What's the most meaningful way to measure investment returns?

It's being called the biggest investment scam ever. The Economist suggested, partly tongue-in-cheek, that the "Ponzi" scheme be rebranded the "Madoff" scheme due to its size and scope. Newspapers and blogs are humming about the institutions and country club members who fell for Bernie's years of lies. Obviously, especially in retrospect, the flags were crimson. A three-person audit firm was one. The supposedly consistent 10-12% annualized returns was perhaps the biggest; the open interest in the S&P 100 options used to run the split-strike strategy was too low to support $17B of activity.

Even if the volume of options wasn't a deal killer, how would you further critique the steady investment results? This is a problem the investment management business has yet to solve, or at least speak honestly about. What's the most meaningful way to measure investment returns?

Leverage and luck are two culprits. Pile on loads of debt either through margin or options and if things go your way, your returns are juiced. If you're wrong, your bad returns are amplified. Luck can be indistinguishable from skill in the short-term. So track records should count for something.

Naturally, hedge funds and other investment vehicles breed opacity. If they divulged everything than others would simple mimic their strategies and trades and therefore "crowd out" that corner of the investment world and dry up the excess returns. But investors now will demand greater transparency, or at least know that such a way of making money is feasible.

Oddly, most investment managers treat the quality of the return as ancillary--quality in the sense of risk and in probable future results. Since their incentives are to make the coveted 2/20 fees, high risk and high returns go hand in hand. Their traditional tools of return calculation use either beta (the covariance between the asset return and the market return) or the standard deviation of the portfolio, in some relation to returns generated. Again, they're not clear as to how the returns were made, only the final number. They also use a flawed definition of risk, but that's worthy of a separate posting.

Unlevered (equity only), market beating, long-term transparent strategies are the best way to measure investment returns; the final return measured against last year's price movement deviations is not enough. It's fair to ask how a manager justifies his fees and the scorecard that should be used to decide whether he should still have a job. Managers owe their clients restful sleep.

For a group that demands, clarity, loose regulations, detailed financial footnotes, and management candor, the investment management industry needs to come clean on how it measures returns. It would help doctors, teachers, and janitors to know that not everyone that manages money is like Bernie Madoff; some of them actually "add value."

------------
Disclosure: none
Image: http://www.yu.edu/uploadedImages/Sy_Syms/Dinner_2008/madoff_web.jpg

A Carnival Quiz

I easily get excited about new businesses and what makes them tick. The industry on my mind over the last several days has been the cruise industry. And after having recently finished my first cruise, I thought this little cruise quiz would be a fun test of your cruise business intuition. Questions of this sort were on my mind between meals and while relaxing by the pool. Enjoy. Answers are posted at the end.


1. Which of the following cruise company does Carnival not own?

A) Princess
B) Holland America
C) Celebrity
D) Seaborn

2. The percentage of worldwide cruise passengers sourced from North America is....

A) 40%
B) 50%
C) 60%
D) 70%

3. Cruises have the well-deserved reputation as places to overeat. What percentage of total passenger ticket sales does Carnival spend of food for its chubby guests?

A) 8%
B) 16%
C) 24%
D) 31%


4. A great (and consistent) source of revenue is derived from other income (alcohol, casinos, souvenirs, land excursions, photos, etc.) True or false, this makes up 50% of total revenue?


5. ALBD means what in cruise economics?


6. Carnival and its publicly-traded rival Royal Caribbean have sales/debt ratios of:

A) between 20% and 49%
B) between 50% and 60%
C) between 61% and 90%
D) greater than 100%


7. What corporate action did the industry's cruise operators recently announce?


A) A near-term discontinuance of stock dividends
B) A huge drop in asset-backed securitizations
C) An increase in the share repurchase program
D) A move in corporate offices from Spokane to Atlanta.






Answer Key: 1) A, 2) D, 3) B, 4) False. It's closer to 25% of sales. 5) Costs per available lower berth day "ALBD". ALBDs assume that each cabin offered for sale accommodates two passengers and is computed by multiplying passenger capacity by revenue-producing ship operating days in the period. 6) C, 7) A.

A few words on public vs. private

After balance sheet concerns and the overall lackluster macro economic environment, the decision to be a public or private company must now keep executives wondering. Is it worth it to be a pubic company?

Most public companies have a culture of benchmarking and short-sided metrics. They are faced with quarterly grillings at the hands of mostly out-of-touch analysts who are more concerned about modeling next quarter's capital expenditures and whether earnings are off by a penny. I'm not just being cynical either. If you've listened to quarterly calls you get my point. Though some notable CEOs have the mettle to withstand the institutional imperative, most do not. A study by McKinsey & Co. shows that 50% of execs would forgo a positive NPV project rather than miss next quarter's numbers. My guess is if all were truthful it'd be even higher.

