Tim Eriksen

I'm state registered (Oregon) and costs are very low. Maybe I paid $500-800 in startup, ongoing is maybe $500 / year. I do separate accounts, not a fund. Managing separate accounts is a lot easier. In Washington state (one of the strictest) you need to pass a Series 63 test to be a Registered Investment Advisor. It is wise to create an LLC for the management company, which will cost a few thousand bucks to set up. Annual fees are just $70 for the LLC and FINRA dues which are probably $200. Capital requirements are $10,000 or $35,000 if you have custody of assets. The management company is not required to be audited. No insurance required. Starting a fund is a lot pricier. Initial offering documents are 10k to 35k. You are required to have the fund audited (12k to 30k). Outside administrator is strongly suggested. That is another 8k to 20k. Independent party (lawyer or accountant) to authorize all disbursements adds $200 to every disbursement including management fees or redemptions. Same capital and insurance requirements. We expected to launch with $3 million and only had 150k. Being optimists we went ahead. Small size means you either cover the overhead or face quite a headwind (2 to 5%). I couldn't afford to cover the overhead and take virtually no income so we faced the headwind and survived. Then 2008 happened. Wouldn't have made it without some seed investors willing to take a chance.

I agree. Interestingly this was the topic I wrote about in my fund's most recent letter: Why We Don’t Care (Much) About Book Value By definition, a value investor is someone who seeks to purchase securities for less than what they are worth. For many value investors that means focusing on the balance sheet and looking for companies where the market price is below the value of the firm’s net assets (i.e., discount to book value). On the conservative end of the value spectrum are investors looking for “net-nets” where the market price of the stock is less that current assets minus all liabilities. (For those who don’t readily recall what they learned in accounting, current assets include items such as cash, accounts receivable, and inventory. In other words items expected to be converted into cash within one year.) Essentially this means net-net investors place no value on plant and equipment and other items that are not listed on the balance sheet as current assets. This situation is very rare and typically there are just a handful of stocks to choose from. What is helpful is that technology has made them easier to find due to screening programs. Nearly all value investors broaden their approach beyond accounting book value and look for hidden assets, such as undervalued real estate, or items that have been depreciated whose true value is much greater than what it appears on the accounting statement. This increases the potential pool of investment opportunities without significantly increasing downside risk; however, it requires more investigative work. A screening program cannot tell you if the real estate is undervalued on the books or if the true value of certain assets is greater than the accounting book value. These first two approaches are not focused on the value of the ongoing business, rather they are focused on the value of the business’ assets. Most value investors broaden even further to look for low price to book value stocks. Ideally the market is pricing the stock below book value, but some will allow for a modest premium to book. Typically these are situations where the investor’s downside is limited to the modest premium over book or liquidation value being paid, but the upside is greater since the company’s prospects for future earnings is higher than the net-net or liquidation value approach. While we continually look at and occasionally invest in all three of these types of situations, we long ago gravitated to an earnings focused style of value investing. Warren Buffett described it as moving on from the “cigar butt” approach, where there is one good puff left, to focusing on higher quality businesses that are highly likely to continue to generate free cash in the future. In other words, what we are striving to do is find securities where the market is mispricing the future stream of cash flows. We are looking for stocks with low price to earnings, typically below ten, that have modest, or better, earnings growth prospects. If the price paid is low enough, and the growth does not materialize, our downside should be limited. Hopefully, the downside is that the stock “only” generates returns equal to its earnings yield (the inverse of price to earnings). For example, if we pay eight times earnings and earnings remain flat, the stock would hopefully generate a 12% annual return over time. The only way this occurs in reality is if it is not a capital intensive business. Then earnings are truly free cash flow and can be used to pay down debt, purchase income generating assets, pay dividends, or repurchase shares. Ideally, growth will materialize, resulting in market beating returns due to having earnings increase, and having the market multiple expand. PE (price to earnings) multiple expansion is the essential component necessary for this approach to significantly outperform. This is why the price paid is of great importance. For example, if we purchase a stock at eight times earnings, and earnings grow 25% over three years, and the market valuation increases from eight times earnings to a more rational thirteen times, we would double our money over that three year time frame, which equals 24% annualized returns before fees and expenses. The sooner the PE multiple expansion occurs the greater the returns will typically be. What we do not do is follow the “growth approach” where current valuation is high in relation to the company’s current earnings. In other words the buyer pays a high price to current earnings based on a very high projected growth rate (typically 20% or more per year). Success requires the high growth to materialize and for the high price to earnings multiple to remain stable. The downside (which we find unacceptably risky) is that if the growth stops (or slows) the stock price will typically crater due to it suddenly going from a high projected growth rate to a low projected growth rate. In other words PE multiple contraction occurs, which can be devastating to returns. This approach requires a great deal of investigation and accuracy in regards to future prospects and involves too much downside risk in our opinion.

