Whitney Tilson Interview at FT.com

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Whitney Tilson Posts at Seeking Alpha

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Rational Investors Research Paper by Louis Lowenstein

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Washington Post Article on Value Investing Advocate Louis Lowenstein

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Graham and Doddsville Revisited by Louis Lownestein

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Whitney Tilson Interview on Value Blogger

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Street.com Interview with Whitney Tilson

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What would Warren be Buying?

Lists 7 stocks that Smartmoney thinks Warren Buffett would be buying

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Buffett's 2001 Letter to Berkshire Shareholders

Berkshire Book Value Per Share: $37,920

Direct Quotes:

"Another of my 1956 Ground Rules remains applicable: "I cannot promise results to partners." But Charlie and I can promise that your economic result from Berkshire will parallel ours during the period of your ownership: We will not take cash compensation, restricted stock or option grants that would make our results superior to yours."

"Additionally, I will keep well over 99% of my net worth in Berkshire. My wife and I have never sold a share nor do we intend to. Charlie and I are disgusted by the situation, so common in the last few years, in which shareholders have suffered billions in losses while the CEOs, promoters, and other higher-ups who fathered these disasters have walked away with extraordinary wealth. Indeed, many of these people were urging investors to buy shares while concurrently dumping their own, sometimes using methods that hid their actions. To their shame, these business leaders view shareholders as patsies, not partners."

"Though Enron has become the symbol for shareholder abuse, there is no shortage of egregious conduct elsewhere in corporate America. One story I’ve heard illustrates the all-too-common attitude of managers toward owners: A gorgeous woman slinks up to a CEO at a party and through moist lips purrs, "I’ll do anything you want. Just tell me what you would like." With no hesitation, he replies, "Reprice my options.""

Bill Nygren interview with Value Investor Insight

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Mauboussin on Strategy

Over the last few weeks I have read all of Michael Mauboussin's (Chief Investment Strategist at Legg Mason Capital Managment) white papers on investing. Here are some of my favorite takeways with white paper titles headed in bold. You can find the white papers at this direct link:

Decision-Making for Investors
"Any individual decision can be badly thought through, and yet be successful, or exceedingly well thought through, but be unsuccessful, because the recognized possiblity of failure in fact occurs. But overtime, more thoughtful decision-making will lead to better overall results, and more thoughtful decision-making can be encouraged by evaluating decisions on how they were made rather than the outcome." - Robert Rubin

"Investing is a net present value positive activity; otherwise, savers would forgo current consumption in the expectation of greater future consumption. Inversely, with few exceptions gamblers engage in a netpresent value negative pursuit. The longer your time horizon in investing, the more likely you are to generate a positive return. The longer your time horizon in gambling, the more assured you are of a loss."

"Indeed I can be wrong more often then I am right, so long as the leverage on my correct judgements compensates for my mistakes." - Leon Levy founderof Oppenheimer Funds

Exploring Network Economics
"There is a central difference between the old and new economies: the old industrial economy was driven by economies of scale; the new information economy is driven by economics of networks." - Cal Shapiro and Hal R. Varian Information Rules

"Of networks there will be few. In a particular space one network tends to dominate, while the rest fight over the scraps. Network builders understand that anything other than first place is an also-ran. Microsoft and Ebay's 90%+ market shares offer testament to this point." - Brian Arthur, Economist

"We believe networks provide one of the few sources of sustainable competitive advantage. Once entrenched, dominant networks prove difficult to dislodge. Newtwork users become locked-in, and their switching costsrise sharply. Lock-in and switching costs are central to a network's sustainable competitive advantage."

The Economics of Customer Businesses
"Generally accepted accounting principles actually hide the value of a loyal customer, an impressive feat of concealment given what loyalty can do for the great majority of companies." Frederick F. Reicheld, Author of the Loyalty Effect

"First, acquisition costs tend to rise as an industry matures and companies compete for late adopters. Since the spending patterns of late are often not as good as earlier adopters, companies must make diligent spending decisions when the industry reaches maturity.On the other hand, if a customer business benefits from network effects, it can actually see acquisition costs decline as it gains share. Typically, multiple networks compete for customer attention, but once a company gets ahead customers want to join that network precisely because others alreadyhave."

