TwoCitiesCapital

I'm about 16% in cash after pushing a bunch of my cash position into fixed income CEFs a few weeks back and recent appreciation in my holdings. I'm also 7% short in Tesla and Netflix combined and will be receiving a large cash payment from the sale of BBRY that will Bump my cash position up to 25%. I'm also letting all dividends go to cash instead of reinvesting, so those bond CEFs yielding 10% will be a large contributor to cash in the next year or two.

I think that generally captures the spirit but isn't descriptive enough. Value investing is the art of not losing money through this concept we call a margin of safety. It's the minimization of the chance for a permanent loss of capital. Buying low can achieve this as risk is a function of price - but you can also achieve this through buying quality companies at reasonable to high prices because it's predictable that they will keep on compounding value. Thus buying KO at 20x earnings can be just as much value investing as buying a cigar butt at 3x. This is mostly what I've been learning over my 6 years of exposure to value investing. It's all about limiting downside. The upside takes care of itself and you'll achieve decent returns. If you want amazing returns, you're most likely going to have a competitive edge and leverage (like Warren) or tweak your style to take more risk than you ordinarily would when the opportunity arrives and nobody else is around to do it.

I think a lot of it depends on how many talented people are in the game. Right now, you have a lot of talented people throwing a lot of resources in figuring things out. This is not a game that you play to win, because you won't. It's a game you play to not lose. It's a game to play to not lose because you are outmatched. I actually think times like this is exactly when value investing works best - you putter along with "subpar returns" when everyone is making big bucks, and then when they all blow up from making mistakes, you are the guy who survives and is able to profit from the wreckage. The time to be concerned about value investing, if ever, is once everything is blown up. At that point in time, the playing field has cleared and you have a little more leeway to be aggressive and to be able to take on more risk and seek higher returns (playing to win). Sure, people made good money buying conservative investments like JnJ or low P/B stocks at great prices in 2008. You probably made more if you bought Amazon, Apple, Google, etc. You know...the sexy, momentum stocks that typically carried a smaller moat, work in ever changing industries, less downside protection, and have spectacular booms and busts. Value investing will likely always work. I view it as a linear progression of generally lower returns during most years, and when shit hits the fan you are in a position to take a little more risk and make the parabolic profits that change the course of your investment portfolio for decades.

I think you've got it backwards. Return of capital by definition flows to shareholders, it's not a reinvestment in the firm. It doesn't flow to shareholders. When a firm produces cash from operations it goes to the firm's equity, if it's used to buyback, it is an outflow that continuing shareholders do not see. I disagree. It's seen be whichever shareholders are directly selling the shares to the company. The remaining shareholders see no cash, but they see an increase in their % ownership of equity and cash flows and (hopefully) and increased stock price based on P/E and P/FCF multiples.

This is my experience as well. Seems like the site has fallen a lot in quality in the 4 years I have been using, but there is no better alternative.

1) my first major mistake was Shengkai Innovations. You can read all of my articles on it on SA. I thought it was ridiculously cheap and did a ton of research on it. I was very comfortable with the position and had spoken with the largest third party distributors in the Middle East and in the United States so I was pretty confident that it wasnt another Chinese fraud. I bought at $5, more at $8.50, more at $7, more at $5, more at $2.50 (trading for less than cash on hand). I sold everything at $1.50ish after e CFO resigned. There had been a few red flags, but I was so confident in my analysis and the price was so compelling I kept buying more. No fraud was ever proven, or even accused, but the shares trade for about $0.25 today after a 2-for-1 reverse split. Lost something like $6,000 on this one and it was 30-40% of my portfolio at one time. That's a huge sum of money to lose when you're 21. 2) I bought garbage all throughout 2008. Instead of entering positions in high quality branded names, I was buying cigar butt stocks that were cheap on an asset basis. I remember very vividly looking at Limited Brands and Harley Davidson given the strong brand profiles and cheap valuations. I bought over-leveraged dry bulk stocks instead. Lost 75% or so subsequently on on EXM but watched in regret as HOG and LTD both returned over 500% in the following years. I still buy cigar butt stocks but recognize if you can get strong brands at a cheap valuation, it's likely going to end better even if the cigar-butts have a more compelling value just per the numbers. This wasn't all bad though - I did get into BofA with an average price of $7 and Google around $375. I did this with GE in 2008/2009. Had been buying BofA and it dropped like a rock once it fell below $5. All the way to $2 something if I recall. I was watching GE at $7 and didn't buy thinking that the same thing would happen and I could pick it up cheaper. It never happened and I never bought and missed out on a pretty great time to enter....

Someone forgot to tell Japan that for the first several years they did stimulus.. People weren't terribly optimistic in 2007 from what I recall. Not pessimistic but I don't think they were optimistic either. Then again, I was just getting into stocks at that point so maybe I missed something.