So if there were two business for sale for $30 million each, that make $4.5 million pre-tax and $3 million after taxes (33% rate for simplicity). Business A has $30 million of net assets, while Business B has only $15 million of net assets. The buyer of Business A (in an asset purchase) would effectively have no goodwill amortization since purchase price equals net assets. The buyer of Business B would have $15 million of goodwill and get to deduct $1 million per year (1/15 because of 15 year amortization) from pre-tax income. Thus the buyer of Business B will report $1 million less of income and thus pay $333k less taxes. So the cash earnings of the higher quality business will actually be higher by the amount of tax savings from the goodwill amortization. I think some things are actually amortized over 20 years. For example, when micro cap Hennessy Advisors (HNNA) bought the management contract for FBR's mutual funds. Between the added benefit of goodwill amortization and low interest rates, cash rich companies can do some very accretive acquisitions. Hennessy actually borrowed at something like 4%. So you don't even have to be cash rich to do it. The business becomes worth more to the buyer than it was to the seller.

You are asking a great question that I too have wondered about. (Basically I am bumping the question in hopes it can generate some information.)

a quick google search brought up multiple copies. Tilsonfunds has the OID pages while valueplays.net has Tilson's notes from the meeting. http://www.tilsonfunds.com/Mungerwritings2001.pdf http://www.valueplays.net/wp-content/uploads/The-Best-of-Charlie-Munger-1994-2011.pdf

I'm an hour and half north of Seattle, but I would be interested in attending. Tim

You are either mistaken or under very unusual state regulation. An SMA can charge reasonable fees. In my state anything up to 2% is still considered reasonable. Higher than that you get some backlash. SMA's are also not precluded from incentive fees either as long as the client is accredited.

It might be me, but can't fidn a press release anywhere. PDRX is incredibly cheap. Don't know much about management. I don't think the government contract is what some are assuming. I think it is more of a budget over time. Potential revenue, but not necessarily actual revenue. Somewhere I saw that there was a similar agreement signed a year earlier, and according to the company it did not result in material revenue in fiscal 2013.

That is a great question. In the beginning I feared that it was someone who knew more than I did. Time has shown me that is rare. One because I try to do my homework, and therefore be the one with the informational advantage. Two I don't think most of the sellers are sophisticated. They buy on the news (i.e. usually earnings reports) and then get bored when volume dries up. The stock pulls back they then have a loss and sell. I try to do the opposite. Know what earnings are going to be. Buy between earnings when there is nothing going on. Trim or sell out when earnings come out. I am also continually amazed at the slower speed that information is sometimes processed with micro caps. A large cap tends to react quickly (in terms of time maybe not share volume), while the micro cap may take a few hours to digest earnings. Sometimes it is the next day (which is why I assume many of the shareholders are retail investors that aren't monitoring things constantly). I also don't think most of them are well versed in accounting. They seem to be slower to pick up on rising earnings. If an asset manager (or bank) earned a clean 15 cents in Q1 and clean 20 cents in Q2, all else equal, Q3 will be higher than Q2. Basic math.

You could certainly argue that it is not deep value. It is a tweener to me. I probably should have created a category of Value (illiquid) for Teton. It is valued at 9x current run rate of earnings which I would still put on the cheap side, particularly in relation to recent growth rates, industry averages, and the pluses in terms of management track record.

