returnonmycapital

Ross, A while back, I wrote about my foray into BAC warrants and the series L preferreds. It looks like you were doing the same: From "BAC-WT - Bank of America Warrants" (Nov. 3, 2011) "I have bought BAC wts (class A) with 13.30 strike at an average of 2.75. I have also bought BAC pfd (series L) at an average price of 750 (yield 9.67%). Per $1,000 par of pfd., I have bought 75 wts (1,000 / 13.3 = 75). This has created a reasonably low strike convertible pfd security. My total cost per $1,000 par is 956.25 which earns close to 7.6% yield. My assumption is that the pfd. will eventually trade at par and the business will eventually earn 1% on assets of about $150 - $200 per share (putting the common fair value at about $20, imo, given interest rates today). The wts currently trade at about 45% premium to the stock. I expect that premium to decline approx. 6% per annum. Netting out the premium decay fromt the pfd dividend receivable gives a net 1.6% yield. Which gives a 1% yield advantage over the common. Should dividends increase on the commn, the wt strike will decline $1 for $1 (unlike WFC wts). This hedges, to some extent, the wt's premium decay. If the pfd is money-good and eventually trades at par, this operation should result in profit, even if the wts expire worthless. If you leverage the pfd., with an attractive spread and it proves to be money-good and the common gets through the strike price by 2019, this should offer a superior operation to holding the common. And finally, because the series L pfd is already a perpetual convertible, should the common later rise well past $20, you might get some extra kick from the pfd rising through par. Example, given a $750 pfd cost, option breakeven on the common is $37.50 per share. And, while not wanting to dwell on the negatives, it's no small thing to have even marginally better terms to the common in any prospective liquidation scenario." I would add that the premium on the BAC class A warrants has gone down to about 36% over the last month or so. The premium decay over the remaining life of the warrant is significantly lower than when I initially posted, increasing the net yield on the combined security. I have been adding to the position recently.

Leftcoast, thanks a bunch.

I agree, follow TBV as a proxy for the operating health of the underlying business. Goodwill still includes Countrywide/ML froth and is probably materially overstated.

Leftcoast, I just bought XBOX 360 with Kinect for the kids for Xmas. I plan to set up Live through our WIFI at home and stream entertainment. But being somewhat cheap and ignorant, I bought the 4GB version. Will I still be able to stream content on Live with so little memory? Will a USB memory stick work? If not, what do I do?

I'll take a stab at it. From a business perspective, which is the only one I believe to be rational, gold is worth its marginal cost to market plus a pre-tax margin. Currently, from my gold mining sources, the world average cost to market for gold is around USD 500 per ounce (which is higher than I was told). Tack on a pre-tax margin of 10-15% and, voila, gold is worth about USD 550 - 575 per ounce. Anyone paying over that is either not rational or has proof that the cost to market is higher. The problem today is that money has no value (short-term cash rates are negative on a real basis). That puts pressure on the demand for gold, which supposedly holds its real value over time. The supply being reasonably fixed, the price shoots up. Once the Fed shows a tightening bias, as long as it is not too far behind the inflation curve, gold will revert toward its business value. The time to buy gold for rational investors (big lines or not) is when its price is below its business value, not above. But I would just skip all that and buy the large caps that will be around for a good long time. All mentioned in prior posts and almost all offering good value. And compared to gold, excellent relative value.

As at October 28 (date of 10Q filing), BRK had 1,650,759 shares outstanding on an equivalent Class A basis. That's 395 Class A equivalent bought back in the first 4 weeks of October.

My understanding of the lifecos is that their business is affected by: 1) The level of interest rates as they use: a) bonds to invest premiums received, and; b) current rates to discount policy liabilities. 2) Competition: the business is very competitive and each new policy incurs large initial costs (think commissions to salespeople). The strain of low interest rates on float is additionally hampered by low discount rates on liabilities and high underwriting expenses if policy count is growing. The things that offset these headwinds are life expectancy and policy lapses. The lifecos want their customers to live longer than they project and lapse their policies. In an environment of low interest rates and mature, competitive markets, lifecos have poor margins. In order to combat this, they try to reduce business growth and the high costs associated. It risks relationships with salespeople, but it is one of the only levers they have. Unless they go to markets which are growing and lack competition. ELF has stated that they are slowing new policy growth in this environmnent in order to improve poor margins.