"When companies properly calculate customer economics they often find avariation of the 80/20 rule applies: 20% of customers account for 80% ofthe profits."

M&M on Valuation
"Ideally, value investors can find businesses with prices below value where the value will increase over time. This value increase comes as management successfully deploys capital at attractive returns and fends off the migration to a commodity P/E multiple. In this case, value creation for the investor compounds in two ways - as the price to value gap narrows and as value grows."

Contrarian Investing
"We sometimes delude ourselves that we proceed in a rational manner and weigh all the pros and cons of various alternatives. But this is seldom the actual case. Quite often "I decided in favor of X" is no more than "I liked X".... We buy cars we "like" choose the jobs and houses we find"attractive", and then justify these choices by various reasons." - Robert Zajonc, Psychologist

"It is the long term investor, he who promotes the public interest, who will in practice come in for the most criticism... For it is the essence of his behavior that he should be eccentric, unconventional, and rash in the eyes of the average opinion. If he is unsuccessful, that will only confirm the general belief in his rashness; and if in the short run he is unsuccessful, which is very likely, he will not receive much mercy. Worldy wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally" - John Maynard Keynes

Aver and Aversion
"It is a decisive fact about a person whether he possesses the freedom to act independently, or whether he characteristically submits to group pressures."- Solomon E. Asch

"It's possible that people who are ... good investors may have what you call functional psychopathy. They don't react emotionally to things." -Antoine Bechara

Clear Thinking About Share Repurchase
"A buyback of an overvalued stock can add to earnings per share while decreasing value for continuing shareholders and a buyback of an undervalued stock reduce earnings per share while enhancing value for ongoing holders. Thus, earnings-per-share accretion or dilution has nothing to do with whether a buyback makes economic sense because the relationship between the P/E and the interest rate dictates the accretion or dilution, while the relationship between price and expected value dictates a stock buyback's economic merits.

Repurchasing overvalued shares or refraining from buying undervalued shares because of the unfavorable earnings-per-share impact is shareholder unfriendly finance. Similarily, the notion that buybacks of high-P/E stocks are bad, or that buybacks of low P/E stocks are good defies economic reasoning."

Size Matters
"To suppose that safety-first consists in having a small gamble in a large number of different companies where I have no information to reach a good judgement, as compared with a substantial stake in a company where one's information is adequate, strikes me as a travesty of investment policy."- John Maynard Keynes

Buffett's 2000 Letter to Berkshire Shareholders

Berkshire Hathaway Book Value Per Share: $40,422

Direct Quotes:

"Two economic factors probably contributed to the rush of acquisition activity we experienced last year. First, many managers and owners foresaw near-term slowdowns in their businesses and, in fact, we purchased several companies whose earnings will almost certainly decline this year from peaks they reached in 1999 or 2000. The declines make no difference to us, given that we expect all of our businesses to now and then have ups and downs. (Only in the sales presentations of investment banks do earnings move forever upward.) We don’t care about the bumps; what matters are the overall results. But the decisions of other people are sometimes affected by the near-term outlook, which can both spur sellers and temper the enthusiasm of purchasers who might otherwise compete with us."

"Agonizing over errors is a mistake. But acknowledging and analyzing them can be useful, though that practice is rare in corporate boardrooms. There, Charlie and I have almost never witnessed a candid post-mortem of a failed decision, particularly one involving an acquisition.
Ever since we first published our economic principles in 1983, we have consistently stated that we would rather purchase businesses than stocks. One reason for that preference is personal, in that I love working with our managers. They are high-grade, talented and loyal. And, frankly, I find their business behavior to be more rational and owner-oriented than that prevailing at many public companies.

But there’s also a powerful financial reason behind the preference, and that has to do with taxes. The tax code makes Berkshire’s owning 80% or more of a business far more profitable for us, proportionately, than our owning a smaller share. When a company we own all of earns $1 million after tax, the entire amount inures to our benefit. If the $1 million is upstreamed to Berkshire, we owe no tax on the dividend. And, if the earnings are retained and we were to sell the subsidiary (not likely at Berkshire!) for $1 million more than we paid for it, we would owe no capital gains tax. That’s because our "tax cost" upon sale would include both what we paid for the business and all earnings it subsequently retained.

