Bob Rodriguez – FPA Capital Q3 Letter

In the fund`s last letter, Bob Rodriguez made it clear he is cautious with stock markets valuation – over 20x  P/E (ttm) and 15x P/E (12m fwd), which compares to 1996-1998 and 2004-2007 – and the economy perspectives. There were a couple highlights in the letter:

  • How he thinks of cash: 

“We think of cash as an asset that has no duration, but provides an embedded call option  that can be exercised when quality assets are cheap on sale.”

  • Comment on career risk: 

“It is often a lonely endeavor to be a true contrarian absolute value manager. Most people feel secure in the knowledge that others like them are nearby, doing similar activities, and generally moving in the same direction. Most people do not want to be alone or feel awkward because they are the only ones dancing on the dance floor.”

  • What he looks for in companies:

“Our pipeline of companies with long histories of profitability, strong industry positions, pristine balance sheets, and solid management team (…)”

  • His view on stretched valuations and value screened paramenters:

“It is hard to intelligently deploy capital when most people are stretching for yields. We can see the reaching for return effect in our “core value screen” which looks for companies selling below 15x earnings, 7x cash flows, 2.2x book value and 1x sales, and have debt to capital of less than 40%. This screen is qualifying less than one hundred names currently, which is in the bottom third historically.”

  • Macro thoughts:

“The U6 unemployment rate, which includes part time employees who would prefer ful time jobs, is almost double the 2007 level of 8.0%, and has increased in the last six months from 14.5% to 14.7%. Total nonfarm employment is still 4.5 million below the 2008 level. As a result, the civilian employment-to-population ratio has dropped from over 63% in 2008 to 58.5%. This is almost five-point drop is the real hit to employment level, and it is substantial.” 

“The real median income for U.S. households measured in 2011 dollars has declined by nine percent since 2000 (when it hit $54,932) to $50,054 per household.”

“In our eyes, further quantitative easing is neither logical nor well thought out, since the upside does not offset the risks.”

“White concludes that the current ultra easy policy is neither likely to be effectively transmitted to the real economy, nor to lead private sector spending to respond and reduce unemployment.”

Bottom line: macro backdrop is worrisome, with unemployment at high levels, household real income falling over a ten year period and lack of investments. S&P margins should drop going forward which should give an opportunity to value investors deploy capital wisely. Cash is king (almost 1/3 of NAV is in cash). He keeps looking for high quality companies with discount to their intrinsic value and acknowledges the rally was of low quality companies.

Full letter can be found here.


FPA Crescent Fund Q3 2012 Letter

The just released letter from Steve Romick, portfolio manager of FPA Crescent Fund, discusses the disinvestment in Walmart after his thesis played out. His frame was based on buying a “infinite duration bond with a rising coupon – a bond-like equity”, in which could have a potential return between 9% to 14% per year based on three pillars: operating income growth, share repurchases and dividends paid.

Also, he mentioned why he has sold his position in Ensco, an international offshore contract drilling company. For an average business, returns should not be outstanding. Moreover, it`s a cyclical company. So basically they bought it below replacement value of its assets and sold it during high cycle earnings, where investors were paying for the “E”. In his words:

“Our goal when investing in commodity businesses is to buy assets and sell earnings. Capital intensive, cyclical businesses often trade at discounts to the value of the underlying assets when their respective industry is in distress (companies are either losing money or earning less than what`s expected in a more normal environment). When  earnings rebound, the market seems to forget that the businesses are cyclical. Investors begin to value them on earnings as if another downturn isn`t in the cards.” 

He also began shorting yen via OTC derivatives as Japan`s prospects continue to worsen. His goal is to get paid off for the “if” part of the thesis instead of the “when”.

The full letter can be found here.

Charlie Munger at Harvard (2010)

Munger is definitely one of the greatest minds in value investing history. In this link you may find a transcript of an interview with him at Harvard in 2010. He is a brilliant, arrogant (in a good way), intriguing  and funny mind. Some quotes I have highlighted may be found below:

“It`s not brilliance. It is just avoiding stupidity.”

“Believing just by buying volatile stocks you make an extra 7 percentage points per annum, I mean those people still believe in the tooth fairy and yet it is taught to the children.” 

“Financial outcomes in security markets are not plottable. It is not a law of God that outcomes in security prices will fall over time on a curve and follow reality according to Gauss` curve. Quite the contrary, the tails are way fatter.” 

“Now you think accounting is something we can trust?”

“But boy, teaching people they don`t really have to pay and a lot of the credit being given for education, a lot of it in for-profit education. This is very foolish credit given to people who are never going to learn much. (…) I think it does enormous damage to shovel out a lot of dumb credit, raising false hopes.”

