Story of Squanderville and Thriftville

While browsing the web, I was doing my usual round of picking up investment related stories. I stumbled upon the Berkshire Hathaway site. Anyone who isn't immediately thrown off by the almost lifeless simplicity of this site, would know that this site is a treasure chest of incredible amount of wisdom.

There is an article posted on the web site that I seem to have missed previously. I would like to highlight the following: a Fortune article from Buffett regarding the U.S. Trade Deficit. This article is a must read for anyone interested in macroeconomics, business and investing. In fact, if you have any relation to U.S., then you may find this article interesting.

Buffett describes a story of two islands called Squanderville and Thriftville. As you may have guessed from the names, the people in Squanderville prefer to squander their earnings (food, in this simple scenario) and live beyond their means. People of Thriftville, on the other hand, live well within their means, and do not mind having a surplus of food production. They eventually start trading; and in a matter of years, people of Squanderville realize that they could just offer Squanderbonds to the nation of Thriftville in exchange for food -- and Squandervillites never have to toil in the fields again. The story goes an and morphs into something very intersting.

Buffett, in his usual charming way, completes this story and talks about a way to fix the alarming U.S. trade deficit problem. He describes something called Import Certificates (ICs) that are issued to U.S. exporters.

Complete article: http://www.berkshirehathaway.com/letters/growing.pdf

Intrinsic Value Realized

Mr. Market has been incredibly excitable last week (Sept 15-19, 2008)... near the last couple of days of the week, the Mr. Market has been incredibly exuberant.

One thing I have noticed is that in the wild swings of the market, Mr. Market realized the value of Berkshire Hathaway. It closed the week at $147,000 per share. Notice that the intrinsic value that I calculated was $145,517. Frankly, I never thought that the equity would trade above my intrinsic value calculation so soon. This goes to show the positive side of the wild mood swings of Mr. Market.

Question is, should one sell their Berkshire Hathaway unit(s) to the enthusiastic market? I for one will not, since I will stick to my motto that Berkshire is for life. If I could find an appropriately priced business that can have level of consistent cash flows like Berkshire, or sane management as Berkshire, then I would gladly sell [most of] my Berkshire units (but never all) and buy that business. Alas, there is no such business I know of at this current time. That being said, I am in the long haul with Berkshire -- perhaps one of the finest businesses around.

I expect the price to fluctuate and perhaps go back down to the levels from a week ago. An intelligent investor must not be concerned with the daily fluctuations of equity prices.

Market Commentary for August 2008

Very sensible and clear market commentary has been posted by ABC Funds for the month of August, 2008. I greatly enjoy listening to the monthly commentaries as they put a lot of the market noise into perspective.

Commentary is also available as an mp3. The complete text follows:

Securities trading during the month of August can be characterized by continued extraordinary price volatility as stock prices see-sawed back and forth. Interestingly, the market has weathered considerable negativity over the past month with lingering solvency concerns over the mega U.S. mortgage lenders Fannie May and Freddie Mac as well as the uncertain affairs of Lehman Brothers, U.S. banks, etc. Nonetheless, the market continues to confound investors as frenetic trading volumes and price volatility seem to be masking a resurgent U.S. dollar, relatively low American interest rates, a +3.3% second quarter U.S. GDP growth rate and generally decent corporate profits. For many investors the glass appears to be half empty as rampant negative psychology appears to have permeated the marketplace.

As fundamental analysts and contrarian investors we are starting to uncover an increasing number of significantly undervalued equities. However, largely due to widespread investor fear and a drive toward liquidity these stocks drift even lower despite improving prospects. At times these price declines make little sense. For instance, we offer an example of one of our ABC Funds shareholdings, Jo-Ann Stores. Jo-Ann Stores, the largest U.S. retailer of fabrics, is a solid company with improving sales, financials, and a tangible book value of $18.00. However in the space of several months its share price plunged from $24 last fall to $9.03 on January 16, 2008. We were most perplexed since president and CEO Darrell Webb had been doing an excellent job of running this $2 billion sales company in a very difficult retail environment. Upon deeper analysis we found nothing fundamentally wrong with the company and couldn’t really explain the drastic price decline. Now, seven months later and after two excellent quarterly reports as well as improved operating guidance the shares are trading at over $25. Now, considering the capital appreciation from $9 to $25 the question is: what has changed since the January 2008 $9.03 low? Nothing really. Unfortunately, Jo-Ann Stores is a typical example of the extraordinary trading volatility in the marketplace.

The fact is investors are in a “show me” mode. Furthermore with the incessant concern of “other shoes to drop” in the U.S sub prime mortgage area, many investors, bankers and institutions have become gun-shy. Not helping matters is the considerable speculation on the health of numerous hedge funds in that a number of these capital pools have imploded and are closing shop. This situation, additionally, has enervated the securities markets.

While it may sound trite, the present financial uncertainty, fear and rush toward investment liquidity is producing a growing number of attractive opportunities. The daily price volatility due to investor angst is also providing huge trading swings and excellent investment entry points for those with the necessary stamina and patience. We are constantly surprised how certain dirt-cheap stocks have drifted lower and lower despite improving fundamentals. Overall, it is our belief that negative market psychology has overtaken long term fundamental analysis. This will change.

Once again we believe that the overlooked value market while currently languishing presents excellent, long term value. Many pubic companies continue to trade at significant discounts to their net asset or replacement values. As a result we continue to expect more and more company share buybacks, mergers, acquisitions and takeovers. Although we are not certain what the necessary catalyst will be to spur on a significant upturn in value stocks we remain optimistic and patient. Not unexpectedly, we look to the Jo-Ann Stores example of investment patience producing long term financial rewards.

Thank you,

Irwin A. Michael, CFA

This time it is different (not really)

An intelligent investor studies enough history and understands enough about the economy to know that history does repeat itself. The Economist has written this article to show how it is different this time around -- but as I read this concise and informative article, I am drawn to the fact that things aren't very different after all.

Sure the bear market this time around, got the double shock of commodity prices and credit freeze, but some market fundamentals are still the same. To name a few; human greed, speculative nature of traders, and short term focus are still strong as ever, if not much worse.

As an intelligent investor, it is important to note all these factors and understand them, but not let them directly affect your decision to buy or sell any business. The macro knowledge must only be used as a guide to understand how businesses function and can be affected. An intelligent investor never tries to play the prediction game and place bets on expected the future trends -- no matter how educated those guesses are. There is enough ink spilled daily by various experts who predict the market for a living. If they were always making correct predictions, market would actually be efficient and all securities would always be efficiently priced. Reality is evidence to the contrary.

The only criterion for an investment must be valuation, and nothing else. This must be true at all times -- boom or bust.