Contrast that situation to what happens when we own an investment in a marketable security. There, if we own a 10% stake in a business earning $10 million after tax, our $1 million share of the earnings is subject to additional state and federal taxes of (1) about $140,000 if it is distributed to us (our tax rate on most dividends is 14%); or (2) no less than $350,000 if the $1 million is retained and subsequently captured by us in the form of a capital gain (on which our tax rate is usually about 35%, though it sometimes approaches 40%). We may defer paying the $350,000 by not immediately realizing our gain, but eventually we must pay the tax. In effect, the government is our "partner" twice when we own part of a business through a stock investment, but only once when we own at least 80%."

"Leaving aside tax factors, the formula we use for evaluating stocks and businesses is identical. Indeed, the formula for valuing all assets that are purchased for financial gain has been unchanged since it was first laid out by a very smart man in about 600 B.C. (though he wasn’t smart enough to know it was 600 B.C.).

The oracle was Aesop and his enduring, though somewhat incomplete, investment insight was "a bird in the hand is worth two in the bush." To flesh out this principle, you must answer only three questions. How certain are you that there are indeed birds in the bush? When will they emerge and how many will there be? What is the risk-free interest rate (which we consider to be the yield on long-term U.S. bonds)? If you can answer these three questions, you will know the maximum value of the bush and the maximum number of the birds you now possess that should be offered for it. And, of course, don’t literally think birds. Think dollars.

Common yardsticks such as dividend yield, the ratio of price to earnings or to book value, and even growth rates have nothing to do with valuation except to the extent they provide clues to the amount and timing of cash flows into and from the business. Indeed, growth can destroy value if it requires cash inputs in the early years of a project or enterprise that exceed the discounted value of the cash that those assets will generate in later years. Market commentators and investment managers who glibly refer to "growth" and "value" styles as contrasting approaches to investment are displaying their ignorance, not their sophistication. Growth is simply a component usually a plus, sometimes a minus in the value equation.

Alas, though Aesop’s proposition and the third variable that is, interest rates are simple, plugging in numbers for the other two variables is a difficult task. Using precise numbers is, in fact, foolish; working with a range of possibilities is the better approach. Usually, the range must be so wide that no useful conclusion can be reached. Occasionally, though, even very conservative estimates about the future emergence of birds reveal that the price quoted is startlingly low in relation to value. (Let’s call this phenomenon the IBT Inefficient Bush Theory.) To be sure, an investor needs some general understanding of business economics as well as the ability to think independently to reach a well-founded positive conclusion. But the investor does not need brilliance nor blinding insights.

At the other extreme, there are many times when the most brilliant of investors can’t muster a conviction about the birds to emerge, not even when a very broad range of estimates is employed. This kind of uncertainty frequently occurs when new businesses and rapidly changing industries are under examination. In cases of this sort, any capital commitment must be labeled speculative.

Now, speculation in which the focus is not on what an asset will produce but rather on what the next fellow will pay for it is neither illegal, immoral nor un-American. But it is not a game in which Charlie and I wish to play. We bring nothing to the party, so why should we expect to take anything home?

The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hands."

"At Berkshire, we make no attempt to pick the few winners that will emerge from an ocean of unproven enterprises. We’re not smart enough to do that, and we know it. Instead, we try to apply Aesop’s 2,600-year-old equation to opportunities in which we have reasonable confidence as to how many birds are in the bush and when they will emerge (a formulation that my grandsons would probably update to "A girl in a convertible is worth five in the phonebook."). Obviously, we can never precisely predict the timing of cash flows in and out of a business or their exact amount. We try, therefore, to keep our estimates conservative and to focus on industries where business surprises are unlikely to wreak havoc on owners. Even so, we make many mistakes: I’m the fellow, remember, who thought he understood the future economics of trading stamps, textiles, shoes and second-tier department stores.

