Half of the Price of a Common Stock is “Fashion”

One of the best interviews with the Kahn brothers was with the Ivey Value Investing Class in 2005 and there’s one part in particular that encapsulates the mindset required to be a successful value investor. Here’s an excerpt from that interview:

25.57 The only thing I can say is we maintain a really strict contrarian approach. So if something is very popular and everybody loves it and we’re buying it we have to say to ourselves what are we doing wrong here. Because I’d say half of the price of a common stock is ‘fashion’ basically so what we’re doing is we’re buying long skirts at the thrift shop when mini skirts are in favor. So we’re buying the long skirts for a dollar or two and then waiting till long skirts come back into Saks and if you can do that you’re halfway home you know you’re almost halfway home if you can just stick to being a contrarian.

 

Source: The One Thing All Value Investors Can Do To Get You Halfway Home – Irving Kahn

Sequoia Fund Bails Out of Valeant Pharmaceuticals and You Don’t Have to Make Your Money Back in the Stock You Lost it In

Our new leadership elected to sell our position in Valeant Pharmaceuticals, exiting completely by mid-June. Valeant was our largest position to start the year and its 80% decline through June 30 badly penalized our results. – Sequoia Fund Shareholder Letter

Sequoia Fund management’s decision to finally exit their stake in Valeant Pharmaceuticals ends a painful almost year long slide in their biggest position and what was at one time their best performing holding.

Sequoia was an early investor in the Mike Pearson era Valeant.  A strong believer in what they saw as a savvy manager who took a value approach to buying healthcare assets and wringing efficiency from them.   Sequoia started purchasing Valeant in early 2010, probably at prices in the mid teens, and by the end of the year the position accounted for 10% of the funds assets.  At year end they already had a gain of 78%.  A fantastic return on investment in less than one year and a big boost to the fund’s performance.

The fund managers continued to build a position over the next five years and were enjoying the outperformance the stock added to the fund’s returns.  By 2015 the position reached 20% of the fund’s assets and Sequoia also became Valeant’s single largest shareholder.

Then in August of 2015 the position began to lose money.  You can’t fault the fund managers for sitting on the position while the stock declined in August along with the rest of the global markets. Continue reading

Cash Flow Advice From Hong Kong’s Richest Man – Li Ka-shing

Advice from an 80 year old billionaire with businesses that span across many different industries, from old line manufacturing to high tech.  One of the pearls of wisdom he cites is an important factor in sizing up investments and operating businesses, cash flow is king.

“I’m always very careful with my cash flow.  That will ensure I have extra capital to get into another industry whenever I want to.”

Forget gross merchandise volume, return on equity or debt-to-equity ratios. The most important metric in business is cash flow, according to Li. The tycoon says he’s been keeping an eye out on cash flow since he became an entrepreneur more than six decades ago. One needs to generate good cash flow before expanding into other industries and to store up some insurance for a rainy day, he said.

Source: Five Pieces of Advice From Hong Kong’s Richest Man – Bloomberg

“Not everything that can be counted counts, and not everything that counts can be counted.”

So often in the investment business, we look for answers in quantitative models. Systemic risk is 19.2 — time to hedge! Systemic risk has fallen to 7.9 . . . Phew, we can all breathe easier now! Alas, if only it was so simple. There is a quote, often and perhaps erroneously attributed to Albert Einstein, “Not everything that can be counted counts, and not everything that counts can be counted.” Apocryphal or not, it’s true in all walks of life and certainly true in evaluating systemic risk.

Source: Systemic Risk: You’ll Know It When You See It

Cliché – Bull Markets vs. Bear Markets

In a bull market you’re not as smart as you think you are and in a bear market you’re not as dumb as you think you are.

Source: Bull Markets vs. Bear Markets

Checking In On the Commodities Cycle

2015 was another dismal year for commodities, the third year in a row of negative returns.  Over supply continues to be the universal theme in the market, however capacity cuts are beginning to be announced.  As the saying goes the cure for low prices are low prices.

The real curse for commodity prices, however, is on the supply side. The last decade’s commodities boom has led to irrational investment in new projects. China’s demand for iron ore and coal declined only this year, but commodity prices have been dropping since 2011. These price declines reflect concerns about a persistent surplus as mining firms continue to expand supply. Global iron ore production is expected to have increased by 100 million tons in 2015 despite the declining demand from China, and further increases are expected over the next two years.

Source: The Commodities Crash: A Supply-Side Perspective

Liquidity is a Coward

Liquidity is a coward – It’s never there when you want it.

