vinod1

I approximated up the shares a little bit since Walmart's fiscal year does not match up to calendar year and I wanted to normalize it to calendar year. I need to double check this. Vinod

I did look that deeply into either Aldi or Leader Price. I need to look into them in more detail. Thanks!

I put together my rather sloppy valuation work on Walmart at the link below. I usually try to document my thesis for myself in a 1-2 page summary to make sure that I have record of my reasoning for any investment. Any feedback/critique would be much appreciated. I have went through all the AR from 1972 on and jotted down notes that strengthen at least in my mind their competitive advantages but I have not included them in the document as it is takes too much time. http://vinodp.com/documents/investing/WalmartValuation.pdf Thanks Vinod

Thanks!

This is as sensible an investment approach as any that I have read. You bought an exceptionally good business at a decent margin of safety with a catalyst and hedged market risk when the broad market is above its fair value. If it does not fit some definition of value investing, too bad :) Vinod

Thanks!

Thanks!

Yes, this is just for the near "inevitable's". Vinod

Graham frequently uses 30 years of data in many of his examples. Here is what he has to say on this topic "The soundness of a security purchase is determined by future developments and not by past history or statistics. But the future cannot be analyzed, we can only seek to anticipate it intelligently and to prepare for it prudently. Here the past comes in - through the back door, as it were - because long experience tells us that investment anticipations, like other business aniticipations, cannot be sound or dependable unless they are closely related to past performance." Businesses are characterized by periods of ups and downs especially when measured over decades and profit margins are one of the most mean reverting of all in a capitalist economy. I think a good knowledge of profit margins and the business factors that contributed to them would be of great help in evaluating a company. I tried to reverse engineer some of Buffett's purchases and from what I found given the same information (without hindsight) I would not have made those purchases - because they looked too expensive. Many of Buffett's home runs involved expanding profit margins from their historical low levels. Of course you need to know the business cold to assess why there might be an opportunity to increase profit margins. Take PG for example, its profit margin averaged around 4.7% as recently as the 1984-1988 period and is now triple that during the most recent 3 year period. There are many factors why the profit margins have expanded but if you look at their 40 year data, you have many such reversions of profit margins. None of this implies that profit margins are going back to those low levels, but should give you a good indication of the narrowness of margin of safety at this time when compared to other periods of lower margins. All this might be a waste of time - but I find it entertaining anyway and hope if an opportunity comes my way I would be much better prepared knowing the long term record. Thanks Vinod

Thanks all for the comments. I am mostly interested in the raw data, so it looks like I might not find it in the sell side reports. I subscribe to VL reports but it goes only about 18 years and some of the data is available only for the last 12-13 years. I bought up old S&P 500 guide books to get data all the way back to 1984. I am looking for 40-50 year data, primarily for the "near inevitables" like PG, JNJ, KO, AXP to get a better sense of how their margins have evolved and what factors might have contributed to it. It looks like I have to find the information the hard way. Vinod

Does anyone know how to get access to sell side research? I am thinking if this would be a quick way to get acquinted with a company, especially its long term performance. I got this idea after looking at Pershing Square's persentation on Kraft. I have painstakingly compiled the profit margins of its competitors in various categories just to see what kind of margin expansion is likely and saw that this is exactly what is already available in Pershing Square's presentation. I do not think I have seen any sell side research before other than Alice's BRK report and wanted to see how I would be able to get access to such reports. Do I need to have an account with a full service firm? Or is there an alternate way to get access to such reports. I am mostly interested in the data and could care less about the actual recommendation or price target. Thanks Vinod

Great idea! I was trying to find charities/non-profits, etc where you get the most bang for your buck, but so far I had been really disappointed when I took a detailed look at them. I found that the best charities seem to target only about 85% of total "collections" to go to actually helping the poor. The other 15% is overhead for example, charity drives, events, etc. Even this 85% is very inefficiently deployed and in some of the very small charities that I had an opportunity to look into, about $2 worth of service is being delivered for every $5 that is collected. I think many more people would be willing to donate large sums if there is some credible evidence that the money is really being put to good use. A rating agency for non-profits would go a long way in both improving the performance of existing charities by highlighting the amount of waste and in increasing the amounts donated by people. Thanks Vinod

