater and more widespread. In the '20s, a tiny class of people were financial promoters and a tiny class of people were buying securities. Today, it's deep in the whole culture, and it is way more extreme. If sin and folly get punished appropriately, we're in for a bad time.

And do you see a chance that our current economic woes could reach to a level closer to the Great Depression?

Well, nobody can predict that very well because we've never faced conditions as extreme.

Very few people realize how much we've screwed up. Even in leading law schools and business schools very few people realize that the mess at Enron never could have happened if accounting customs hadn't been changed. What we have now is a bigger, more widespread Enron.

When the regulators put in the option exchanges, there was just one letter in opposition saying "you shouldn't do this," and Warren Buffett wrote it. When they wanted to make the securities market function better as a gambling casino with vast profits for the people who were croupiers—there was a big constituency in favor of dumb change. Buffett was like a man trying to stop an elephant with a pea shooter. We're not controlling financial leverage if we have option exchanges. So these changes repealed longtime control of margin credit by the Federal Reserve System.

You get unlimited leverage.

Unlimited leverage comes automatically with an option exchange. Then, next, derivative trading made the option exchange look like a benign event. So just one after another the very people who should have been preventing these asininities were instead allowing foolish departures from the corrective devices we'd put in the last time we had a big trouble—devices that worked quite well. The investment banks of yore, chastened by the '30s, were private partnerships, or near equivalents. The partners were dependent for their retirement on the prosperity of the firms they left behind and the customs and culture they left behind, and the places were much more responsible and honorable. That ethos, by the time the year 2006 came along, had pretty well disappeared. Our regulators allowed the proprietary trading departments at investment banks to become hedge funds in disguise, using the "repo" system—one of the most extreme credit-granting systems ever devised. The amount of leverage was utterly awesome. The investment banks, to protect themselves, controlled, to some extent, the use of credit by customers that were hedge funds. But the internal hedge funds, owned by the investment banks, were subject to no effective credit control at all.

You and your partner, Warren Buffett, have for years warned about the dangers of the modern derivatives markets, particularly credit derivatives, and about interest rate swaps, currency swaps, and equity swaps.

Interest rate swaps have enormous dangers given their size and the accounting that has been allowed. But credit default derivatives took that danger to new levels of excess—from something that was already gross and wrong. In the '20s we had the "bucket shop." The term bucket shop was a term of derision, because it described a gambling parlor. The bucket shop didn't buy any securities. It just enabled people to make bets against the house and the house furnished little statements of how the bets came out. It was like the off-track betting system.

Until the house lost its money and suddenly disappeared. Or the house made its money and suddenly disappeared.

That is right. Derivatives trading, with no central clearing, brought back the bucket shop, because you could make bets without having any interest in the basic security, and people did make such bets in the billions and billions of dollars. Some of the most admired people in finance—including Alan Greenspan— argued that derivatives trading, substituting for the old bucket shop, was a great contribution to modern economic civilization. There's another word for this: bonkers. It is not a credit to academic economics that Greenspan's view was so common.

Isn't it ironic in a sense that what we now have is a world in which every major financial institution is a federally chartered bank.

We had a rule that a business couldn't also be a deposit-insured bank, because we didn't want every business to be able to use the government's credit to do anything it wanted. It was a profoundly good idea to prevent the banks from being in other businesses.

Well now, when the captive finance companies like General Motors Acceptance Corporation are too big to fail and get in trouble, we give them a bank charter so that a company whose main interest is to preserve employment in Michigan gets to use the government's credit in huge amounts to sell more cars. This is crazy. Our whole regulatory system was long designed to prevent what we're stumbling back into as a reaction to a crisis. We do not need a bunch of non-banks with unlimited access to the government's credit.

So some of the steps that we're putting in place now to try to correct the problems are creating new problems.

Yes. We're also recreating old problems because we're reacting hurriedly to a crisis.

I think it's a given that you have to change General Motors in order to save it.

Well, of course. But count on some changes being silly.

The Federal Reserve is today buying assets that it wouldn't have even considered looking at a year ago.

I think the problem is so extreme that nothing non-extreme has any chance of working. I like the fact that it is so willing to do things that have never been done before, because we have problems that we have never seen before. I am a right-wing Republican, and I like the fact that Obama has put into the White House Larry Summers, who is a ferociously smart human being and will try to do the right thing even if it offends some people. I think that's a quality that we need right now.

What do you think of the job that President Obama is doing so far?

Given the circumstances, I think he's doing very well indeed. I don't want to trade him in at the moment for any other Democrat.

Do you have any views on the fiscal side of things—the mix of fiscal stimulus, tax cuts, and the like?

We have to save the financial system, in spite of our revulsion about the way many of its denizens behave. We also need a huge spending stimulus from the federal government. We have a whole lot of things that are worth doing. By and large, the president does not plan to have people standing around holding shovels in the middle of some forest. He is talking about fixing infrastructure and so on. In the city of Los Angeles, where I live, the streets are a disgrace compared with the streets in Japan. Japan had so much fiscal stimulus that you can't find a pothole on a side of a mountain.

As part of the response, the U.S. government and governments worldwide are printing money at a rate that is absolutely unprecedented. Should people be worried about deflation?

Sure. But the dangers from what we have to do are less than the dangers that would come if we responded much as we did in the '30s.

I think it is dangerous to have big disasters in a modern economy. I regard pre-World War I Germany as an advanced, decent civilization. After all, little Albert Einstein got a very good, subsidized primary education in German Catholic schools. But in its economic misery, Germany became dominated by Adolf Hitler. We've seen some god-awful people come to power in various miseries in various countries. Enough misery has huge dangers in a world where we have new pathogens, atomic bombs, and so forth. So we can't afford to have huge economic collapses. I think we have to do what we're doing. We're hooked. And so are the other advanced nations.