Recent purchases in the last month: DSL - Doubleline income solutions fund NLY - Annaly BSBR - Banco Santeder Brazil SAN - Banco Santander LCSHF - Lancashire SHLD - Sears holding

I've started a position in BSBR over the past two weeks as opposed to simply adding shares to Santander like I have been for months. Seems like the discount is finally wide enough to attract me to the single name instead of the parent co.

I think you're very wrong here and that is the difference between minority ownership and a majority stake. Taking a majority stake means the cash is yours because you get to decide what to do with it. With a minority stake, there should be a discount for a lack of control since the executives could squander it with or without your input.

I agree. I picked up a small position on Thursday in NLY. I like fixed income investments at this point. You can find a lot that have been pummeled, have decent yields, and trade at discounts to NAV at this point which is great if you do think rates can't go much higher and/or are worried about the stock market. Especially mortgage securities given they have lower durational risk than a comparable bond due to higher yields, small principle return each month, and slowing prepayments. The thing to keep in mind is that these mortgage REITs' price action will likely be highly correlated with that of the market - not really a true hedge like other fixed income assets might be. But at such discounts to NAV with high yields on low leverage, I can't think of a much better time to be buying them. The only thing they're missing is a guarantee of lower rates.

I agree with wknecht. I work with equity swap derivatives every day and have added some clarity below: This is mostly correctly. Also probably includes variation margin to some extent for the P/L that has moved against Fairfax/Counterparty since the last cash settlement. Also correct. It could also be LIBOR minus a spread depending on swap rates. From the looks of it, Fairfax lost 2,220B on the index portion of the swap, but paid a total amount of 2,269B total. This means they're probably losing money on the interest leg too if the subtracting of the spread resulted in a negative figure for a period of time (totally possible, have seen it before). Since these typically settle monthly, or quarterly, it's possible Fairfax was losing money on both sides of the trade for 3 or more months. Chances are they'd receive the whole $1B back and settle the P/L with a separate payment. You don't pay your settlements cash with your collateral unless if you go bankrupt. But for all intents and purposes of the total cash changing hands, this is correct. Also, I agree, the 132M is likely the accrued liability that they had in current losses on the swaps for this reset period.

I looked into doing this once. What I was able to determine was that you could have a self directed IRA that as invested in LPs and LLCs as long you were not the managing member of said LP or LLCs. This would mean you can use it seed the hedge fund of a friend, but not the one you're starting. At least that's what my understanding of the rules as of 3 years ago when I was looking into this.

I don't think the high yield market is attractive and prefer duration risk to credit risk. Likely there is no catalyst for nav gap to close on most CEFs Its not necessarily "high yield" (I.e. junk bonds) just because it's higher yielding. Many of these funds are picking up dollar denominated foreign debt, mid term duration, at prices below par. And since you're buying below NAV, you get another boost to yield. Many also employ leverage. A fund could feasibly yield 7-9% on mid grade foreign bonds that sport a coupon of 5-7% with leverage and the 8% discount to NAV. I'm not saying these are AAA rated entities but it's not like they're B either. You're picking up currency and a little extra credit risk in exchange for lower interest rate risk. Check out doubleline's CEFs. They've been hammered but it's because the used to trade at a 10% premium. The NAVs are only down 6-7% during the spike. The discount you're buying them at now is already pricing in another 100+ bp rise. If that happens, the 8% yield is all yours and the discount disappears. Did I mention they're 20% in cash too to reinvest in a rising rate environment? Its not a sure thing, but is far more attractive to me then showcasing on long term bonds that are highly leveraged to interest rates with no diversification and no margin of safety.

Instead of speculating with long term bonds, there are several high yielding, mid duration CEFs that yield 7-9 percent and trade at a 6-8 percent disount to NAV. That's less risk with a pretty good return if you're right.

Also, in regards to your comment about easy credit: I have a friend who is a new graduate who works part time. She was able to get a 20, 000 car loan with no money down and 0% interest for the first year or something like that. Sure it's only one instance, but I wouldn't necessarily dismiss it as an isolated instance either.

I think there is a lack of appreciation for how much damage a large decline could cause. You could make 7% ever year for 5 years straight and hit a 25-30% correction will all but wipe out your gains over the previous 5 years. For 5 years the portfolio of cash and bonds would "lose" only to end up ahead in the last year AND would be significantly ahead after the 5 subsequent years of a recovery when assets were moved over to risk assets. I still participate in the markets but am wary of the effects of this trickle-down wealth effect that Bernanke is trying to institute. Think about it, interest rates are already at historic lows, margins are at historic highs, valuations based on multiple measures are historically high, and there are still the potential for great threats between China and Europe and even the U.S. IMO. I'm not saying a crash is imminent and I have only been in the bear camp AFTER fully participating in the recovery in 2009, 2010, and 2011. My point is risks are high, positive catalysts can only run so much further, and there are tons of potential negative shocks. I think a "guarded" approach is warranted. Its not like I'm all in cash, just have been taking gains off the table and moving 30-40% to cash and bonds over time.