Public companies almost universally decide to grant top employees stock options. However, though these carry a tax benefit, the compliance savings of not having to abide by Sarbanes-Oxley (private co's don't have to follow this), would more than offset the tax advantage for most companies. An alternative to public stock options: a combination of cash incentives and private stock offerings. The only issue is they can't bail and sell with the ease of the the public markets. But who wants a short-term marriage anyway?

I would prefer to own a private business. I don't need to know my net worth every day. I'm in it for the long haul and I'd rather sacrifice next year's numbers for a long-term strategy that makes sense. If you're a company that needs constant access to the capital markets, a daily performace scorecard, and thinks high doses of liquid shares should be granted to top talent, stick with the public model. As for me, I prefer my privacy.

-------------------------
Disclosure: I still think some public companies are awesome.
Image: http://act.psy.cmu.edu/awpt/pictures/graph.gif

The Covered Call

The credit bubble has made fools out of many people. Economists assumed housing prices couldn't systematically drop. Banks didn't care about the underlying credit worthiness of the home owners since they quickly repackaged the loans and sold them to Fannie, Freddie, or Bear Stearns. Economics has lived up to its reputation of being a backward looking study whose predictive ability stinks. Financial risk cannot be measured based on distributions of historical returns since history does not repeat itself. This time is, and will continue to be different than '29, '73, '87, or '01. Stockpickers, this site included, have made gutsy bets on downtrodden stocks only to see their market prices plummet further.

VIX

With the CBOE volatity index (VIX), "fear index" at all-time highs, options are steeply priced due to implied near-term volatility. A high VIX index, if you're a contrarian, is a bullish signal since markets tend to place too much emphasis on the recent past.

A short call

This particular strategy is an alternative to the 1.27% yield of a 6-month T-bill or could be a long-term investment with capped upside and limited downside. Here's the play: Find a stock whose fundamentals you aren't too afraid of. Simultaneously buy shares and sell a deep-in-the-money call option. I've selected Discover Financial, a previous long only recommendation.


DFS

Discover Financial (DFS) issues credit cards and processes payments. Charge-offs are rising but Discover has over $10B in cash, only 1.85B in debt, a mere 30M in mortgage-related securities, and $1B in loan loss provisions for those who are indifferent about poor credit records. Loans, like with American Express are securitized and are therefore off-balance-sheet. Lack of willing buyers of receivables is the most serious near-term concern. Yesterday Visa and MasterCard announced a $2.75B settlement with Discover over anti-competitive practices. That adds more of a cash cushion. This is a good business at a good price (not a great business at a fantastic price--these situations are obviously rare).

The possible payoff

A 7.50 Nov 2008 call sells for 2.55/2.95 (bid/ask). If you buy 100 shares at 9.68 + .05 per share commission and collect the 2.51 (2.55 - 4.00 commission) from the short call option you face a 74% loss if the stock goes to zero, a breakeven scenario at 7.27 and a maximum profit of 2.88% if the stock finishes above 7.50. The stock could drop a further 22% from the current price and you'd still make 2.88% (including commission). This could be compared to picking up nickles in front of a steam roller. I think the downside protection is sufficient to justify a short-term alternative for idle cash.

_____________________

Disclosure:
Faro has recently made this trade. Do this with only a small portion of your available cash. Don't get too greedy and only invest in a company whose fundamentals you believe to be sound. If I were long-only one credit card company it would be AXP (a similar covered position could be made with a slightly higher investment and a lower maximum payoff).

Image: http://blog.sellsiusrealestate.com/wp-content/credit-bubble.gif

For Sale?

After the worst week ever for the Dow, the recent drop-off is now worthy of wikipedia. At cocktail parties and dinner tables the topic du jour is the market and the effect on investors' retirement accounts. We love to put the stock market in the simplest of terms, and in an odd retrospective view. The stock market is merely a place where businesses are bought and sold. Contrary to popular opinion, it is never universally wrong or right to buy or sell. But we should at least think about why we're buying or selling a piece of a business.

Cash flows

According to finance theory (and sometimes reality) the value of any asset is equal to the present value of all future expected cash flows. And with some stocks down 80% +, their very existence is now questioned, even without the toxic balance sheets of banks. Peak to trough the market has fallen over 46%, well into what economists consider bear market territory.