What I'm hearing from you, Charlie, is "so far so good"?

It is very reasonable to react with the extreme vigor that's been shown. In retrospect the vigor wasn't quite enough. I would argue that it was pluperfectly obvious the government had to save all these banks and major investment banks.

So on a scale of 1 to 10, how big a mistake was it that they let Lehman Brothers go?

I don't think that was a mistake. You can't save everybody. That would have created unlimited revulsion in the body politic. I probably would have let Lehman go, too.

Even though the market seized up very dramatically afterwards and we had some of the most difficult short-term financial consequences of that failure?

We needed a total correction to a system that was evil and stupid. You can't have a rule that no matter how awful you are, you're always going to be saved. You have to allow some failure. We don't need all our bright engineers going into derivative trading and hedge funds and so on. We need some revulsion.

How and why do you think economists have gotten this so wrong?

I would argue that the economists have not been all that good at working concepts of good and evil into their profession. Nor do they understand, at all well, the economic consequences of bad accounting.

In fact, they've made a profession of driving value judgments out of the subject.

Yes. They say it's not economics if you think about the consequences of good and evil, and good and bad business accounting. I think what we're learning is that when you don't understand these consequences, you don't have an adequately skilled profession. You have big gaps in what you need. You have a profession that's like the man that Nietzsche ridiculed because he had a lame leg and was very proud of it. The economics profession has been proud of its lame leg.

So in order to cure the lame leg, you would lean more toward an approach to economics that takes human nature into account?

If you totally divorce economics from psychology, you've gone a long way toward divorcing it from reality.

The same could be said of psychology. If you divorce economics from psychology...

That's what's wrong with psychology professors. There are so few of them that know anything about anything else. They have this terribly important discipline that all the other disciplines need and they can't communicate that need to their fellow professors because they know so little about what these other professors know. This is not an unfair description of much of academia.

You've often said that one of the keys to your success has simply been to avoid making the garden-variety mistakes that you see other people make.

Warren and I have skills that could easily be taught to other people. One skill is knowing the edge of your own competency. It's not a competency if you don't know the edge of it. And Warren and I are better at tuning out the standard stupidities. We've left a lot of more talented and diligent people in the dust, just by working hard at eliminating standard error.

If you had to characterize a few mistakes that you see executives making, which ones jump out at you?

An extreme optimism based on an inflated self-appraisal is one. I think that many CEOs get carried away into folly. They haven't studied the past models of disaster enough and they're not risk-averse enough. One of the very interesting things about Berkshire Hathaway is how chicken it is, how cautious, how low is its leverage. But Warren and I would not have been comfortable with more risk, entrusted with other people's net worths. There was no reason for our financial institutions to stretch as much as they did, with the leverage, the shady people and the compromises.

Let me play devil's advocate. People might say, "Wait a minute. I'm at bank A and I'm competing with banks B, C, and D, and they're running at higher leverage and the system is willing to give them that additional leverage and they're making more profits. Unless I operate at their leverage ratios, I can't pay my traders competitively and I will fail."

You've accurately described the way the culture generally works and you have seen in the present crisis how well it works for the wider civilization when everyone insists on not being left behind in lowering standards. I think the culture is simply going to have to learn to work more the way Berkshire Hathaway does, instead of the way Citigroup did.

Do we go back to the old partnership model?

It would be vastly better. The culture of Goldman Sachs as a partnership was morally superior and better for the surrounding civilization than the culture that came after it went public.

Do you think we're going to be able to go back to some of the more traditional models that you value?

A lot of it is going to be forced, so we'll go some in that direction. However, there are powerful forces intrinsic to the system that resist reform. But I have lived in my own life with responsible investment banking. When I was young, First Boston Company was an honorable and constructive firm and very much served the surrounding civilization. Investment banking at the height of this last folly was a disgrace to the surrounding civilization.

Looking forward, I think we'll be fortunate if we're able to muddle along with 0 to 1 percent growth, 2 or 3 years out.

If you're used to growing 3 to 4 percent per year and you go to no growth at all for 10 years, which is roughly what happened in Japan, then, as human tragedies go, that's not major. That's not the rise of Hitler. It's painful, but it's quite endurable.

Are you worried about China and the possibility of unrest there, given this global economic slowdown?

The people rising fastest in the Communist Party are engineers, and that's hugely desirable. The Chinese people have vast virtues intrinsic to their culture and their nature that make me optimistic that China will keep advancing. If China has to adapt to 4 percent growth instead of 10 percent growth, China will manage.

In many ways I see China and the United States as being natural allies. Both economies are tremendous importers of oil. It's in both of our interests to come up with effective, low-cost, clean energy solutions. Yet we have these perpetual frictions that tend to dominate the debate. Any views on that and what we could do to address those questions?

China is a nuclear power with more than a billion people, talented, driven, and achievement-motivated. I think we have no practical alternative but to get along with China. I think, properly handled, our relationship can be a big plus.

Getting back to prospects for growth, I would bet on technology.

We think alike. And we may even take our present misery and use it to boost our chance of ending up where you and I want us to go. We probably have a man in the White House who is quite friendly to this concept.

A crisis is...

We may be forced into much desirable change. If there aren't a lot of new jobs in derivative trading, maybe the engineers will have to do more engineering. If you look at the history of Berkshire Hathaway, you will find that time after time we did something that I describe as turning lemons into lemonade. Part of my Berkshire Hathaway holdings came from a dumb investment.

I didn't realize you made dumb investments.

I certainly did. I think it's part of a life lived right that you learn how to make some lemonade out of your lemons.

So turn the clock back. Imagine that you're a young law school graduate from a top law school, one of the top grads the same way you were several years ago, what advice would you give to a graduate looking at the world today?