If memory serves ubuy2wron, you are a shareholder of E-L Financial. You should call Paul Taylor (ELF CFO) at 416 947 2578 and arrange a meeting with him or someone at Empire Life. I was in there not long ago and they offered me a meeting with the head of the Dominion (P&C). I can only imagine they would do the same with Empire Life. Otherwise, Paul may be a good source. And a nice fellow. Reading ELF's annual reports, specifically with regards to Empire Life, offers some limited colour on the operation as well, but I suspect you've been doing that.

With a profitable underwriting business (cost of float has been negative over time), BRK's insurers are worth at least BRK's investments per share. These days, investments per share = book value per share (about $100,000 per A share). WB suggests there must be some value to the operating businesses. In today's news release, he states "considerably" more than the 10% of BV purchase limit. At 10% of book value, his purchase price for the operating businesses is around $10,000 per A share. The operating businesses are probably earning $6,500 per A share on a pre-tax basis, implying a multiple of only 1.5X pre-tax earnings for the rest of BRK. Maybe the question should be: why 110% and not 160% of book?

Foreign cash might flow back to the US more readily if US GAAP rules treated international cash holdings as already repatriated. Corporations wouldn't have to pay an actual tax until repatriation of the cash but they would have to show a tax liability on their balance sheets (lowering retained earnings in their book value). Current rules keep cash away from productive use at home.

Actually, I am showing that it wasn't until F2004 that options were expensed as per GAAP.

Re: Microsoft earning in F2001 If you were to deduct the cost of issuing employee options in F2001, which I believe from F2002 on was expensed as per GAAP in the P&L, Microsoft earned only $5.084 bn in F2001, or about $0.48 per basic share outstanding. That would suggest a growth in earnings per basic share of approx. 18% per annum. And owner earnings have been higher than GAAP earnings in most years between F01 & F11 (7 out of 10).

I don't know what sort of wording will be used in the revised prospectus, but in our last get-together, Francis stated that he had decided to stop accruing the 12b-1 Distribution fee. He also mentioned the Shareholder Service fee and, as far as I know, he has no plans to charge for that either. He is concerned with doing what is right. This being his first experience as a US-registered manager, he is having to learn about the differences between Canada and the US. And there are some pretty big differences.

When did that happen? According to their prospectus, it still has one. "Rule 12b-1 Distribution and Shareholder Service Fees The Trust has adopted a Rule 12b-1 plan under which the Funds pay the Distributor up to 0.25% of the average daily net assets of the Funds for distribution services and the servicing of shareholder accounts. Rule 12b-1 payments to participating financial institutions begin to accrue immediately on a daily basis and typically are paid on a quarterly basis. " Morningstar also says there is one. http://financials.morningstar.com/fund/expense.html?t=US1704311000&region=USA&culture=en-us In the next Prospectus, which I believe is coming out in April, you will find that the 12b-1 fee has been eliminated for both funds.

There is no 12b-1 fee on the Chou America funds. They have been eliminated.

With reference to Francis' ownership in the Chou America Funds: At launch, he invested USD 500,000 in each of the two funds. Now worth considerably more.

Myth, Those are outstanding numbers, if the rent is collectible, and suggest that real estate is undervalued in the area you are referring to. My general feeling is that the correction in residential real estate in the US might be overdone. Again, I am only speaking from an economic standpoint. Whether prices appreciate in the near-term is irrelevant with economics like you have described. What I mean is, if you require price appreciation for the economics to work out, stay away. Your numbers suggest an attractive return on equity, even without a mortgage.

I am not debating the relative merits of investing in real estate, equities, bonds, cash, etc. I am trying to get some understanding of present real estate values and where John Q. Public is concerned, the value of owning a home versus renting a home. And doing so from an economic perspective. My example suggests that on a basic economic level, it is better to own than to rent in the area I referred to. If the general consensus suggests that it is better to own than to rent today, unlike in 2007, real estate values should begin to help the general economy. However, if it is better for John Q. Public to continue to rent, then real estate will continue to work against the economy. Leaving aside one's opinions on the general level of indebtedness, this sort of survey might be helpful when organizing one's thoughts on banking and other economically sensitive industries.