I only took a quick look to see if it was interesting and definitely like what I see. Disciplined underwriting, consistent/conservative reserving, and a rational asset allocation policy. However, they could be better on the investing front (higher allocation to equities when market is overvalued and lower allocation to equities when market is undervalued). Based on an expected return of about 5.8% for the portfolio as a whole (based on their seemingly preferred allocation of 80/20 bond/stock mix and assuming a return of about 5% on fixed income and 9% on equities) and about an 88% CR (their last 11 year avg), their pre-tax earning power is about $150 million after a $6 million reduction for interest expense. With a 30% tax rate (past three year average) I get about $5 per share in normalized earning power or about a 12%-13% ROE. This would justify about a 1.5 book value multiple which at the current book value of about $40 translates into an IV of about $60. If you assume that their reserves are overstated by 12-15% then book value increases to about $45-$46 which translates to an IV of about $70. At a current market price of about $54 it is trading at about 80% of IV. This does not seem to offer sufficient enough margin of safety for investment at this time. I like what I see so far, so I am going to dig much more and hopefully Mr Market might give an opportunity may be in the next decade or two. Thanks again for doing this research and sharing it with the group. Thanks Vinod

Thanks for sharing your research. SUR looks like a very promising find. I took a look at a couple of their annual reports and as with evaluating any P&C company that passes the more mathematical filters so I am trying to assess the following qualitative factors (which prevalou has already pointed out): 1. They had an average combined ratio of 87% over the last 10 years. The question I would ask is what is the reason for this performance? What compititive advantage did they have that allows them to keep the combined ratio this low? Did the specific line of business itself have such low combined ratio overall across companies in this industry? It could not be just because they have discipline or have smart underwriters. Do they have lower costs than the compitition and if so how did they achieve it? Do they have some relationships/networking advantage? Do they have financial strength/ratings significantly better than compititors? I have not seen anything (so far) that leads me to believe they really have any compititve advantage that would generate lower CR than the compitition other than via discipline, which they do seem to have. So this leads me to believe that the surety line of business might be generating low CR across the board for all companies in the industry or at least those companies that do it right with enough discipline. I am not able to find a comparable mono-line writer focussing on surety that would allow a true comparision to peers. 2. What does the tail risk looks like? In this business the losses seem to come from just a few occurances as they generally do not expect to payout much i.e. very low premium relative to payout. So you need a really long time (say 25-30 years) to even begin to get a general idea of the true costs. They had a high CR of 119 once already in 2003 and not sure of the probable frequency of this due to having less than 15 years of data. Also if economic/credit conditions are going to be unfavorable going forward, how would this reflect into the CR? 3. What are the growth opportunities? This line of business seems to have relatively rational participants with stable pricing so no possibility of really hard markets that would increase the premiums and profits is ruled out. So is the current situation is about the best that could likely be expected in terms of profits? I think this looks like a very promising find and going to dig deeper and just wanted to pick your brain to see if you have any thoughts that you can share. Thanks Vinod

Both have different risk/return profiles but problem I am having with LUK is more around trying to nail down its IV at something other than its adjusted book value. LUK's value can vary quite a bit based on how you estimate the IV of NOL and Fortescue (stock and the 4% revenue note). I just am not able to get a good handle on these two items. Do you have any suggestions on this? Thanks Vinod

Thank you! Few lectures especially in investing can remain relevant after 50 years but this is gem. Vinod

I have not looked into it yet, but BAX is something you might want to consider. It price got down because of a short term issue with a recent recall. Vinod

Yes!