Well, that's easy. I would avoid fields where prosperity depended to a considerable extent on misbehavior. I would not go into a plaintiffs' law firm. I would be afraid of what that would do to me. And I would want to work for people at a business that I admired, and I would take less money to do that.

Podcasts As A Source Of Knowledge And Ideas

2009-08-20T10:56:00.002+08:00

Karl recommend tree podcasts. They are

1. Blomberg On the Economy

2. Value Line Observer by The Value Guys

3. Gannon On Investing

____________________________________________________________________________

This is my first article for Gurufocus. Something I’ve wanted to do for a long time. So I thought I’d do something slightly different in order to get my feet wet. Over the past few months, I have tried out a handful of podcasts due to the fact that my commute to work every day is 30 minutes each way. In this article, I will discuss 3 that I find to be the very best. They include a Bloomberg podcast, a value investor named Geoff Gannon and a couple of guys that review the latest Value Line issue with their opinions of what some opportunities might be.

I will assume that readers of this article know how to use iTunes. If not, you can get started here:

[www.apple.com]

In short, to listen to podcasts, all that is needed is an Apple computer or a Windows based PC or laptop. iTunes can be used to subscribe (for free) to the podcasts discussed in this article. You can listen to them on your computer as long as it has speakers or headphones attached. No secondary device like an iPod is actually needed. Details on how to use iTunes is beyond the scope of this article.

Blomberg On the Economy

The first podcast that I will discuss is the Bloomberg On the Economy podcast. This podcast is typically 30 minutes long. There is a new podcast each weekday of the week. There is typically one person interviewed with a strong financial background. Experts on various areas of economics and even gurus appear on podcasts.

To prove that gurus do in fact appear on the podcasts, I would like to point out that George Soros did an interview on July 8, 2009. He discussed the financial crisis and why the government needs more regulations on things like credit default swaps.

A wonderful surprise occurred when someone I never heard of was interviewed on July 20, 2009. A professor of economics from Calgary. From Bloombergs web page, this description is provided:

“ Philip Verleger, economist and founder of PKVerleger LLC, a professor at the University of Calgary's Haskayne School of Business and a former U.S. government adviser, talks with Bloomberg's Tom Keene about oil and gasoline prices, global fuel demand and a shortage of storage capacity.”

Philip Verleger is probably the best interview I can recall. He concentrates all of his studies on oil. He did a wonderful job explaining the supply/demand issues with oil and what rational pricing should be.

More information on the Bloomberg On the Economy podcasts can be found here:

[www.bloomberg.com]

Value Line Observer by The Value Guys

This is an interesting podcast. It is basically 2 friends who claim to be Wall Street veterans. This is the internet though, so who knows for sure? This podcast comes out once a week. In the podcast, each host will mention 3 stocks that they think are worth consideration and give some reasoning.

Sometimes I kinda get upset over their logic. Sometimes they focus on the wrong metrics. But it is nice to see that they occasionally talk about things like free cash flow and enterprise value to conclude what a companies value is. Yes, they actually try to value companies using more than PE ratios.

They are very good at two things. They entertain and they are informative and general have well rounded thoughts. A more informed version of Jim Cramer without the sense of panic.

Recently, they mentioned Greenlight Capital Re, Ltd (GLRE). A newer insurance company that Daivd Einhorn is involved with. From what I have read, David Einhorn is a majority shareholder and a member on the Board of Directors. He seems to have no direct involvement in operations from what I have officially read thus far. However, I have found atleast two sources (including The Value Guys) thus far that say that David Einhorn runs the investment portfolio for this reinsurer. Maybe this is the next BRK? They provided a compelling argument for GLRE, which included the business model. They basically will directly insure anyone the think they can make money off of. If they think they can’t with some level of certainty, they will refer the potential customer to another firm . The other firm takes the risk and GLRE pockets a referral fee! The point is, without this podcast, I would not even know about GLRE.

Definitely a good source for ideas.

Ganon on Invsting

This podcast has some good news and some bad news. The good news is that this is by far the best value investing podcast I found. The bad news is that there are only 20 or so podcasts and no new ones. The ones that do exist are gems though. Geoff Gannon basically takes questions and discusses his thoughts. This show is not about indivudal stocks. It is about investing and how to think about investing.

For example, someone asked about debt and how he uses it. He quickly stated that debt/equity ratios are pointless. It exists because it is easy to calculate. His opinion is that debt should be looked at relative to cash or free cash flow. He said that he likes to look at debt in a way as to think of how long it will take for the company to pay off the debt if it is “business as usual” going forward. This may be obvious, but it is far better than what TV provides as investment information.

There is more than this one example though. He is consistently good at teaching value investing concepts and seems to be a very well rounded value investor.

His blog, also no longer updated can be found here:

[www.gannononinvesting.com]

I’ve tried contacting Geoff through e-mail and received no response.

http://www.gurufocus.com/news.php?id=65636

Seth Klarman on value investing

2009-08-18T21:07:00.002+08:00

"So if the entire country became securities analysts, memorized Benjamin Graham’s Intelligent Investor and regularly attended Warren Buffett’s annual shareholder meetings, most people would, nevertheless, find themselves irresistibly drawn to hot initial public offerings, momentum strategies and investment fads. People would still find it tempting to day-trade and perform technical analysis of stockcharts. A country of security analysts would still overreact. In short, even the best-trained investors would make the same mistakes that investors have been making forever, and for the same immutable reason – that they cannot help it." - Seth Klarman

Many thanks to David.

While i agree with what Seth Klarman said, i think that a country of security analysts who understand value investing would intensify the competitions and hence results in less undervalued opportunities available. As in any industry, intense competition eats away profit margin. Ben Graham is truly a great person in publising The Intelligent Investor!