So if you have some cash on the sidelines, here's what to look for in companies and in strategies:

• A super clean balance sheet: since credit is a huge part of the problem, debt is now a sin. We have yet to see the coming wave of corporate debt defaults. The 10%+ spread of non-investment grade debt to US Treasuries is a testament to risk and uncertainty.
  

• Tiny market caps: these are thinly traded and have little or no analyst coverage; their price swings can be the biggest and their pricing the most inefficient.

• A large cash pile: this serves as a further cushion, or margin of safety, against a greater collapse.

• A business: a product or service that is needed or wanted in any economic environment.

• Options: covered calls (if you'd like to lower your effective cost basis but cap your upside, consider this) or married puts (to protect the downside).
  

And?

Faro is finding extreme value in global mining, Brazilian poultry, and Chinese education. Timing the market bottom is a fool's errand. However, I wouldn't bet (long at least) on banks or the American consumer (70% of GDP). Shrinking retirement accounts, falling home prices, and tightened credit must eventually bring even the most spendthrift of consumers to question whether to fork out $40.00 for dinner or drop $200.00 for jeans. Though the recent plunge reflects this, the enhanced awareness may likely lead to a self-fulfilling prophesy: an even bigger drop for companies that sell stuff people only think they need.

_______________

Note: Though readers may note the poor record (along with the market) of previous stock recommendations on this site, Faro is happy to report a flat last two weeks due to a short position in a domestic retailer.

Image: http://www.biojobblog.com/for_sale_sign(1).jpg

A Letter to Williams-Sonoma Management

Corporate excess is nothing new. The below is a letter that will be sent today to executives of Williams-Sonoma regarding the firm's use of a leased jet.

---------------------------------


September 29, 2008

W. Howard Lester
3250 Van Ness Avenue
San Francisco, CA 94109

Dear Mr. Lester:

Williams-Sonoma, Inc. has a storied past of brand equity and profitable growth. From its humble beginning in 1956, to its coveted Oprah endorsements of recent years, the company has pushed forward with winning strategies and has an impressive base of loyal customers. This, coupled with an attractively-valued stock, is what led us recently to become part owners (shareholders) of Williams-Sonoma (WSM).

We know things are tough. As shareholders, we salute the company's efforts to maximize returns on advertising by trimming the length of the catalogs and by tweaking both circulation numbers and catalog recipients. To say the market is challenging is an understatement. Home prices are correcting (falling). According to futures on the S&P/Case-Shiller Home Price Index this is likely to continue through the next several quarters.

Though systematic risk is unavoidable, certain expenses are well within management's control. Our concern is the company's use of a leased corporate jet. The related-party nature of this arrangement also raises eyebrows. As you read this, a jet is parked, or is perhaps soaring through the air, at the cost of over $12,328.78 per day (plus use-related expenses). Williams-Sonoma's likely future dealmaking and travel convenience needs do not warrant such lavish travel perks, independent Board approval aside. What could possibly justify such an expense?

We are cheerful about the long-term prospects of the company, and as shareholders, are compelled by its rock-bottom equity valuation. However, saying no to corporate waste and conspicuous luxuries is an important cost-cutting measure in any macro environment. Cruising in style in an owned or leased jet should not be part of the corporate ethos. It costs four cents per share and no measurable value can be expected from it. That money would be better spent increasing the share repurchase program. Now is the time to reverse this misappropriation of shareholder funds.

We welcome your comments.


---------------------------------

Brink's Home Security

A Breakup

Companies are always in flux: acquiring, divesting, buying back stock, retiring debt, borrowing money, managing investments, dealing with macro concerns (housing, joblessness, markets), and appeasing customers. Divestitures, often times, are part of the "creative destruction" of capitalism, and serve as chances to break up crappy businesses that a company's overpaid for, or to truly separate units that don't share common "synergies."

This can help boost returns. Spinoffs fall into this category. Unloved, unwanted, or companies in the better-off-on-their-own category soon break free and relish their independence as new entities. They're now let loose of the parent company's TPS reports and fading memories of clashes over uses of capital. Parents are relieved and can now truly focus on how to appeal to shareholders' complaints. Ain't the life of a public company grand?

Independence can ironically be the most synergistic. Brink's Home Security (BHS) sells monitored security services in a highly fragmented market to over one million North American customers. Activist investors Steel Partners and MMI Investments have encouraged a divorce of BHS from Brink's, a provider of armored transport and cash services. The company is set to break free from its parent by the end of October via a tax-free spinoff. Shareholders will receive one share of BHS for every share of Brink's (the parent). BHS will emerge with a spotless debt-free balance sheet and will be allowed to use Brink's name for three years. Then, a rebranding campaign will ensue. That sounds like a perfect opportunity to be acquired.