Lately, the most promising "bushes" have been negotiated transactions for entire businesses, and that pleases us. You should clearly understand, however, that these acquisitions will at best provide us only reasonable returns. Really juicy results from negotiated deals can be anticipated only when capital markets are severely constrained and the whole business world is pessimistic. We are 180 degrees from that point.

When Charlie and I read reports, we have no interest in pictures of personnel, plants or products. References to EBITDA make us shudder does management think the tooth fairy pays for capital expenditures? We’re very suspicious of accounting methodology that is vague or unclear, since too often that means management wishes to hide something. And we don’t want to read messages that a public relations department or consultant has turned out. Instead, we expect a company’s CEO to explain in his or her own words what’s happening.

One further thought while I’m on my soapbox: Charlie and I think it is both deceptive and dangerous for CEOs to predict growth rates for their companies. They are, of course, frequently egged on to do so by both analysts and their own investor relations departments. They should resist, however, because too often these predictions lead to trouble.

It’s fine for a CEO to have his own internal goals and, in our view, it’s even appropriate for the CEO to publicly express some hopes about the future, if these expectations are accompanied by sensible caveats. But for a major corporation to predict that its per-share earnings will grow over the long term at, say, 15% annually is to court trouble.

That’s true because a growth rate of that magnitude can only be maintained by a very small percentage of large businesses. Here’s a test: Examine the record of, say, the 200 highest earning companies from 1970 or 1980 and tabulate how many have increased per-share earnings by 15% annually since those dates. You will find that only a handful have. I would wager you a very significant sum that fewer than 10 of the 200 most profitable companies in 2000 will attain 15% annual growth in earnings-per-share over the next 20 years.
The problem arising from lofty predictions is not just that they spread unwarranted optimism. Even more troublesome is the fact that they corrode CEO behavior. Over the years, Charlie and I have observed many instances in which CEOs engaged in uneconomic operating maneuvers so that they could meet earnings targets they had announced. Worse still, after exhausting all that operating acrobatics would do, they sometimes played a wide variety of accounting games to "make the numbers." These accounting shenanigans have a way of snowballing: Once a company moves earnings from one period to another, operating shortfalls that occur thereafter require it to engage in further accounting maneuvers that must be even more "heroic." These can turn fudging into fraud. (More money, it has been noted, has been stolen with the point of a pen than at the point of a gun.)

Charlie and I tend to be leery of companies run by CEOs who woo investors with fancy predictions. A few of these managers will prove prophetic but others will turn out to be congenital optimists, or even charlatans. Unfortunately, it’s not easy for investors to know in advance which species they are dealing with."

"A bit of nostalgia: It was exactly 50 years ago that I entered Ben Graham’s class at Columbia. During the decade before, I had enjoyed make that loved analyzing, buying and selling stocks. But my results were no better than average.

Beginning in 1951 my performance improved. No, I hadn’t changed my diet or taken up exercise. The only new ingredient was Ben’s ideas. Quite simply, a few hours spent at the feet of the master proved far more valuable to me than had ten years of supposedly original thinking.
In addition to being a great teacher, Ben was a wonderful friend. My debt to him is incalculable."

Buffett's 1999 Letter to Berkshire Shareholders

Berkshire Hathaway Book Value Per Share: $37,987

Direct Quotes:

"Our acquisitions usually develop in the same way. At other companies, executives may devote themselves to pursuing acquisition possibilities with investment bankers, utilizing an auction process that has become standardized. In this exercise the bankers prepare a "book" that makes me think of the Superman comics of my youth. In the Wall Street version, a formerly mild-mannered company emerges from the investment banker's phone booth able to leap over competitors in a single bound and with earnings moving faster than a speeding bullet. Titillated by the book's description of the acquiree's powers, acquisition-hungry CEOs -- Lois Lanes all, beneath their cool exteriors -- promptly swoon.

What's particularly entertaining in these books is the precision with which earnings are projected for many years ahead. If you ask the author-banker, however, what his own firm will earn next month, he will go into a protective crouch and tell you that business and markets are far too uncertain for him to venture a forecast."

"This explains, by the way, why we don't own stocks of tech companies, even though we share the general view that our society will be transformed by their products and services. Our problem -- which we can't solve by studying up -- is that we have no insights into which participants in the tech field possess a truly durable competitive advantage.