Credit Crisis

2009-05-15T23:23:00.003+08:00

I have drawn a mind map summarising the development of the credit crisis and its solutions. The main purpose is to help my friends who are taking their final paper of the ACCA exam to gain a better understanding of the recent credit crisis.

You may access to the PDF @ Credit-Crisis

Alternative Investments and its Costs - Part 1

2009-05-01T14:45:00.008+08:00

Many of us might have the experience of being approached by sales representative to invest in alternative investments such as investing in fine wine, watches, collectibles, arts and etc.

I attended a wine investment talk the last week and here is some notes:

10-12% compounded annual return in the last twenty years.
Focus investment on Bordeaux chateaux and only from top vintages.
Supply of top vintage Bordeaux chateaux is scarce naturally and also limited by law whereas demand is growing significantly over the years and mainly comes from the developing world.
The inventory of Bordeaux chateaux will only deplete from time to time due to consumption.
Therefore, all factors suggest that the prices of fine wine will only go higher and higher in the future.
Return from S&P 500 over the past twenty years is roughly 8% per annum V.S. Return of 23% per annum on a certain brand of fine wine
Long term investment perspective is required. They recommended a period of 3-5 years and average clients normally have a 3 years investment horizon.

IS IT an ATTRACTIVE INVESTMENT?

Many people in the room appears to be interested.

What are the questions you need to ask ?

1. How to value fine wine?
2. Is the projection of past performance into future reliable? What are the assumptions behind this projection?
3. What are the COSTS of investment?

Basically, they avoided to answer the first question and saying that the history had proved itself. This led me to ask the second question. They answered that it was 'guaranteed' and all factors pointed to this conclusion.

Let's say you agree with them and fine wine is a great investment. What about the costs?

5% of the value of your initial investment. It comprises their commission and first three years of insurance and storage costs.
2% per annum start from the fourth year of investment. This is for the storage and insurance costs.
Another 5% selling costs based on the exit price.

They insisted that it is cheap. Agree? How much is your brokerage fees? Do you think that is cheap?

Let's consider a scenario. Assuming that the price of fine wine will rise at the historical maximum of 12% a year in the next three. What is your net return (compounded annually) after 3 years?

A. 12%
B. 10%
C. 8%

Answer is C, 8% per annum.
Where is the other 4% per annum?

Conclusion:
Costs are always very important in investing. It will eat away our future profits. Future profits are not guaranteed but costs are guaranteed to be incurred.

I don't know much about investment in fine wine and i don't know how to place a value on it. It might be a good investment given the special limiting factor over its supply and the strong demand from China and Russia.

Additional information:
What are the tricks they usually use?
1. Comparing a single investment/product against S&P 500. They might choose a high return investment on hindsight and compare it against the AVERAGE return on stocks. This is not a fair comparison.
2. When they start to use the words 'Confirm', 'Guarantee' and etc. You need to be careful.
3. They tends to avoid discussing about the costs of investment.

Cacola International - AGM

2009-04-30T11:50:00.008+08:00

This is an update on Cacola Furniture International after the AGM which was held on 29 April 2009.

There had been several adverse developments recently:

1st
The chairman and founder Chau Yeung Chau @ Zhou Dagui reduced his shareholdings from 50.63% to 27.72% on 23.10.2008 at a price of S$ 0.20 per share. (Net cash per share at that time = $ 0.146, Net book value per share = $ 0.243)

As a founder and chairman of a company, he should clearly know how much the company is worth. It is absurd to sell his shares at $ 0.20 in a market downturn unless he had a good reason, However, no details had been given so far and he didn't turn up on the AGM, Shareholders had tried to enquire about this in the AGM but we were not satisfied with the answer given by the board.

Generally, there are good reasons as well as bad reasons for this to happen:

1. Urgent need of money for whatever appropriate reasons. (eg. losses on personal investment)

2. To suppress the share price and to fool other shareholders, then buy back at a cheap price.

In the case of Cacola, i do not have any conclusion currently.

By comparing the shareholdings statistic in the AR, the only thing i learned about the buyers of those shares was that they hold their shares through UOB Kay Hian Pte Ltd. I did not know why these substantial shareholders were not required to make disclosure and i felt that it was their intention not to let us know.

2nd
Suspicious amount of RMB 86 million classified as other receivable, for initial set-up costs of new home decoration business by the 'potential associates'. It is surprised to see that a company can give RMB 86 million (one-fifth of their net worth) to 'potential' associates.

When i questioned the board on this issue, the board provided some explanation and assured that the RMB 86 million would be recovered by the end of 2009.

3rd
Financial controller resigned in March. The board is still in the process of searching suitable candidate.

4th
The management of Cacola had issued two negative profit guidances for 4Q08 and 1Q09.
In my humble opinion, this move was not necessary as this would only further shaken shareholders' confidence. The guidance itself did not provide any figures and this would create unnecessary 'fear' to the shareholders between the period of the release of guidance and the release of actual results.

Between, the board mentioned that the 1Q09's result was only about half compared to 1Q08.

5th
Trading halt on 28/4 -29/4 due the service of a writ of summons on subsidiary.

6th
Neither Chairman nor CEO of the company attended the AGM.

All of the above events have a common characteristic, which is that it exerts a huge pressure on share price of the company. Share price just keep falling even though Cacola has a net cash per share of SGD 0.11.

I have to admit that this is my mistake as i have been over focused on the net cash V.S. market capitalisation and have been over relied on bottom-up measures. I realised the importance of management's factor in estimating the investment value of a company. Management's integrity and its willingness to communicate with shareholders are vital, otherwise cash piles could disappear overnight.