You are right. From Page 48 of AR "At the inception of the short positions, the resulting equity hedge ($1.5 billion notional amount at an average S&P 500 index value of 1,062.52) represented approximately one-quarter of the company’s equity and equity-related holdings ($6,517.9). At December 31, 2009, as a result of decreased equity and equity-related holdings of $6,156.5 and increased short positions, the equity hedges had increased to approximately 30%." Vinod

1. I take "ignore macro" guidance as essentially not trying to use macro factors (interest rates, growth rates, currency changes, etc) to form specific opinions on the direction of the stock market. I do not think "ignore macro" ever meant ignoring macro variables in valuing and evaluating securities (can the business survive high inflation, can be business prosper if there is a sharp drop in economy, can the business earn decent return on invested capital due to the likley foreign competition, etc). 2. This also resonates with what Grantham is saying recently about value investors. Many value investors, including people like Pabrai are essentially investing in stocks ignoring the risks on far left tail. They just seem to assume that things would not really get too bad. Most of the time they seem to assume that things would not get too bad. So their investment strategies would most likely get good returns as long as we do not have a Great Depression type scenario or something close to that. But if such a scenario does occur, they would suffer very large permanent loss of capital. Many of the smallest stocks with high debt loads or highly cyclical businesses would not survive a 1 in 50 year event. Yet this is precisely the area where several deep value investors seem to invest a large portion of their portfolios. This seems to me to be quite different from the types of securities that Graham (via requring very very stringent criteria as evidenced by his emphasis on earnings/survivability "under depression conditions") and Buffett have invested in (See's, GEICO, Coke, Washington Post, Gillette preferred, Amex, Wells Fargo, General Dynamics, Boeing, etc). I respect Pabrai and posters on this board a lot but just could not reconcile this seeming obliviousness to far left tail risks. Thanks Vinod

I gave a conceptual example in the report that should better explain how to value float. Vinod

Thanks for sharing. Vinod

You are correct. It should all be pre-tax. So the hurdle rate is only 6.7%. I might be wrong in this, but drawing a line in the sand on pricing so that you are only writing business that have an expectation of profit and let the float fall to whatever level it may be. Doing something like this should be possible - basically underwriting discipline. Overall the float does add value, I do not disagree with that. Paying 1.67% on float seems nice, but we know there are going to be surprises and they are only going to be negative surprises so there is always the possibility of much much higher costs than anticipated. This is basically what Buffett has emphasized so much in his annual letters: We have no interest in writing insurance that carries a mathematical expectation of loss; we experience enough disappointments doing transactions we believe to carry an expectation of profit. I guess this boils down to one of risk tolerance thing. Prem seems to be saying, let float cost a little bit more, we know we are going to do much much better investing on the float, so let us not reduce float all that much. Vinod

Three conditions that prevail in insurance, but not in most businesses, allow us our flexibility. First, market share is not an important determinant of profitability: In this business, in contrast to the newspaper or grocery businesses, the economic rule is not survival of the fattest. Second, in many sectors of insurance, including most of those in which we operate, distribution channels are not proprietary and can be easily entered: Small volume this year does not preclude huge volume next year. Third, idle capacity - which in this industry largely means people - does not result in intolerable costs. In a way that industries such as printing or steel cannot, we can operate at quarter-speed much of the time and still enjoy long-term prosperity. - Buffett in one of his annual letters

You need to look at the benefit of incremental float. I am not saying float has no benefit for fairfax. Say Fairfax is able to choke the 4b written at 105 CR by 25% so that you are writing only 3b at 100 CR. If they exhibit this level of discipline the float would be about 9b instead of 12b. (Calculating a crude average float tail of 3 years - 12b float/4b written). By giving up 3b float fairfax is able to save 200m. So the cost of incremental float is 6.7% after tax (200/3000) - so we need 10% pre-tax returns on the incremental float that need to be generated from the bond portfolio. Is this worth the cost and risk?0 Vinod