Our lack of tech insights, we should add, does not distress us. After all, there are a great many business areas in which Charlie and I have no special capital-allocation expertise. For instance, we bring nothing to the table when it comes to evaluating patents, manufacturing processes or geological prospects. So we simply don't get into judgments in those fields.

If we have a strength, it is in recognizing when we are operating well within our circle of competence and when we are approaching the perimeter. Predicting the long-term economics of companies that operate in fast-changing industries is simply far beyond our perimeter. If others claim predictive skill in those industries -- and seem to have their claims validated by the behavior of the stock market -- we neither envy nor emulate them. Instead, we just stick with what we understand. If we stray, we will have done so inadvertently, not because we got restless and substituted hope for rationality. Fortunately, it's almost certain there will be opportunities from time to time for Berkshire to do well within the circle we've staked out."

"Berkshire will someday have opportunities to deploy major amounts of cash in equity markets -- we are confident of that. But, as the song goes, "Who knows where or when?" Meanwhile, if anyone starts explaining to you what is going on in the truly-manic portions of this "enchanted" market, you might remember still another line of song: "Fools give you reasons, wise men never try.""

"There is only one combination of facts that makes it advisable for a company to repurchase its shares: First, the company has available funds -- cash plus sensible borrowing capacity -- beyond the near-term needs of the business and, second, finds its stock selling in the market below its intrinsic value, conservatively-calculated.

When available funds exceed needs of those kinds, a company with a growth-oriented shareholder population can buy new businesses or repurchase shares. If a company's stock is selling well below intrinsic value, repurchases usually make the most sense. In the mid-1970s, the wisdom of making these was virtually screaming at managements, but few responded. In most cases, those that did made their owners much wealthier than if alternative courses of action had been pursued. Indeed, during the 1970s (and, spasmodically, for some years thereafter) we searched for companies that were large repurchasers of their shares. This often was a tipoff that the company was both undervalued and run by a shareholder-oriented management.

That day is past. Now, repurchases are all the rage, but are all too often made for an unstated and, in our view, ignoble reason: to pump or support the stock price. The shareholder who chooses to sell today, of course, is benefitted by any buyer, whatever his origin or motives. But the continuing shareholder is penalized by repurchases above intrinsic value. Buying dollar bills for $1.10 is not good business for those who stick around.

Charlie and I admit that we feel confident in estimating intrinsic value for only a portion of traded equities and then only when we employ a range of values, rather than some pseudo-precise figure. Nevertheless, it appears to us that many companies now making repurchases are overpaying departing shareholders at the expense of those who stay. In defense of those companies, I would say that it is natural for CEOs to be optimistic about their own businesses. They also know a whole lot more about them than I do. However, I can't help but feel that too often today's repurchases are dictated by management's desire to "show confidence" or be in fashion rather than by a desire to enhance per-share value.

Sometimes, too, companies say they are repurchasing shares to offset the shares issued when stock options granted at much lower prices are exercised. This "buy high, sell low" strategy is one many unfortunate investors have employed -- but never intentionally! Managements, however, seem to follow this perverse activity very cheerfully.

Of course, both option grants and repurchases may make sense -- but if that's the case, it's not because the two activities are logically related. Rationally, a company's decision to repurchase shares or to issue them should stand on its own feet. Just because stock has been issued to satisfy options -- or for any other reason -- does not mean that stock should be repurchased at a price above intrinsic value. Correspondingly, a stock that sells well below intrinsic value should be repurchased whether or not stock has previously been issued (or may be because of outstanding options).

You should be aware that, at certain times in the past, I have erred in not making repurchases. My appraisal of Berkshire's value was then too conservative or I was too enthused about some alternative use of funds. We have therefore missed some opportunities -- though Berkshire's trading volume at these points was too light for us to have done much buying, which means that the gain in our per-share value would have been minimal. (A repurchase of, say, 2% of a company's shares at a 25% discount from per-share intrinsic value produces only a ½% gain in that value at most -- and even less if the funds could alternatively have been deployed in value-building moves.)