Overall, i still believe that a portfolio consist of 10 stocks which are significant discounted to their net cash value would do well in the long term.

This is not a recommendation to buy or sell Cacola or any other stocks. This write-up is just for reference.

Warren Buffett on Wells Fargo

2009-04-22T02:30:00.001+08:00

'Banking is a very good business unless you do dumb things,' says Wells Fargo's largest shareholder.
Interview by Adam Lashinsky
Last Updated: April 20, 2009: 11:40 AM ET

SAN FRANCISCO (Fortune) -- As the largest shareholder of Wells Fargo through Berkshire Hathaway (BRKB), Warren Buffett knows the San Francisco bank deeply. He first invested before Wells Fargo was bought by Norwest, where current Wells Chairman Dick Kovacevich was CEO. As part of his reporting for his feature on Wells Fargo (WFC, Fortune 500), Fortune Editor at Large Adam Lashinsky spoke at length with Buffett by telephone on March 26.

Fortune: How is Wells Fargo unique?

Warren Buffett: It's sort of hard to imagine a business that large being unique. You'd think they'd need to be like any other bank by the time they got to that size. Those guys have gone their own way. That doesn't mean that everything they've done has been right. But they've never felt compelled to do anything because other banks were doing it, and that's how banks get in trouble, when they say, "Everybody else is doing it, why shouldn't I?"

What about all the smart analysts who think no big bank can survive in its present form, including Wells Fargo?

......
Full article on CNNmoney

Wells Fargo analysis

2009-04-10T19:40:00.006+08:00

While many banks were severely hit by the crisis, Wells Fargo remained strong and standing. This has incited my interest to analyse the bank as i am keen to find out the intricacies working behind this bank that has resulted in its ability to survive the ordeal.

If you are interested in reading my three-page write up on Wells Fargo, please visit here.

Please send me an email if you want a more detailed analysis.

The author has an investment in Wells Fargo.

My Portfolio - Cacola Furniture International

2008-10-16T22:00:00.015+08:00

With the recent market turmoils, many stocks have been ridiculously undervalued. I have discovered a few companies which fall under Benjamin Graham's net-net approach together with an element for growth. I have made a summary of my analysis of the Singapore listed-China based company Cacola Furniture International below.

Business
Cacola designs, manufactures and distributes a wide range of modern-style home and office furniture under two brand names: CACOLA (家居乐) for panel furniture, sofas and mattresses and KELOG (凯洛克) for high-end mattresses.

Most of its products are sold in China (77%) with the remaining sold into other international markets (23%) such as Hong Kong, Canada, South Africa, Morocco, Algeria, Spain, Australia and Kuwait. Sales to USA represents roughly 5-6% of the total revenue.

Revenue derived from wholesale business represents more than 70% of turnover, 20% from export and less than 10% from retails.

In the financial year 2007, the company has increased its stores number from 88 stores to 129 stores. In the first-half of 2008, Cacola opened 23 new specialty stores, bringing it to a total of 152 stores. Cacola plans to further increase its retail points-of-sale in the PRC to 180 specialty stores by the end of this year.

Asset Light model - the distributors and third-party retailers bear most of the running costs of these Cacola stores. This distribution strategy is part of the company's asset light business model. Mr. Chau Yeung Chau, Cacola's executive chairman, said in his first letter to shareholders, 'Since our public listing, we have seen a strong rise in enquiries from retailers to become Cacola representatives.'

Comparison
Benjamin Graham said in the first chapter of Security Analysis,

Isolated analysis and evaluation of an individual security is impractical.

I extended my research to cover several other companies in furniture industry to have a better understanding of the relative merits of those company. Those companies include 1 china company - Man Hwa Holdings, and 3 non-China based companies.

I would like to highlight a few key ratios to understand the attributes of its asset-light strategy.

Gross profit margin (GPM)- Generally, the gross profit margin for the furniture is about 30%. Cacola adopts a cost-plus approach and is confident of maintaining its gross margin at 33%. The company has proved that they are able to maintain it despite higher raw material costs.

Net profit margin (NPM)- Obviously, this is more important than the GPM. Cacola has the highest NPM (23%) among the five companies. The next best company is Man Hwa Holdings with NPM of 13%. Two other non-China based companies have a NPM of less than 5% with a more than 30% GPM. Cacola's asset light model and passing the stores' running costs to its retailers have contributed to this.

ROCE - Cacola has a ROCE of 39.6% for the year 2007, it could be higher as the company is current holding huge amount of Cash. This is the best among the 5 companies which i study, the next best is Man Hwa, with a ROCE of 24.7%.

Brand - During 2006 and 2007, the company has received the Guangdong Top Brand and the Guangdong Province Well-Known Trademark respectively. The Guangdong Province Well-Known Trademark award is based on sales revenue as a measure of market presence. As a comparison, Man Hwa has received the China Top Brand award in September 2007.

Stores growth - the key elements here are it must be a profitable growth, fast recovery of investment and avoiding the risk of overtrading. As i have mentioned above, Cacola has opened 23 new stores in the 1st half and plan to open another 36 stores in the second half. Man Hwa plans to open 87 new stores in 2008 to 300 stores. The asset light strategy is once again a plus for Cacola expansion as we can see the debt on Man Hwa's book is rising fast.

Tax exemption - Cacola enjoyed a tax exemption status on its wholly owned subsidiary, Dongguan Yeung Chau Industry Limited (“Cacola Industry”), which represents more than 80% of the group net profit (based on reverse engineering) and is exempted from the state and local statutory income tax for the ﬁrst two proﬁtable ﬁnancial years of its operations starting from the ﬁnancial year ended 31 December 2007, and thereafter is entitled to a 50% relief from the state corporate income tax and exempted from the local rporate income tax of the PRC for the following three ﬁnancial years. Man Hwa also enjoyed the similar tax exemption benefits. The tax exemption will be expired on next year, which means we have to consider the impact on the earning power.