I'm not sure that he said that. He has said that buying Berkshire Hathaway was a mistake and that he should've probably bought a (well-managed) insurance company instead. Originally he made money using Ben Graham's investing style. Then he realized that investing in cigar butts works better if you have control over the company and can liquidate fast or realize the value of the assets quickly. Then he realized that it's better to buy wonderful businesses like See's Candies than it is to buy cigar butts. And insurance can be a wonderful business too, but only if the underwriting is good and only if their float is invested well. There'd be a large focus on buying private businesses. He'd probably buy stocks too through his insurance companies. 2- To me, there's a difference between Walter Schloss and Warren Buffett. Schloss' style is very close to Ben Graham's and I'm sure he'd invest in a lot of microcaps if he was managing less capital. But there's a reason why Buffett is in a league of his own. His preferred investment is a private business, not a stock. "Size is always a problem," Mr. Buffett told me last month. "With tiny sums [to invest], it's extraordinary what you can find. Most of the time, big sums are one hell of an anchor." source: ‘Behind the Decision, a Lesson from a Mentor’, Wall Street Journal, Nov. 5, 2009 and “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. But you can’t compound $100 million or $1 billion at anything remotely like that rate.” source: ‘Homespun Wisdom from the Oracle of Omaha’, Business Week, June 25,1999 The clear implication is that his investment universe would be larger (i.e. micro caps would be an option) if he were managing a smaller sum.

People who study Buffett should spend more time on the early partnership years IMO. It is fascinating. They weren't all cigar butts but most were micro caps. Holding................................................................market cap at time Commonwealth Trust Co (bank) bought in 1957-58 - $1 million (he owned 12% of the stock) National American Fire Insurance 1957-59 - $2 million (he owned 10% of the stock) Sanborn Map 1958-1960 - $4.7 million (he owned 23% of the stock) Demptser Mill 1956-1960 - $1.5 million (eventually owned 70%) even American Express was small enough that he bought 5% of the o/s shares.

Good point. By liquid I mean able to typically get in and out within a week for those with portfolios less than $5 million. Anyone investing in the space knows liquidity can dry up surprisingly fast. The key is to use that to your advantage. I think micro caps investing is the best way for enterprising investors with smaller sums to grow their portfolio more quickly without leverage.

I believe focusing on micro and small caps is the easiest way to outperform the market. The companies are easier to understand and there is no institutional competition. My fund has significantly outperformed the market over its 7 year life and my personal record is longer than that. There are differing approaches. Some choose a less concentrated, deep value approach that often means owning illiquid stocks, where the stock price may stay flat for some time before popping. While I occasionally nibble on those I prefer more liquidity that allows me to buy stocks at 6 times earnings and typically sell at 10 times earnings. When I find the right one I have no problem going to 15% position (the fund's limit) or higher for my personal account. listed alphabetically Deep Value ideas (illiquid) - BOZZ, PDRX, SADL, SHFK, TETAA, TRKX Value (liquid) - CPKF(bank), PDER Liquid with near term catalyst (higher earnings) - CNRD, HNNA, NROM I also go for listed micros and small caps - AM.TO, HNRG, INBK (bank), PRLS The key is to develop a large watch list. Since you can research them in a much shorter period of time than a large cap it is relatively easy to do over time.

I can't find the source but my notes show that back in 2009 and 2010 the portfolio was WFC and USB. Someone calculated out that it was 1,596,956 shares of WFC and 134,091 shares of USB. Those numbers matched reported portfolio numbers very closely. Companies 3,4 and 5 were added in March quarter of 2011. Presumably BAC in late 2011 and March quarter of 2012.

I am pretty sure you are joking. It is hard to talk about issues like charity without religion entering into it. For many it is the moral framework out of which their giving to charity is based. Setting religion aside, if we can, Buffett always made a rational (or utilitarian) argument that it was better for society for him to compound and society to wait. This bordered on a moral argument to me. (He could have chosen an "it is my money and therefore my choice argument" but did not). In 2005, he changed his mind (Snowball p. 662). I am just curious if anyone knows of an interview where he addresses the change? Does he admit that his previous view was wrong? Or, does he not acknowledge that and imply that facts changed (e.g. his rate of compounding decreased or world needs became more immediate)?

My logic disagrees a bit with with yours. Would you rather have $100,000 or use the $100,000 to purchase a loan of $100,000 with no interest that is long enduring? The answer for me is I would rather have the $100,000 and not have to ever worry about the $100,000 loan. Thus it is worth less than 100%. Having said that, I do think the value is closer to $100% than say 50%. You also want to make sure not to double count the insurance operations and the float. If you value the float separately (whether or not at 100%) you then should only put a very conservative multiple on underwriting profits of the insurance operations since it may incur sizable catastrophe losses from time to time.