As I recall from my forays in 2008, 30-50 cent dollars often become 15-25 cent dollars as the general market falls 30-50%. Also, in such a steep downturn, there are usually economic implications that affect the viability of 30-50 cent dollars anyways given they're often in some sort of "temporary" trouble. I'm investing my money in what I view to be undervalued securities period - regardless of what the market is doing - but if the CAPE and Tobin's Q suggest the market is 30-40% overvalued then I will choose to a significant portion of my money in cash and bonds as opposed to investing in 30-50 cent dollars which will likely become even cheaper in the future. I'm beginning to appreciate the idea of taking calculated risks and managing my downside as opposed to trying to maximize my upside at all times. Keeping 30-40% in cash/bonds makes sense to me when the general market is overvalued, even if there are opportunities. Chances are that there will be better opportunities during the correction and I still get to participate at a 60-70% level in the markets if I'm wrong.

agree 100%. even the greatest investors are not automatons. there is no way he would have taken a big stake in this technology company without personal relationships being front and center. I think shareholders have to learn not to separate the CEO from his own soul. Anyone with good conscious, and I'm betting you all expect your CEO's to have good conscious instead of being psychopaths, would agree that sometimes there are battles to be fought that extend beyond the basic role of the CEO. Otherwise why would Prem or Buffett even entertain things like "The Hospital For Sick Children", "Planned Parenthood", "The Gates Foundation", or "The Glide Foundation"? In fact, why even do big shin-dig AGM's like they do? You guys should be treated like Leucadia Shareholders...just an hour of their time every year! Of course personal stances will play a role at times in their investments and behavior. Buffett ran Salomon's because he had to save the investment. This happens and it's nothing new. RIM is a relatively small investment in the grand scheme of things...Salomon's could have taken Berkshire out if Buffett had not stepped in. Cheers! It may be a relatively small investment financially, but it sure seems like its taking up a good amount of his time. Investors need to take their emotions out of investing, and it seems like Prem has not been doing this the last few years. He comes up with theses (like his expectation of deflation he's been preaching for the last 6 or so years) and seems to not want to admit he's wrong and move on. I think this is disingenuous. 1) He bought deflation hedges with a maturity of 10 years for a reason. It hasn't been 10 years yet so it's hard to say he's absolutely wrong on these - no? Secondly, it was to hedge his business - not necessarily to maximize investment gains. As I recall it took years for him to be "right" on the CDS too, but that protected Fairfax from the financial crisis AND provided huge profits. I'm not saying that it will happen again, but I think it's clear from U.S. GDP coming in at 1% in Q1 despite a "recovering housing market" and trillions in stimulus that there is still a very real deflationary threat. Same could be said for your Europe if we see another spike in interest rates like we did in 2011 where the borrowing costs of Italy and others nearly doubled in the span of weeks. As Prem is fond of pointing out - it took years for Japan to experience deflation. These aren't events that occur overnight. They're long-term secular trends. 2) On Blackberry, just because he was wrong to invest at $40 doesn't mean he was wrong to double down at $7, nor does it mean he's emotionally attached to have done so. By becoming involved (and by buying at such a cheap price) he had the potential to mitigate the losses from the original investments and possibly turn a profit. In a sense, he was limiting his downside while amplifying his upside. It wasn't that long ago that BBRY was pushing over $1B in FCF a year. Right now it sports an EV of just $2B. If it ever recovers to some sustainable shadow of it's former self, it will be seen that Prem got a ridiculous price for the company at $7 and probably a good price at his average of $17. If the company fails, chances are he still makes money on the shares bought at $7 and he was able to mitigate the losses with some small gains while retaining upside potential. I don't see how this equates to being emotionally attached...the liquidation value of the company is quite clearly more than $7 and probably more than the $10 it trades at. How do you get a liquidation value of $7? And how is Prem going to buy the company at $7? I think you misread my comment - I said chances are he'd make money on his investment at $7 (when he doubled down to 10% ownership in 2012) in a liquidation scenario. I didn't suggest liquidation was only $7. I think it's between $12-15 if cash burn is kept at an acceptable rate and were to do so relatively soon.