Valuation
(i) As an Asset Play - Why it's cheap

The below key ratios are based on Cacola second quarter Financial Statement for the period ended 30.6.08 and translated at exchange rate on that date.

Ben Graham's net net approach - $ 0.200 per share (Net current asset - Long term liabilities)
Gearing - Net Cash
NTA - $ 0.213 per share
Cash - $ 0.137 per share
Share price on 16.10.08 - $ 0.100

Margin of safety based on Net Current Asset - 100%

What i can see here is, if i buy the shares in the market and paid for $ 0.100. I am in fact earning $ 0.037 instantly. Theoritically, i can buy the whole company without paying anything and earning a 37% return instantly.

In order to avoid accounting misjudgment, i also capitalized the operating lease commitment to show it as a liability, but it only has a small impact on the valuation.

(ii) As a Fast Grower

“Market commentators and investment managers who glibly refer to 'growth’ and ‘value’ styles as contrasting approaches to investment are displaying their ignorance, not their sophistication. Growth is simply a component—usually a plus, sometimes a minus—in the value equation.” ~ Warren E. Buffett

The company is growing at more than 20% currently. I try not to be too optimistic and i would rather based my valuation on assets. I think it is unrealistic to project current growth rate into the future because:
- this company is a new listed company and has no sufficient track record.
- A company can't always growth faster than the GDP, which is currently at 9%.
- China's property market is going down, it seems logical to predict the demand for furniture will also go down for, maybe a year or two. But i think that more Chinese would buy property at lower prices and hence have more disposable income to buy furniture.

Current PE : 1.41 (based on 2007 earnings)
Dividend yield : 14%

If PE remains at the same level, growth in earnings will translate into growth in share price. The expected return from the stock is the growth in earnings over time plus the dividend yield.
I will make a conservative assumption of a 9% growth rate in its Cash Earnings over the next 3 years, given its small size and the GDP growth rate. However, i still need more facts to support this assumption, and this assumption might change after i discover more things.

If PE rise back to historical PE of about 8 in this industry in three years, together with a 9% growth in earnings. The valuation would be S$ 0.74. a 7-bagger. However, it is optimistic.

Other items & risks
The company's executive chairman sold 22.91% of Cacola's outstanding shares which he hold through Rainbow Champion Limited to "Investors" in an OTC trade. He still deemed to own 27.72% of Cacola's outstanding shares through Rainbow Champion Limited. Those shares were sold at $0.20 while the market was trading at $0.11 on 23.10.2008. I am still trying to figure who is the investor and the reason of selling. $0.20 a share seems to be at the fair value of Net Current Assets.

Current market crisis seems to be a 'once in a life time opportunity' according to Martin J. Whitman, Third Avenue Management. I have taken my position but please remember to do your homework and don't just believe in what i write here. I have a spreadsheet for the analysis of the 5 companies, email mail me at Sephirothngoi@gmail.com if you need it.

Note: The Author has an investment in Cacola Furniture International.

Update on Mark to Market

2008-10-16T21:48:00.002+08:00

banks should be allowed to value certain assets on the basis that they will be held to maturity rather than being forced to estimate their current fair value. ^{link »}

The new rules will allow banks to transfer some assets out of trading books, where they can show they intend to hold them for the longer term. ^{link »}

The impact of the reform could be dramatic. KBC, the Belgian bank which yesterday announced a writedown of 1.6bn (£1.25bn) on collateralised debt obligations (CDOs), indicated that its third-quarter profits could be as much as 500bn higher. ^{link »}

This has been a good idea to amend the existing fair value accounting. However, banks would try to shift most of its distressed assets out of its trading books. Since they are not going to write it down, the values of those assets on balance sheet will remain a big question mark. ^{link »}
- from EU backs proposals to ease 'mark to market' accounting rules - Business News, Business - The Independent via sharedcopy.com

Wall Street on 'SALES'

2008-10-16T21:38:00.003+08:00

"Mr Ngoi, the market is falling!", my lecturer said to me today during break time.

Then i asked him a question, "Sir, you like Cartier right? What would you do if the one of the Cartier watch is offering 50% discount for three days?"

He then said that he would go and buy one. And i continued, "So why the same company is 50% (probably 70%) cheaper than last year and you don't want to buy?"

By the way, he is a great lecturer in teaching professional ethics.

This is the universal investors' sentiment in the market. Mr. Market is going crazy and offering his position at distressed price level, and the investors are filled with fear and runaway.

Mr. Martin Whitman said,

Unfortunately, the public always redeems when it should be buying and buys when it should be redeeming.

I have seen one very interesting way of looking at financial news before, and now i will demonstrate how it works here. I address it as 'The Contrarian's Jokes'

For example, recents headlines from Wall Street Journal, The New York Times and Google's News:

1. Nikkei Falls 11% on Recession Fears
2. World Markets Fall as Investors Weigh Relentless Trouble
3. SEC Eyes Mark-to-Market Accounting Rules
4. European Stocks Extend Losses

We can view the above news from the The Contrarian's Jokes perspective:

1. Wow, the Japanese market is 11% cheaper today!! Quickly go and grab Toyota Industries!
2. It is unbelievable! The whole world is on sales!
3. When Accounting Rules becomes the headlines, you know we are in a great sales!
4. The Europe stocks become even cheaper now! Can't Miss! Once in a life time opportunity!

The above 'The Contrarian Jokes' is purely for entertainment purposes.

Professor Sanjay Bakshi - Behavioral Finance and Business Valuation

2008-10-12T23:19:00.002+08:00

I am learning Professor Sanjay Bakshi's Behavioral Finance and Business Valuation online. This is the most valuable course i have ever studied.