A while back (2008 as I recall), we had a discussion on real estate values around North America. I would like to see where we stand today. My method of valuing residential real estate is to compare the rental yield to the cost of borrowing. For example, just outside of Toronto, annual rent of $15,000 on a property acquired for $250,000 has a rental yield of 6%. The cost to finance 75% (a Canadian norm) of this acquisition today might be 3.5% on a 5-year fixed mortgage (a variable mortgage is 2.25%). The pre-property tax, pre-insurance return on equity in this transaction is ($15,000 - .035*.75*250,000)/.25*250,000 = 14%. If you factor in property taxes and insurance, the cash return on equity falls to 8%, if you can collect 100% of the rent. Not half bad. For those who have some understanding of what is going on where they live, it might be interesting to see how things have changed and where there might be value. Please specify what area you are referring to.

As recently as September, management (Francis) owned all of the units outstanding of each fund. There may be a few others by now but 100% of the seed money was Francis'.

In response to Ballinvaroginvestors: When will normalized bank earnings re-appear? In lieu of the quality of my forecasting abilities, I prefer the following line of thought: 1) For 2010, WFC is offering 10% earnings yield while earning 30% of pre-tax, pre-provision profit (ptppp); 2) In 2009, WFC earned 20% on ptppp which equates to 7% earnings yield at its present price; 3) Imagine in 2011 40% ptppp, which equates to 12% 4) Say in 2012, back to a more normal 50% or 16% earnings yield. None of these earnings yield figures involve any growth in the volume of business for WFC, but nor do they suggest a lower volume. The question really is, which is more probable, a return to 20%, remain stuck at 30%, or a gradual improvement to 40-50%. Assign your probabilities and your expected earnings yield pops out. Mine is for a gradual improvement and so my expected earnings yield is well higher than its present 10%. And I can be pretty patient with 10% in the meantime. What did Monish Pabrai write in the Dandho Investor; heads I win, tails I don't lose much?

I don't know how the foreclosure issue plays out, but my bet is it is a lot less of an issue than the media is making it out to be. And I would go so far as to suggest that Wells Fargo is in better shape than Bank of America in that regard. In terms of ROA/ROE, of course today they are nothing to write home about. When netting only 60% of your normal pre-provision, pre-tax profit on present business volume, you are going to see lower returns on investment. Our job is to see past that. Normalized earnings show very attractive ROA/ROE, especially for Wells Fargo (and US Bank) despite their shares outstanding having increased. The takeover of Wachovia will prove attractive. The growth by acquisition route taken by some banks during the meltdown was terrifically clever. This is not the pharma business where sellers know how precarious the value of their purchased R&D is. The reason Warren likes Wells Fargo and US Bank is because they are superior. Do a comparison of all large banks over the last 15 years, two banks will stand out as high ROA businesses with simple banking models and high net interest margin: Wells Fargo and US Bank. Unfortunately, US Bank is fairly valued, as far as I can tell. But Wells Fargo is well behind in its market valuation. Why are so many of us still fighting the last war?

I think this is probably a great time to be looking at this industry. I tend to put any bank with a large investment (trading, advisory, brokerage) group in the too hard pile. Or maybe it's just that I think they offer little to shareholders; it's probably a lot better to be an employee of a Wall Street bank than an owner. Doesn't Wells Fargo look cheap? Its pre-provision, pre-tax profit for 2010 is going to be close to $7.30 per share. Normally, it nets at least 50% of that figure. Currently it is netting only about 30%. As things normalize, the company is perfectly capable of earning $3.70 per share on present business volume. And what about the dividend? Basel III requirements look already met, the bank should begin to ramp up its payout toward the 50% of earnings figure it normally offers. At $23 and change, what's not to like?

Very few Canadians have a right to complain about our tax system, especially if you are a small business owner. I have done my taxes by the book since moving here 11 years ago and have paid about half the rate I would have paid had I stayed in the US/UK, where ease of doing business is on par with Canada. That includes income and property taxes. Few appreciate how good we have it.

I just received my auto insurance policy renewal: Up 30% yoy! After years of declines, what a pop. I deal with the Canadian version of Geico, known as Belair Direct. E-L Financial did mention they were pushing through increases at their Dominion subsidiary, I guess others are as well.