That's assuming they ONLY use the Shiller P/E, nothing else, and are trying to time the market exactly with it. I tend to use it as a guideline for my investment allocation. I think the market is over-valued right now, but I don't want to be fully out of stocks if I'm wrong. With the CAPE and Tobin's Q being so overvalued on a long-term basis, I decided to move 35% of my portfolio to bonds and cash, 15% to European stock exposure, and a 5% short on select U.S. equities. The remaining 55% is in U.S./Canadian multi-nationals and other value plays. As the Shiller/PE ratio becomes more expensive, I'll begin allocating more to cash and bonds and increase my shorts. With each substantial market correction - 15-20% or more - I'll allocate more back U.S. equities regardless of what the CAPE. For me it's not a sign to time the market - it's a measure of the risk inherent in the market that may not be so obvious from 1 or 3 year earnings. I use it to adjust my equity exposure based on the risk in the market. I wouldn't every be 90%-100% in equities without a single-digit CAPE.

The market could care less about a lot of things. It didn't care about the increasing volume of defaulting mortgages in the U.S. in 2006. Value investors prosper from situations that the market doesnt care about. I think we can certainly agree the market isnt always right. It's been above average for two decades and in the last 13 years we've had two 50% corrections in the U.S. with the tobin's Q and the Shiller P/E suggesting that we might see another one soon. I think it's dead on. This. +1. In our lives we we see dozens of small cycles, but only a few of the overarching ones. Bear markets and bull markets that last 20 years often times encompass the majority of a manager's investment experience until they believe the last 20 years represents the norm. We had stock valuations that were way out of wack in 1998-2000 to skew the results of much of the past decade. Now you have had the Federal Reserve maintaining 0% interest rates for last 5 years also arguably inflating stock market indices. Is it any wonder that the last 20 years have remained above average and have been punctuated my massive corrections?

http://www.bloomberg.com/news/2013-08-19/fairfax-financial-to-sell-reinsurance-unit-to-catalina.html

agree 100%. even the greatest investors are not automatons. there is no way he would have taken a big stake in this technology company without personal relationships being front and center. I think shareholders have to learn not to separate the CEO from his own soul. Anyone with good conscious, and I'm betting you all expect your CEO's to have good conscious instead of being psychopaths, would agree that sometimes there are battles to be fought that extend beyond the basic role of the CEO. Otherwise why would Prem or Buffett even entertain things like "The Hospital For Sick Children", "Planned Parenthood", "The Gates Foundation", or "The Glide Foundation"? In fact, why even do big shin-dig AGM's like they do? You guys should be treated like Leucadia Shareholders...just an hour of their time every year! Of course personal stances will play a role at times in their investments and behavior. Buffett ran Salomon's because he had to save the investment. This happens and it's nothing new. RIM is a relatively small investment in the grand scheme of things...Salomon's could have taken Berkshire out if Buffett had not stepped in. Cheers! It may be a relatively small investment financially, but it sure seems like its taking up a good amount of his time. Investors need to take their emotions out of investing, and it seems like Prem has not been doing this the last few years. He comes up with theses (like his expectation of deflation he's been preaching for the last 6 or so years) and seems to not want to admit he's wrong and move on. I think this is disingenuous. 1) He bought deflation hedges with a maturity of 10 years for a reason. It hasn't been 10 years yet so it's hard to say he's absolutely wrong on these - no? Secondly, it was to hedge his business - not necessarily to maximize investment gains. As I recall it took years for him to be "right" on the CDS too, but that protected Fairfax from the financial crisis AND provided huge profits. I'm not saying that it will happen again, but I think it's clear from U.S. GDP coming in at 1% in Q1 despite a "recovering housing market" and trillions in stimulus that there is still a very real deflationary threat. Same could be said for your Europe if we see another spike in interest rates like we did in 2011 where the borrowing costs of Italy and others nearly doubled in the span of weeks. As Prem is fond of pointing out - it took years for Japan to experience deflation. These aren't events that occur overnight. They're long-term secular trends. 2) On Blackberry, just because he was wrong to invest at $40 doesn't mean he was wrong to double down at $7, nor does it mean he's emotionally attached to have done so. By becoming involved (and by buying at such a cheap price) he had the potential to mitigate the losses from the original investments and possibly turn a profit. In a sense, he was limiting his downside while amplifying his upside. It wasn't that long ago that BBRY was pushing over $1B in FCF a year. Right now it sports an EV of just $2B. If it ever recovers to some sustainable shadow of it's former self, it will be seen that Prem got a ridiculous price for the company at $7 and probably a good price at his average of $17. If the company fails, chances are he still makes money on the shares bought at $7 and he was able to mitigate the losses with some small gains while retaining upside potential. I don't see how this equates to being emotionally attached...the liquidation value of the company is quite clearly more than $7 and probably more than the $10 it trades at.