Must visit and read what he has written.

Prof. Sanjay Bakshi's website

Thanks David for the link.

Happy learning.

Mark to market

2008-10-03T18:10:00.013+08:00

In the past, we applied Historical Cost principle to measure assets and liabilities. In order to improve transparency and comparability of financial statements, and also Corporate Governance, we shifted to measure those same assets and liabilities at their fair value. This is also widely known as Mark to Market(MTM) approach.

The recent financial crisis has led to a debate over suspending of mark to market accounting - FAS 157 Fair Value Measurement.

As an accounting student and a self-learner of value investing, i am concerned with the impact on the suspension of MTM accounting in both investment and accounting context. I have the following considerations of suspending MTM:

-Pros-

1. We can avoid the massive write down of those troubled assets and probably we can end this downward positive feedback loop.
(Downward positive feedback loop - When assets prices fall, banks are forced to sell even more assets at fire sales price. Then when their credit rating was downgraded, they got to sell even more assets at fire sales price.)

2. Those troubled assets worth much more than the fire sales price. ( But they are not worth it today and you will never know when will they truly reflect the value recorded in balance sheet)

I am really not able to think of anymore pros for suspending MTM.

-Cons-

1. Accounting industry has been moving towards transparency, as an investor, i really hope to know how much is the current value of those assets in my company. We have been working so hard for the past century to assess is there any impairment loss on property, plant and equipment, inventories, intangible assets and financial instruments. We have seen the useful side of these information, are we going to move backward ?

To me, the best balance sheet is a balance sheet reflects the replacement costs of all those assets and liabilities, except for those whose fair value cannot be measured reliably should be stated at costs.

We all know that some prestigious banks like Goldman Sachs and Bank of America were little affected by the crisis as compared to banks like Citibank and Merrill Lynch.

If there is no MTM accounting, how do i know how much is the portion of real value of those assets and those of fictitious amounts and how to compare those banks on a fair basis?

2. US has announced that it is going to adopt IFRS. IFRS promote Fair Value accounting and is unlikely to follow the US decision on MTM. How to combine two different accounting standards when one applying Fair Value accounting and the other one applying Historical costs or some newly invented method.

3. Many banks are blaming MTM, but why we never heard complaints from banks when they recognized huge profits from subprime previously?

4. Buffett explains it in this way,

I believe in mark to market. I think that accounting in 1974, it was either 1974 or '75, we owned a bunch of common stocks at Berkshire Hathaway. I told our shareholders what the market was. And we used that. I said I think these things are worth a lot more than market. And I think we're going to make a lot of money out of it. But this is what they're worth today. And I don't think anybody gets hurt by telling the truth on that sort of thing.

And I think that once you start saying we're going to peg these things at some price that isn't market, God knows what a financial..

You get in a lot of trouble when you start putting fictitious numbers..

5. The previous model we used to value a lot of the newer financial instruments turned out to be completely wrong, this is why we move forward to MTM.

6. The core problem of the financial crisis is not MTM accouting, it is the attitude of Wall Street gamers and their creative and intriguing derivatives products.

Buffett foresee all this in his famous shareholders letter - edited excerpts from the Berkshire Hathaway annual report for 2002

-Conclusion-

Even if standard bearers and regulators suspended fair-market rules today, banks would still be wedded to fair-market principles, at least until all of today’s complex securities are unwound.

The way other than suspending MTM is to amend the requirements to increase the capital whenever the assets to debt ratio or credit rating fall. However, based on my humble knowledge i do not know how to implement it. It is rational for lender to demand higher capital or collateral when that ratio fall.

Final word,
We have learned this experience and probably will be alert for the next few years. However, we tend to forget the past easily and the history will repeat itself.

An exclusive conversation with Warren Buffett

2008-10-03T14:42:00.001+08:00

The interview of Warren Buffet with Charlie Rose.

Bailout for America

2008-10-03T13:11:00.006+08:00

For all American who opposes the plan,

In my humble view this is not a "Bailout for Wall Street" but rather a "Bailout for American".

So wrote Alexander Hamilton in 1790, amid an earlier populist backlash against American bankers.

If banks, in spite of every precaution, are sometimes betrayed into giving a false credit to the persons described, they more frequently enable honest and industrious men of small and perhaps of no capital to undertake and prosecute business with advantage to themselves and to the community.

If financial markets fall, large and small businesses will fall. Unemployment rates and inflation will shoot up, in the end the American the whole American will suffer.

I am not able to explain any better than the greatest investor in the world, who always think that the rich should pay more tax than rest.

I excerpt a few key ideas Mr. Buffett has said in his interview with Charlie Rose,

You've had an economy that's like a great athlete that's had a heart attack, cardiac arrest..

the patient that's on the floor with the cardiac arrest is not Wall Street. It's the American economy..

The 700 billion, if they buy mortgage-related securities or mortgages themselves at current market prices, they’re going to make money over time because the United States government has staying power and it has a low cost of borrowing.

When Berkshire Hathaway laid out three billion dollars for GE today, we didn’t spend it, we invested it. When the Federal government buys the mortgages, they’re not spending it, they’re investing it.

Confidence is key. Confidence is key. You're not going to leave your money with me unless you're confident I'm going to give it back to you.

You’re going to see more people unemployed. But the difference Charlie if we bottom this thing out at seven percent unemployed versus nine percent, that’s three million people, that’s three million people that if we do it wrong you know lose their jobs unnecessarily..

The key here is they’re not spending it, they’re investing it.

At least three things need to happen to bring the deleveraging process to an end,

Financial institutions and others need to fess up to their mistakes by selling or writing down the value of distressed assets they bought with borrowed money.
They need to pay off debt.
Finally, they need to rebuild their capital cushions which have been eroded by losses on those distressed assets.

