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Ultimate Bargain-Hunter Never Had It So Good


Parsad
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Almost never mentioned is that Graham (of Graham & Dodds) almost went bankrupt while applying the methodology. Arguably, untill the recovery actually began, he survived only because he had more money than he had places to put it. Downside volatility.

 

Graham made his money, primarily because he was overweight the right stocks at the start of the recovery, & then held them pretty much through to the top of the cycle. The methodology got him there, but its not universal - it works only in up-cycles. Were today's hedging instruments available at the time, he might well have actually made more in the down-cycles.

 

Almost all value investors have been experiencing extreme adverse downside volatility, & in most cases they made thier money in the up-cycles - classic Graham. A very few have modernized the methodology, largely by taking the opposit side of market hedges (ie: FFH-CDS's, WEB-S&P option puts).

 

We may well eventually conclude that WEB & coy actually had too much capital, & that it effectively drove them into the market too early. They did not risk bankruptcy because they were able to efficiently hedge, something that Graham wasn't able to do.

 

Its not always a bargain

 

SD

 

 

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Isn't it interesting that you see WEB doing all these deals with coupons that convert rather than buying common, at least for brk, which should mitigate the "too early" issue.  Seems to be heads I win, tails you lose to me.

 

Also, for his personal account, a point that I think neither buffett nor the media have made strongly enough (i.e. headline reads buffett says buy stocks) is that it matters *which* common you are buying. Obviously WEB is not buying index funds for his personal account...

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Keep in mind that the convertible component is just an option; the principal stays in either fixed income or senior equity. If the common goes up, great. If the common continues to fall, you swap the debt for equity at a lower conversion rate. The `too early` issue is still there, but hedged.

 

Of real time interest, may well be FFH & its debenture holding in SFK. One of the higher probability outcomes to managements recent comments is a debenture to snr equity conversion; an example of the hedge being used. Disclosure: We hold a long position in SFK common.

 

While there recently seem to be more snr equity than convertible debt issues, its more likely attributable to issuers needing to improve BS ratios vs raise cash. ie: Not a reflection of WEBs macro view.

 

SD 

 

 

 

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About Ben Graham - he was always open to new ideas, re-formulating his methods.

 

In later years, eg Intelligent Investor, he advocated keeping 25-75 pct of stocks+bonds investments in bonds, shifting towards 75 pct bonds when stock market seemed pricey. So I think, had Ben Graham been going into mid-2007 and following his own advice, he would have been 75 pct bonds, only 25 pct stocks.  He probably would have come thru mid-2007 to the present pretty well.

 

My point ... if we want to know what works, what might work in present circumstances, consider re-read of Ben Graham looking for clues to what he learned from his experiences in the 1930's.

 

One thing that stands out is the companies he uses as examples often have no debt.  Taking on major debt is pretty much a phenomenon of the 1990's.  It really shows up in the S&P 500, mid-cap 400, small-cap 600 guides I have from 2001, which have 1990-1999 financial tallies. That debt has to be worked down, before there is a level of comfort restored.

 

Even converts.  SFK Pulp was brought up as an example.  That the debentures convert well above 50c level is surely not a guarantee against dilution, re-negotiation.

 

Consider what Brookfield did with Norbord.  Ran the company with minimal working capital, no reserves, dividending out all "spare" cash so there was no cushion.  Then, in depths (thus far) of outlook, offered financing and backstopped new equity issue at price (86c? that area) which was well above market (60-65c?), ending up with about 75 pct of the common.

 

 

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