The 2006 version was never published. I worked on a contract basis for Walker's Manual from 2004 through early 2006. Those who pre-ordered received a paperback version dated 9/2004 which actually went out near the end of 2005. As for how many stocks from 2000 are still traded? I would estimate more than half.

That is the challenge. It is not economically viable for anyone to do serious publishing or analysis on micro caps unless they go with a very high cost / very few client model. For the individual or small fund it requires a lot of hours. Lots of screening. Building a network of friends who pass on ideas. Reading. Reading and more reading. Going through massive lists of stocks from A to Z both listed and unlisted. You probably have to look at foreign stocks too. The key to making big gains is understanding the information better than others. For example, late last year Hennessy Advisors (HNNA) an unlisted asset manager purchased FBR's family of funds. It was an all debt transaction and quadrupled the size of Hennessy. You would have had to find out about the news and then understand the implication that earnings for Hennessy would also quadruple. In this case there was a number of months where a small investor or fund could build a $200,000 position and watch it rise 2 to 3x. If opportunities like that were common place investing would be easy, but they aren't and it isn't. My approach has been to look for good micro and small caps at 6x earnings or less and sell them at 10x earnings. If that PE expansion can happen within two years I will generate exceptional numbers, if it takes longer, results are more pedestrian, but still very good in terms of overall risk. My two cents.

Maybe I am missing something here, but I don't recall Munger changing the investment strategy at DJCO. It was my understanding that he finally put cash to use. Big difference. Being in cash was a conscious decision and those years should be included in the CAGR. He is not doing 40% a year. He stayed in cash and then in 2009 wisely acted near the bottom and did over 160%. Giving complete benefit of the doubt that all cash and t-bills were for the business, he then was roughly -8% in 2010, up 13% in 2011 and 17% in 2012. I am not saying he cannot generate excellent returns but I don't think you can exclude what appear to me as "thumb sucking" years.

Interesting article. Great exposure for him. I doubt he will be able to respond as he appears to be quite busy with Lucas Energy (LEI). He was appointed Chairman yesterday and he has some serious matters to deal with in a very short amount of time.

Very funny...and very accurate. I couldn't agree more. Cheers! I find it neither funny or accurate. Apply it to freedom of the press. Do you want your rights to be limited to the publication formats in use 200 years ago?

Transportation is largely funded by usage fees. Excise taxes on fuel (gasoline and diesel) are a large component of state and federal highway funding. Aviation fuel taxes fund the FAA and many airports. Thus we already have a system in place that is primarily usage based and not subsidized by non-users. While I believe the efficiency of private enterprises usually more than offsets the profit, it is not a big deal to me the way we currently fund most roads and air travel. My preferred approach to taxes is a required balanced budget (not necessarily over a one year time frame, but less than seven years) funded via a flat tax (same rate for all). Everyone has skin in the game. Those who make more are benefiting more from government thus they pay more. There are no disincentives. And while this may upset some of you since it is religious based - it was also the system designed by God for Israel in the Old Testament. Since I believe God is just, it answers the question of what approach is most fair. (As an aside, this is why I find it ironic when President Obama or Gov. Brown (CA) tries to use a religious basis for higher taxes they misquote a verse about stewardship (to whom much is given, much is required) and apply it to taxes, and ignore the system given by God to Moses.) Note: not looking for a religious debate, just giving some of my primary reasons.

Your comment confuses me. You state that you agree that a recessive (regressive) tax regime is inequitable. Then you proposed a head tax, which is, by definition, a regressive tax. A $12,000 per person tax would a bigger percentage for the poor than the rich. You are contradicting yourself.

Since a single mother of two surviving on $25K a month in income, would find it far more difficult to come up with $5K in taxes, than a single person making $100K and having to come up with $20K in taxes if you went solely by a flat tax. Coming up with that $1000 in rent would be pretty damn hard. A recessive tax regime is far from equitable! Cheers! I think you mean 25K a year, not month. Not sure what you mean by "recessive tax." The common term is regressive. Regressive hits lower income more than higher income. It can be via a head tax (same dollar amount per person) or decreasing rate such that the effective percentage is higher for the lower income payor. Flat tax is same rate regardless of income. It is generally not considered regressive or progressive. Progressive is where one pays a higher rate as income increases. A big part of the tax debate revolves around the whole issue of "fairness."