There is one question that remains unknown is whether the $700 billion is sufficient for the banks to rebuild their capital cushions.

The Senate has approved the $700 billion bailout plan, let's hope the House will agree to save the super athlete.

The interview of Warren Buffett will be provided in next post.

Benjamin Graham and Security Analysis

2008-09-26T12:03:00.008+08:00

I have been reading Security Analysis (1951) for quite sometime, and i manage to finish my first reading by the end of the year. Ben wrote from the outset: 'This is not a book for Novice.' It has been very interesting and challenging for me to fully comprehend it.

Ben has brilliantly demonstrated the value of the principles, concepts and methods in practice and not merely in theory. I was impressed with the examples he gave in the book. Therefore, i did the same thing when i was studying Annual Report and i found it does make sense.

Some may argue that some aspects of Security Analysis are not relevant and probably outdated. I also think that some methods use to analyze the financial statements are not relevant, this is due to the improvement in the Financial Reporting Standards (FRS) after the book was published. In this area, we should learn from Ben his thoughtful considerations as an independent thinker.

I feel that the Benjamin is like a 'predictor' of the possible changes in financial reporting standards (FRS) (or GAAP in US). When i was learning the newest FRS as part of my course, i felt that some of our existing Accounting Standards seems to derive from there. I will explain it further in my future posts. In fact, there is still many flaws and gray areas in current accounting standards and this is what Investors should be aware of. We can learn from Ben the way how he dealt with those issues.

Walter J. Schloss wrote in his reminiscence of Security analysis

Security Analysis says it all. It is up to analysts and investors to put
Ben’s ideas into practice.

And Mr. Erpf told young Walter,

Read the book and when you know everything in it, you won’t
have to read anything else.

A Reminiscence - Security Analysis by Walter J. Schloss · Original page

ACCA World Prize & Discounted Cash Flow.

2008-09-23T21:25:00.016+08:00

I was informed by ACCA that i get a world prize in Financial Management last week. This is my third time receiving a prize from ACCA, the previous are Malaysia and Singapore Prize. Finally, a world prize.

I was quite happy as my hard work finally paid off. However, that was before i read the interview of David Winter.

David Winters explained DCF in this way...

I probably inherited Michael (Price)'s skepticism for DCF. I think of DCF as garbage-in, garbage-out. Conceptually it's right, but the ability of anybody to make accurate estimates is low. During the many years I worked for him, one of the lessons I learned from Michael was not to be so dependent on earnings. Wall Street is so obsessed with, "Did they beat by a penny? Did they miss by a penny?" If you're investing in securities that are so contingent on that, the possibility increases that you're going to get beat. Our approach is to try to buy today at a discount and get tomorrow for free. Somebody showed me a DCF model last week and I looked at it and I was pretty skeptical. They had a terminal growth rate of 2%, and I asked, "What happens if it becomes 5%?" The value went up by 100%.

And Jean-Marie Eveiillard explained DCF in this way...

We never use discounted cash flow. Buffett does not consider discounted cash flow either, because the Way things work, after 10 years you have a residual value which is often about half the net present value. So not only do you pretend to Know what is going to happen over the next 10 years but even beyond. So we never do discounted cash flow, which I think is garbage. It’s as bad as the efficient market hypothesis.

After reading the above two articles, i suddenly felt that i have been awarded the world first place in Garbage-processing. This is really not a good feeling.

I become even more skeptical about all the things that i have learned or i am learning now. I have been learning all the well known academic theory such as the EMH, DCF, Random walk theory and etc. Now i got to unlearn all those things which i have learned and relearn those really useful things. I think i should appreciate what i have learned, it is a strong contrast to me on what it good and what is bad.

I remembered what Peter Lynch have said in One Up On Wall Street,
My distrust of theorizers and prognosticators continues to the present day.

Thanks to David for the above newsletter and explanations.

The Psychology of Human Misjudgement

2008-09-21T21:43:00.006+08:00

- from Charlie Munger : THE PSYCHOLOGY OF HUMAN MISJUDGMENT via sharedcopy.com

Transcript of Charlie Munger Speech at Harvard Law School.

Great learning.

Deleveraging and Market Rebound

2008-09-21T20:14:00.018+08:00

The recent stock market has been highly unstable. The rebound of about 3.4% of DJIA last Friday has deepen my faith in Benjamin Graham's Mr. Market theory. It also reinforce my conviction on the uselessness of Efficient Market Hypothesis.

Let's look back to the past 1960's-70's:

Conclusion:

The market, like individual stocks, can move in the opposite direction of the fundamentals over the short term.
--excerpt from One up on Wall Street by Peter Lynch

The sad truth is Deleveraging will create a downward spiral and is a long winding process, which Mr. Bernanke called "financial accelerator"

We have seen one over another collapsed of the huge investment banks, mortgaged lenders. We do not know how big is the hole, this is because things are too complicated to understand and when those firms suffered from write down tried to sell their assets, they will find that the weak demand forced them to sell at a prices like 20 cents on a dollar. More terrible thing is when their credit rating is lowered, they need to sell even more assets as they are unlikely to raise new capital.

Banks are the place where the money is, however, those banks are tightenning their credit when deleraging. We can logically understands the impacts on the economies as a whole.

The market rebound seems to be the normal behaviour of Mr. Market as what my lecturer told me,
A man has the right to change his mind at anytime.

At this point of time, let's remembered what Peter Lynch said above.

For your information, the Dow is ranked the last in terms of the gains in major markets around the world:
More informaiton on Mr.Bernanke 'financial accelerator'.

I express my appreciation to David for the link.

Sechai

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