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bmichaud

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Everything posted by bmichaud

  1. Pabrai funds owned lots of "cheap cash flow generating assets" and lost 70 percent over a two year period. That is unacceptable in my opinion. I have gleaned the following lessons from the last three years regarding general market valuation: 1. Buffett personally was in all cash until his NYT op ed (around Dow 8500) 2. Watsa was fully hedged until fall of 2008, and is now back to significant hedging 3. Klarman went all in in the fall of 2008 and is now 50% cash All of these prominent value guys thought/currently think this level of the market warrants caution. They obviously take the general market valuation in mind when investing as did Graham. They dont time things which is key - as evidenced by the fact that all three of these guys were early to the market in the fall of 2008. I am going to take their lead and approach taking on market exposure with caution.
  2. http://pragcap.com/robert-shiller-the-sp-will-rally-13-in-the-coming-9-years This seems hard to believe that the market would return 13% cumulatively by 2020, but Klarman and Watsa probabaly would agree to some extent given how hedged they are. Tough to take on significant market exposure at these levels when prominent investors/prognosticators are predicting such low returns. Consensus currently is: 1. 2011 market will advance anywhere from 10 to 20% 2. Emerging markets will power equities through all economic problems I am a little concerned that consensus is 100% certain these two events will take place. To be honest though, I have a hard time putting on hedges here given that the Fed is working so hard to keep the market elevated, profit margins are so high, and the market perceives cash balances to be at record levels (completely ignoring the fact that companies have issued record amounts of debt to generate this cash - similar to taking out a $500,000 mortgage and saying that you are flush with cash). We'll see what happens - I don't know what will take the market down in the next five years, but I think it is prudent to continue to build cash, put on selective individual company shorts, and hedge market indices where appropriate.
  3. I assume FCF is being calculated by subtracting capex from operating cash flow. You can't do this with a bank or axp because it adds back provision for loan loss which is a very real expense despite being non cash. I know value investors are head over heels in love with free cash flow, but normalized earnings are much better indicator of the true economic earning power of a business as long as cash flow confirms the earnings over time. I.e Caterpillar had huge FCF in 2009 because of massive inventory liquidation. That is not an economic reality over time because eventually that inventory must be built up.
  4. Another thing to consider when looking at PE ratios in a historical context is the level of tax rates. Consider the following (when I say pre-tax, I mean pre dividend & capital gains taxes): In 1974 - the top marginal tax rate was 60%, dividends were taxed at the marginal rate, and capital gains were taxed at 36.5%. Based on the PE chart in a prior post, the PE ratio was roughly 9X in 1974 for a pre-dividend/capital gains tax yield of 11.11%. Assuming the market payout ratio was 50%, the after-tax yield drops to 5.75%, and the after-tax PE is 17.39X. Currently - the top marginal tax rate is 35%, and dividends/capital gains are taxed at 15%. Again, assuming a 50% payout ratio, the after-tax yield is 3.88% and the after-tax PE is 25.74X. So - the current market pre-tax PE of 21.88X divided by the 1974 pre-tax PE of 9X is 243%; however, the current after-tax PE of 25.74X divided by the 1974 after-tax PE of 17.39X is 148% - a huge discrepancy due to the difference in tax rates. The 1974-equivalent PE ratio based on today's tax rates can be calculated as follows: 1974 pre-tax earnings yield was 11.11% (100/PE of 9) and the after-tax earnings yield was 5.75% - let's call 5.75/11.11 the after-tax yield margin, which was 52% in 1974; currently the pre-tax earnings yield is 4.57% (100/PE of 21.88) and the after-tax earnings yield is 3.88% for an after-tax yield margin of 85%. If we divide the 1974 after-tax earnings yield of 5.75% by today's after-tax yield margin of 85%, we arrive at a 1974-equivalent pre-tax earnings yield of 6.76%. By dividing 100 by 6.76, we arrive at a 1974-equivalent PE ratio of 14.78X. It would take a 32% drop in the market to reach this "1974-equivalent" PE ratio and 54% drop to reach the "Golden Level" of 10X. In order to evaluate the fair value of the market, one must look at interest rate levels. The BAA yield averaged 9.58% in 1974 for an after-tax yield of 3.83% (based on a 60% marginal tax rate), and the current BAA yield sits at 6% pre-tax or 3.90% after-tax (based on a 35% marginal tax rate). For the sake of argument, let's assume the after-tax BAA yield is an appropriate rate to use to capitalize after-tax market earnings. In 1974 the after-tax earnings yield was 5.75% versus the after-tax BAA yield of 3.83% - assuming the market should yield the after-tax BAA yield, then one could say the 1974 market was undervalued. Today's market yields 3.88% after-tax versus an after-tax BAA yield of 3.90% - hence, one could say today's market is roughly fairly valued. I say all this merely to point out that tax rates make a HUGE difference when comparing PE ratios across time periods and that investors waiting for 10X PE ratios may be waiting for a long while. I hope I am wrong though because a 10X PE market would be a dream. (Excel sheet with calculations attached)
  5. Only my second post on here but thought I'd pitch in... Businesses - 97% of NAV 1. RIG - 44% 2. XOM - 17% 3. WFC - 11% 4. MCD/KFT/EXC - 8, 8, and 7% 5. HRB calls - 2% Net Cash & Workouts - 3% of NAV 1. NOVL - larger than 3% b/c of some leverage Averaged a 50-50 split between Business/Net C&W through June, July, and August, then took off shorts just before September rally. Not quite ready to put the shorts back on, but getting there. I follow these investment advisors out in Ohio (James Investment Research (JIR), jir-inc.com) as they provide some timely market research. I do not trade in and out of my core holdings, but will manage exposure via short positions, and I find the JIR folks helpful in that regard. Caterpillar is a core short I use, and it is currently trading just off its all time high - good protection if the market takes a whack. Again, going back to JIR research, they have called the rally in treasuries to perfection - their indicators are finally starting to weaken for bonds, which I have been waiting for to start moving into the TBT treasury short.
  6. Interesting special situation currently in progress is Novell (NOVL). Elliot International Capital Advisors bid for the NOVL back in March for $5.75, and soon after Paulson & Co established a 5% position at around $6.00 per share. Paulson has since upped its position to 8.5%. The stock is currently around $6.00 as the deal has taken longer than expected to materialize. Samana Capital, Paulson & Co, and Elliot International currently hold 8.7%, 8.5%, and 7% of total shares outstanding, respectively. This is a coattail play betting the big guys make something happen - whether it's a sale, buyback, or special dividend. Total market cap is $2B and there is $1B of cash on NOVL's balance sheet.
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