Revenues are largely recurring and costs fairly consistent. Operating margins have stood at an enviable 25-26% over the last couple years. Returns on capital, a sign of business strength, run close to 18%. Business is good. Revenues are up 8% year-over-year. Amidst the bursting of the real estate and credit bubbles, homeowners seem to still worry about strangers breaking in.

The Competition

ADT is probably the biggest name in the game. It is 15x BHS' size in sales but has nearly twice the attrition rate (12.7% vs. 7%) and less than half the operating margin. ADT, a division of Tyco, would love to gobble up a smaller but better run competitor.


The Breakup Fee

From the most recent form 10Q:

"Year-to-date expenses related to our strategic review, proxy matters and the spin totaled about $9 million. We’ll probably spend another $8 million to $11 million on this effort, so total expenses for these matters should be in the range of $17 million to $20 million for the year."


And....

To spend close to 50% of last year's operating income on strategic review, proxy stuff and other legal and accounting bills is a gutsy move. As future details surface, namely executive comp and insider ownership, BHS appears to be a strong, easy to understand, and predictable business. At 15x EBIT I'd consider a deeper look into this soon-to-be-public subsidiary.


---------------
Disclosure: none

Rambling on crunches, herds, lies, and bankers

The most impressionable thing with the current economic correction (most often called credit crunch) is not about the magnitude Lehman's chapter 11 filing, Merrill's sale to BofA, or AIG's balance sheet problems. It is what otherwise extremely intelligent people will do when led by greed and herd-like behavior. Nevermind the liquidity crisis, market dislocation, sharp selloff, or whatever bullshit terms rich managers use to justify their behavior and poor risk management, finance needs more straight talkers. "I made a mistake. I foolishly benchmarked my decisions against my peer group and I lost your money. I'm sorry." Failing to acknowledge the truth is both dangerous and detrimental to learning.

Bad lending and falling home prices

I daringly call it a correction (not a credit crunch) because it is leading to return of old-fashioned lending standards, the four C's: character, collateral, capital, capacity. Banks, for fear of future losses if anything, are returning to this standard (1). Housing prices in the short- to near-term will feel the affect. The Case-Shiller Home Prices futures index seems to agree prices will decline through 2010 (2). This bodes ill for most. Banks especially will suffer as a significant portion of real estate will continue to fall in value. Sometimes getting kicked in the nuts is the only way to learn.

A pain in the ARS

Auction-rate securities (ARS) are not cash equivalents (3) and everyone knows that. The maturity is greater than 90 days and they were never in the same seemingly "risk-free" category as T-bills. Banks sold them because of the commissions they made and failed to support the market when people stopped showing up for the auctions. Investors were left with discounted illiquid securities and firms only capitulated on making the investors' whole when regulators levied fines and warnings of great legal headaches. Their behavior has been nothing short of deplorable.

Securitizations and cheap money led to lackadaisical lending standards as banks tried to outshine other banks in their quest to chase yield. Banking once was about making a reasonable spread on interest paid on deposits vs. interest earned in long-term investments. We should learn a lesson from the less enviable traits of human nature.





--------------------
Disclosure: None

Notes:
(1) "Banks to toughen lending standards into 2009"
(2) "Composite 10 city U.S. Futures Market"
(3) According to SFAS-95, cash and cash equivalents are: risk-free assets with original maturities of 90 days or less.
(4) Image

The Rembrandt Question

Williams-Sonoma

It's usually a bad idea to buy the stock of a company only because you like their product. Clearly, however, there must be a service or product behind the business that: 1) is needed or desired, 2) has pricing power (ability to raise prices ahead of inflation, and 3) trades at a reasonable price (more like a bond than a Rembrandt painting). In the end, business models and economics are critical.


In addition to these points, there are a couple questions I often ask myself when I consider owning a piece of a public company (buying a stock). Could I LBO (leverage buyout) the company? Is there any Rembrandt premium? Stocks are valued partly like bonds (discounted expected future cash flow) and partly like Rembrandt paintings (1). If stock picking is presumed to be a worthwhile exercise then this statement is critical. I only wish I had been the first to say it in those words.