Please be clear about one point: We will never make purchases with the intention of stemming a decline in Berkshire's price. Rather we will make them if and when we believe that they represent an attractive use of the Company's money. At best, repurchases are likely to have only a very minor effect on the future rate of gain in our stock's intrinsic value."

Excerpt from Eddie Lamperts Annual Letter to Sears Shareholder

I think this is a very valuable excerpt from Eddie Lampert's letter to Sears shareholders and provides you with great insight into his thought process

"I want to close with a broad observation. I am an avid reader of books, newspapers, and magazines, and in the course of my reading over the last year, I have noticed that there is a significant degree of interest in the press about Sears Holdings. This is not surprising: as a well-known, high-profile American company, Sears will always attract considerable attention. There is no shortage of commentators who are eager to make known their perspectives on our company and its prospects. Some of these do so “on the record”; others cloak themselves in anonymity or do not disclose the true motives that are driving their comments.

Although all the attention Sears Holdings is receiving is, in some fashion, flattering, I would caution you to approach much of what is written and said about us with an appropriate amount of healthy skepticism. This is particularly so with respect to the loudest views, the most widely held views, or the so-called “expert” views. For many commentators, analysts, and reporters, their success is dependent on the excitement or controversy generated by their articles – not on the accuracy of their writing or of their predictions.

As a long-term value investor, I am constantly on the lookout for situations in which the conventional wisdom of the commentators and “experts” is incomplete. There are many such examples, and those are the situations that produce real opportunities. I will not dwell here on the many instances where the “conventional wisdom” – for example, the view that Kmart would neither emerge from bankruptcy nor survive its first Christmas as a new company in 2003 – has turned out to be only “conventional” and not at all “wisdom.” I will simply say that I am pleased with the progress we are making at Sears Holdings. We are hiring great people, creating a winning culture, and focusing relentlessly on profitability. We have accomplished much in eight months and have a long way to go. We will continue to get better, which also entails recognizing the mistakes we make and correcting them.

One subject where the conventional wisdom has been much on display recently is the issue of capital expenditures. As I made clear in my very first letter to shareholders, we do not subscribe to the view (seemingly widely held) that more is better, or that there is a certain amount that must be spent on cap ex every year. The question we ask at Sears (and I believe every business should ask) is: “What is the most productive way to allocate the capital that we have on hand and the cash flow the company generates?” In some cases, spending money on the construction of new stores or the updating of existing stores produces real bottom-line benefits. In those cases, increasing capital expenditures is an attractive option. But if the analysis shows that allocating capital in some other way – for example, on acquisitions or stock repurchases – will generate superior returns, then it would be a mistake to plow money into capital expenditures merely because that is the “accepted practice” or “expected.” (That approach – of uncritically following accepted or prevailing practice – is what led many telecom companies astray as they tried to “keep up” with WorldCom’s expenditure levels.)

A meaningful analysis of the retailing industry would show the following. Between Sears and Kmart stores, we have approximately 2,300 large-format domestic stores – which is considerably more than Target (around 1,400), JC Penney (a little over 1,000), and Kohl’s (fewer than 1,000). The issue for Sears Holdings is therefore not one of building more stores, but rather one of making our existing stores more productive and relevant to our customers. Part of the solution obviously includes capital investments in existing stores. But that is not the complete formula, and, in any event, spending on existing stores should be expected to improve the operating performance of these stores.

For a reader, the key is to read broadly, but to be appropriately skeptical of the so-called experts. For a business executive, the key is to think about and understand one’s business and its strategic and financial characteristics, make decisions based on that understanding, and have the confidence to stay with well-reasoned decisions even in the face of vocal doubters. Most observers and financial pundits missed the turnaround at IBM, missed the turnaround at American Express, missed the turnaround at JC Penney, missed the emergence of Google, and missed the resurrection of Kmart – until it was abundantly clear that those companies had succeeded. In all those cases and in many others, imposing the right disciplines; adjusting the cost structure; creating an atmosphere of teamwork and collaboration; and being willing to learn while having the confidence to stay the course in the face of skepticism – were the necessary preconditions of success. We are not yet even one year into the merger, and we have plenty of work ahead of us, but that is the culture that we are committed to building at Sears Holdings."

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