America’s Infrastructure

The Economist has an article about the current infrastructure in America. The article contains some of the same figures which Sellers Capital use in their VMC investment thesis.

A few excerpts from the article:

In 2005 the American Society of Civil Engineers estimated that $1.6 trillion was needed over five years to bring just the existing infrastructure into good repair. This does not account for future needs.

The private sector is hungry to invest. In May Morgan Stanley raised $4 billion for its new infrastructure fund.

In January a national commission on transport policy recommended that the government should invest at least $225 billion each year for the next 50 years.

The article also outlines the underfunding of water infrastructure. Which is one the reasons behind Whitney Tilson picking MWA in July 2007, as mentioned in Kiplinger.

America’s ageing water infrastructure is sorely underfunded: the Environmental Protection Agency forecasts an $11 billion annual gap in meeting costs over the next 20 years.

Spinoffs: A Quick Summary

Below is an excerpt about spinoff investments from Joel Greenblatt’s You Can Be A Stock Market Genius.

1. Spinoffs, in general, beat the market.
2. Picking your spots, within the spinoff universe can result in even better results than the average spinoff.
3. Certain characteristics point to an exceptional spinoff opportunity:

• Institutions don’t want the spinoff (and not because of the investment merits).
• Insiders want the spinoff.
• A previously hidden investment opportunity is uncovered by the spinoff transaction (e.g. a cheap stock, a great business, a leveraged risk/reward situation).

4. You can locate and analyse spinoff prospects by reading the business press and following up with the SEC filings.
5. Paying attention to “parents” can pay off handsomely.
6. Partial spinoffs and rights offerings create unique investment opportunities.
7. Keep an eye on the insiders.

This points are useful when looking at investment opportunites like EMC and SATS.

Magic Formula

I have posted before about Magic Formula investing, with the help of Digital Look I have prepared a table of magic formula type shares in the UK.

I ranked companies by their ROCE, then by P/E, then combined the ranks giving a high rank to those with both a high ROCE and a low P/E.

The top 19 companies are:

Company	ROCE	P/E
Sport Media Group	129.06%	2
New Star Asset Management Group	290.10%	2.8
Charlemagne Capital	122.89%	3.3
Creston	107.44%	3
Synarbor	84.54%	2.2
Jacques Vert	108.37%	3.4
RDF Group	81.49%	2.5
Garner	483.33%	4.4
Yell Group	70.85%	2.3
Belgravium Technologies	125.06%	3.9
Somero Enterprises (Reg S)	86.60%	3.5
OPD Group	118.41%	4.1
Lincat Group	82.95%	3.6
Litcomp	79.18%	3.6
Celtic	68.53%	3.2
Castle Support Services	86.39%	4.1
Topps Tiles	82.28%	4.6
Solid State	75.17%	4.4
Avingtrans	75.09%	4.4

Vulcan Materials

Vulcan Materials (VMC) produces construction aggregates and other construction materials. Sellers Capital thinks the company is worth US$85 a share, compared to a current share price of US$75 (compared to US$70 when the original analysis (pdf) was done).

The US$85 estimate is the expected value from three scenarios

1. Pessimistic: US$60 a share with 30% probability.
2. Most likely: US$90 a share with 55% probability.
3. Optimistic: US$105 a share with 15% probability.

Summary of their investment thesis:

• Aggregate is a wide moat business.
• America’s infrastructure is poor and needs a investment of US$1.6 trillion according to the Society of Civil Engineers.
• Worst case is flat growth for building infrastructure.
• Demand for aggregates not dependent on residential housing.
• The last three decades has seen growing volumes in aggregates.
• Scarcity = increased pricing.

Perceived Problem: Volumes will decrease due to lower public expenditures and bad housing and commercial markets, and prices will decline.

Sellers Capital View: Volumes will decline slightly, pricing will be stable to increasing.

Resources for Value Investing

• Magic Formula
• Yahoo Screener
• Gurufocus
• Stockpickr
• Seeking Alpha
• Pabrai Investment Funds - Mohnish Pabrai
• Pershing Square - Bill Ackman
• Fairholme Fund - Bruce Berkowitz
• Greenlight Capital - David Einhorn
• Tilson Investment Trust - Whitney Tilson
• Spencer Capital Management - Kenneth Shubin Stein

2008 Berkshire Hathaway Shareholder Meeting: Detailed Notes

Reflections on Value Investing has posted some notes from the recent Berkshire Hathaway meeting. Below are some quotes that I noticed.

I started investing when I was 11. I believe in reading everything in sight. I wandered for 8 yrs with technical analysis. I read Intelligent Investor, chapters 8 and 20 I recommend, and if you absorb it you won’t be a lemming.

Our job is not to select great managers, our job is to retain them.

In business school the amount of time spent teaching option pricing is total nonsense. You only need 2 courses, how to value a business and how to think about stock market fluctuations.

We never want to trade reputation for money.

There is a lot I wouldn’t buy even if best management in world, as it doesn’t make much difference in a bad business.

We want a company with durable advantage, which we understand, can trust management, at a good price.

If I were working with small sums of money, it would open up thousands of possibilities. We found very mispriced bonds. We found them in Korea a few years ago. You made big returns but had to be small size. I wouldn’t be in currencies with small amount of money. I had a friend who used to buy tax liens. I’d look in small stocks or specialized bonds.

Several times I have had 75% of my non-Berkshire net worth in a situation. You will see things where it would be a mistake not to act. You won’t see them often, and the press and your friends won’t be talking about them.

We have lower due diligence expenses than anyone in America. I know of a place that pays over US$200m to its accountants every year, and I know we are safer because we think like engineers – we want margins of reliability.

A brand is a promise.