I must agree with him in the quote above in which people do not have the right incentives or the proper education or college programs to really develop the skills needed – within that in mind we enter into an entirely separate topic: student loans. As the economic recovery is lackluster, how will these students find jobs? (i) Students might not have the proper skills developed (I`d argue many colleges are mainly concerned on new enrollments only) (ii) There are just no jobs with so much uncertainty lingering (iii) New enrollments represents people with no jobs that are able to get easy credit to fund its full board tuition (sounds like a good option for someone with no job). Will it be the next credit bubble looking forward? Who`s gonna pay for that anyway? Ok, let`s move on…

“In a miasma of prosperity and gambling with $100,000 bills floating around like confetti, you can`t expect people to bahave as if they were in a monastery.”

It is quite serious when you have troubles and the people who do things are proud of their ignorance”

Howards Marks backs up one of Munger`s answers saying:

“I think that the problems we`ve had have stemmed from human failings and they are never going to change. You can adjust here and there, and you can encourage and dissuade with regulation – but the ability, for example, for greed to overcome morals and prudence, will never change.”

Bottom line: we should not trust accounting nor use the past as a good proxy for the future. Moral hazard and conflicts of interest are a big issue that will linger going forward. Behavioral finance is something every single investor should be aware of and study deeply. Understanding our minds and how we frame scenarios and process information to make decisions is way more important than a discounted cash flow. Last but not least, avoiding mistakes is the most important thing.

Hugh Hendry & David Einhorn at The Buttonwood Gathering 2012

Hugh Hendry is in the first part of the movie. He is the founding partner of Eclectica Asset Management and became known in 2008 as Eclectica earned +31.2%. At minute 56, Einhorn comes in to debate FED policies. No bottom up value investing theme, but definitely worth understading how he frames macro decisions that at the end of the day might affect us, value investors.

Watch live streaming video from theeconomist at

Seth Klarman quote from Q2 Letter

“The market roller coaster of 2012 continues. Speedy ascents. Sudden plummets. Unexpected twists and turns. Gut-wrenching volatility, only to end up where you began.”

 “It is a strange world we inhabit. One where economies remain extremely depressed yet almost no companies go bankrupt, while low interest rates encourage holders of capital to speculate. One where global turmoil mounts while the world passively watches. One where nearly every member of Congress will insist that we need to rein in deficit spending, while collectively Congress accomplishes virtually nothing. It would be absurdly funny if it weren’t so incredibly tragic.

(Source: Baupost Q2 Letter)

Original post from Zerohedge can be found here

Howard Marks Interview

The interview below is one of the best I have seen lately. Howard Marks, portfolio manager of Oaktree Capital and author of the book “The most important thing” (which can be found here) discusses his investment philosophy and beliefs.

Some outstanding quotes from the interview:

“The interesting thing about investing is what I call the perversity. The point is that it is so not intuitive”

“The success, which is doing better than the market in a risk-return sense, comes from understanding things better than the market. Most people don`t understand things better than the market, and most people don`t understand the need for understanding thins better than the market”

“It is having a correct non-consensus opinion when the consensus is wrong, which is not all the time”

“I think that the people there have to be deep and stimulated and stimulating and interested in discussing. I try very hard to create an environment where one person`s success doesn`t have to come at the expense of another” 

“Almost on the surface, if everybody says “We won`t do that”, then that is probably going to be cheap” 

“(…) as long as emotion takes over, then efficiency will not be realized”

“I would say that is one of the things working on the side of the patient investor, is the fact that he has a longer time frame. On te other hand, we don`t explicitly – there is a new phrase – time arbitrage. (…) Having patient capital is a great advantage.”

“I think that we always try to stress the danger of overconfidence.” 

“The most dangerous thing is to think you got it figured out, or that you can`t make a mistake, or that your estimates are right because they are yours. (…) On the other hand, it is really not a good business for people who don`t have some ego because you to do the things that Dave Swensen describes as lonely and uncomfortable.(…) You have to be strong enough in ego to hold difficult unusual positions and stay with them.”

“Taking more risk should not be one`s goal. One`s goal should be to make smart investments even if they involve risk, but not because they involve risk. That is a very important distinction.”

“Blindly accepting more risk to get the return you used to get in a high-return world can be a big mistake”

 “You might have another horse that has a lower probability of winning but the odds are so much higher, that`s the smart bet – leaving alone anything specific that you know about the horses” 

This one is just great:

“We don`t want to invest in high quality or safe things because a so-called safe thing at bad odds is a bad investment. Sometimes I think the word “quality” should be banished from the investment business if you want to make money.” 

Was he referring to big dividend payers? Or even treasuries?!

“If you buy a cheap stock when the market is high, it is a challenge because, if the market being high is followed by a general decline in prices, then for you to make money in your cheap stock, you have to swim against the tide”

“If you don`t have a superior insight, then how can something be to your advantage?”

“(…) human mind is very good at blotting out bad memories. Unfortunately, most important learning is from bad memories.” 

“(…) the most important thing is realistic expectations.”

“The people that I think are great investors are really characterized by exceptionally low levels of loss and infrequency of bad years.” 

Finally, here is the video: click here for the video