Recently I was listening to an interview with Jeff Gundlach, the CEO and CIO of Doubleline Capital, where he was talking about the liquidity of commercial mortgage backed securities (a type of bond that is backed by mortgages on commercial buildings) and he used that phrase to describe the market in those securities.   Until you have actually been in a position that you can’t get out of at a reasonable price you would never understand how true that statement is.  Unfortunately in the last week, many high yield bond investors and managers at Third Avenue Focused Credit Fund are finding out how price and liquidity can disappear just when you need it most. (Third Avenue Blocks Redemptions From Credit Fund Amid Losses)

I love clichés.  The thing about clichés is that they wouldn’t be around and so heavily used if they weren’t true.  In this case, there is a hard lesson to learn.  One that can go without notice until you are right smack in the middle of it and wishing there was a way out.

Continue reading

There’s No Free Lunch – Reaching for Yield in MLPs

Investors have been looking for income from alternatives to low yielding bonds since the Federal Reserve lowered the interest rates to zero after the 2008 financial crisis.  This search for income in a low interest rate environment has led to a huge inflow of investment into master limited partnerships and high yield bonds over the last few years.  According to the Wall Street Journal, from 2010 to 2014 a net $44 billion flowed into MLP mutual funds and exchange-traded funds.  Lured by yields of 6% plus at a time where the 10 year treasury bond yields 2 percent, investors have been forced into assets that carry far more risk.

Continue reading

Picking Up Pennies in Front of a Steamroller

Below is a very sad tale from a newbie trader who didn’t understand that taking asymmetric risk can be fatal.   The trader shorted a $2.00 stock thinking it was going to go to zero, but then a news release was put out saying a group of influential investors had taken a position in the stock and the stock immediately zoomed up 600% in the after hours market.

The lesson here is that taking a short position where you have only $2.00 of upside and unlimited downside (in his case much more than he even had to lose) is like picking up pennies in front of a steamroller.  You could make a little, but if you’re wrong you’re going to be flattened.

This story is an absolute worst case scenario, but even so the risk is not commensurate with the reward.

A 32-year-old small-business owner from Gilbert, Arizona, posted this page after a huge loss on KaloBios Pharmaceuticals.

Hello to all you traders out there. I’m starting this page out of the recommendation of other traders in the community.

I hesitated on doing this but I literally owe Etrade $106,445.56 as of this moment what would you do if you were in my situation? I’ll do whats needed and sell what I have to get them paid but if someone feels my pain and is willing to help out—who am I to say no?

If you don’t want to donate I understand, at least read my story of what happened today and protect yourself from the same happening to you! This is a terrible lesson for me but if this helps just one person than I’m happy I wrote this.

I’m a fairly new trader, been trading since about March of this year. I have learned alot about the community and trading…well not enough about trading as you will soon hear.

I have a fairly small account, but its over PDT. As of this morning it was $37,000. I keep it small because I wanted to manage risk, the most I can afford to lose is what I have in the account….$37,000. When I get some profits I take them out of the account because I wouldn’t want to lose more than $37k.

I was holding KBIO short overnight for what I thought was a nice $2.00 fade coming. At the close of the bell I saw the quote montage clear out and figured today there was no action after hours in the stock. So I went to my office for a long meeting. I got out of the meeting and saw a message from one of my buddys, he asked if I was ok since I was short KBIO….my heart dropped. “Shoot did I blow up my account, everything I worked for? I don’t want to lose all $37,000 that would be terrible.” —It was much worse.

The stock was at $16 and my account was negative over 100k. I figured it was a mistake, Etrade would never let that happen, they must have cut the position when my account got to $0….nope. I immediately called them and they confirmed I still owned all the shares. He says that it got out of hand too fast for them to cover me, he says that all he can do right now is cover. I was devistated. I asked him to cover at $16 and he waited trying to find me a good exit. I told him to do it asap and the fill was around $18.50 avg.

At the moment not only is my $37k gone, but I now owe ETrade the negative balance of over $106k. I always knew I could blow up an account and I was financially able to “afford” to lose the $37k. Never in my wildest dreams did I imagine that Etrade would NOT have some sort of stop or circuit breaker in place that would automatically cut a position if the account went to $0…..how could they ever let it get to -$144k loss on a account that small! Also, why did I have to call them to find out what was going on, why did they not alert me or call me when it went neg???

Source: Joe Campbell GoFundMe page for E-Trade – Business Insider

Make Hay When the Sun Shines

Cliche´ – “Make Hay When the Sun Shines”

For my son and daughter:  The sun is shining right now, but some days are rainy.  You have to appreciate the good days and prepare for the inevitable bad ones.  Now that you have a job, you need to begin a lifetime of saving.

I love cliche´s.  The dictionary defines them as:  a phrase or opinion that is overused and betrays a lack of original thought.  But I see them as useful pearls of wisdom from experience that are easily remembered and used to convey a valuable lesson.

What are some of your favorite cliche´s?  Why do you like them and how do they relate to business, investing or life?

Let me know by sending an email