We waste a lot of time, but we waste it on things we want to waste it on.

Investment Portfolio

Readers of this blog may be familiar with, blogs like ControlledGreed.com, Gannon on Investing, Value Investing, and a Few Cigar Butts and Value Discipline.

I intend to follow their lead and start posting about potential investments. And keep track of the resulting portfolio.

The portfolio will be highly concentrated, following the example of Mohnish Parbrai with ten positions each making up roughly 10% of the portfolio.

Companies I am looking at include:

Sears - SHLD:

• Run by Eddie Lampart, and has Mohnish Parbrai, Bruce Berkowitz and Bill Ackman as investors. My Value Idea has a post about Sears: Sears Holdings is the hype real?. Which outlines why this may be a good investment.
• Value Investing, and a Few Cigar Butts has a 18% position in SHLD.

Winn Dixe - WINN

• US Supermarket chain that has come out of bankruptcy. The Tilson Focus fund have invested 13% of their portfolio in the company.
• Whitney Tilson writes about the investment in this article: Winn-Dixie Stores: A Turnaround in Progress at Seeking Alpha.

EchoStar - SATS

• Spin-off from EchoStar Communications (which has Bruce Berkowitz as an investor). The business makes set-top boxes for subscription TV, has seven satellites and US$1bn in cash.
• The idea came from a write up by vinlin1060 at Value Investor Club, which I was able to read with a free guest membership that lets you view posts more than 45 days old.

Office Depot - ODP

• Recent investment by Joel Greenblatt.
• Controlled Greed has a position.

A Thought About Valuation and Multiples

A multiple is just someone else’s discounted cash flow – with all the messy maths and assumptions hidden behind a single number.

Market multiples (be it a price earnings, revenue or EBIT multiple) are just single number that hides the assumptions the market is making about that company’s expected future cash flow (and the level of risk associated with that cash flow).

Transaction multiples just hide the acquirers assumptions around the expected cash the asset will produce under their ownership / capital structure / management etc.

Seth A. Klarman

gone to the dogs has a post featuring a speech by Seth A. Klarman (the author of Margin of Safety) at MIT. Here are a few quotes from the speech:

Seth Klarman makes the point that most investors lack a strategy that equips them to deal with a rise in volatility and declining markets.

Buying at a discount creates a margin of safety for the investor—room for imprecision, error, bad luck or the vicissitudes of volatile markets and economies.

The best investors do not target return; they focus first on risk, and only then decide whether the projected return justifies taking each particular risk.

Recourse leverage changes this equation, as you can seemingly own all the investments you want simply by borrowing to buy them. There is no healthy portfolio discipline enforced by the desire to make new purchases or the anticipation that you may want to. There is also a bit of a slippery slope in that if a little leverage is good, why isn’t more leverage better? When do you stop?

Value investing, the strategy of buying stocks at an appreciable discount from the value of the underlying businesses, is one strategy that provides a road map to successfully navigate not only through good times but also through turmoil. Buying at a discount creates a margin of safety for the investor—room for imprecision, error, bad luck or the vicissitudes of volatile markets and economies. Following a value approach won’t be easy for everyone, especially in today’s media-dominated, short-term oriented markets, in that it requires deep reservoirs of patience and discipline. Yet it is the only truly risk averse strategy in a world where nearly all of us are, or should be, risk averse.

We’ve delivered great returns to our clients for a quarter century—a dollar invested at inception in our largest fund is now worth over 94 dollars, a 20% net compound return. We have achieved this not by incurring high risk as financial theory would suggest, but by deliberately avoiding or hedging the risks that we identified. In other words, there is a large gap between standard financial theory and real world practice.

Value investing involves the purchases of bargains, the proverbial dollars for fifty cents. Unlike speculators, who think of securities as pieces of paper that you trade, value investors evaluate securities as fractional ownership of, or debt claims on, real businesses.

Value investing lies at the intersection of economics and psychology. Economics is important because you need to understand what assets or businesses are worth. Psychology is equally important because price is the critically important component in the investment equation that determines the amount of risk and return available from any investment.

My firm’s approach is to seek situations where there is urgent, panicked or mindless selling. As Warren Buffett has said, “If you are at a poker table and can’t figure out who the patsy is, it’s you.” In investing, we never want to be the patsy. So rather than buy from smart, informed sellers, we want to buy from urgent, distressed or emotional sellers. This concept applies to just about any asset class: debt, real estate, private equity, as well as public equities.

The stock market is the story of cycles and of the human behavior that is responsible for overreactions in both directions.

Berkshire Hathaway

Few highlights from Berkshire Hathaway’s 2007 annual report.

Charlie and I look for companies that have:

• a business we understand
• favorable long-term economics
• able and trustworthy management; and
• a sensible price tag.

A truly great business must have an enduring “moat” that protects excellent returns on invested capital.

But if a business requires a superstar to produce great results, the business itself cannot be deemed great.

There’s no rule that you have to invest money where you’ve earned it. Indeed, it’s often a mistake to do so.

[Talking about investments in different types of companies] To sum up, think of three types of “savings accounts.” The great one pays an extraordinarily high interest rate that will rise as the years pass. The good one pays an attractive rate of interest that will be earned also on deposits that are added. Finally, the gruesome account both pays an inadequate interest rate and requires you to keep adding money at those disappointing returns.

[On buying Dexter, a shoe business with Berkshire stock] In essence, I gave away 1.6% of a wonderful business – one now valued at $220 billion – to buy a worthless business.

[On buying Amazon bonds at 57% of par] Yes, Virginia, you can occasionally find markets that are ridiculously inefficient – or at least you can find them anywhere except at the finance departments of some leading business schools.