A brief overview

Williams-Sonoma is "a specialty retailer of products for the home." That wins the award for the simplest opening line of a business description section of a 10K. The company operates 600 stores, primarily Williams-Sonoma (WSM) and Pottery Barn. WSM sells really nice kitchen-related items while Pottery Barn sells furniture and other housewares. 58% of sales are made in retail stores. 42% are direct-to-customer sales (catalogs and online). WSM has felt the downturn of the housing market. Same-store-sales numbers have dropped over 10% while shares have fallen over 50% from last year's high. But are they worth a look today? Two important questions follow.

Could I LBO Williams-Sonoma?

Assuming a 30% premium, the historical average for buyouts, and 60% debt and 40% equity at a 6.5% pretax cost of debt, would put the interest coverage ratio (EBITDA/interest) at 4.5x. This would likely fall in the BBB debt rating, the last notch of investment grade. Would bankers loan under such a structure? Maybe in today's market. Very likely in tomorrow's. It kind of passes the LBO check.

What is the Rembrandt premium?

A Rembrandt premium is most obvious when the bulk of the discounted future earnings is out 5 years plus. Capitalism works its magic when numbers look super good; returns revert to the mean and creative destruction runs its course in most cases. I've recently had this theory of shorting any company that's on the cover of Fortune or Forbes. Since journalists are generally backward-looking, I think this might make sense.

WSM now sells for 7x cash flow, or a 14% cash flow yield. Given the relative strength of its yuppie customer base, and the current valuation, it is not selling for a Rembrandt premium. I don't lose sleep about owning a portion of Williams-Sonoma. The current credit environment has reinforced my belief in understanding not only a company's potential future earnings, but also its balance sheet. The balance sheet has no net debt and the company sells for 2x current assets.


Though I've never bought $40.00 pumpkin loaf tins from Williams-Sonoma, as a shareholder I'm glad thirtysomething white people do.

----------------------

Notes

(1) Charlie Munger
(2) 2007 10K

Disclosure The author has a covered call position in WSM.

And Then There Were Five: IAC/InterActiveCorp's Spin-off

After feeling the heat from disgruntled investors, Barry Diller has now succeeded at splitting IAC into five publicly traded companies. The parent IAC, until the spin, was an amalgamation of internet sites, cable networks, travel services, and mortgage lending. These groups had little in common (not a lot of 'synergies').

The split finalized today after nearly a year of paying high adviser (lawyers and bankers) fees.
The hope is that the svelter IAC will put the $1.3B in cash it extracted out of its other business to work.

However, Moody's slashed its corporate rating to junk due to "the significant reduction in IAC's scale and business diversity with the spin-off of approximately 78% of its revenue and approximately 73% of segment EBITDA." No matter. With a huge pile of cash and less side businesses to worry about, IAC just might fare well. Investors seem to think so: shares traded up over 8% today.

But what of the other four?

TicketMaster (TKTM) received very little detail in past IAC SEC filings. Independence will be great for a seemingly neglected company. Hopefully, the new company will fight Live Nation, a former customer (14% of revenue).

Tree.com (Lendingtree.com) is still an attractive site for consumers to shop for mortgage loans. Lack of company financials makes it too early to say.

HSN (Home Shopping Network): there are few things in today's economic environment that worry me more than strapped customers' willingness to sit and watch a channel (or surf the website) to buy blenders and gold-plated wrist watches.

ILG (Interval Leisure Group): this is a timeshare company. At just over 2x sales and with recurring revenue from gullible consumers, ILG's valuation looks decent.


The greatest joy is the absence of historical line-by-line economics, especially for the four subsidiaries. Bank analysts love to extrapolate these items into the future to justify their "target prices." Lack of such detail, coupled with forced selling (some institutions will have to sell shares of the smaller companies), and the relatively new entrepreneurial zeal of the new bosses, should create some potential buying opportunities. You won't see that on the Home Shopping Network.


---------
Disclosure: None
Image: http://aplasticcentral.com/images/then%20there%20were%205.jpg

An earnings followup

Orbitz

The bookings question: overall, bookings rose to $3B, or 4%. This was a tale of two stories: international jumped 41% to $476M; domestic remained basically flat at -1% growth, or $2.6B. The air side of the bookings did less well, down 13% due to a decline in U.S. volume.

This segment of the travel business is tough: margins are negative, returns on equity capital are decreasing and I'm not sure what edge they have over the competition.

Would I like to run the business over the next five years? No. What would I do as a competitor to erode Orbiz' business, I'm not sure. I'd take a pass on this company though fundamentally it doesn't look like a bubble stock.



Cowen

The company is trading at close to cash because of the deterioration of its model. The future of the super-small boutique firm is looking not so hot as panicked companies and investors seek the comfort of larger and more established banks (though their blunders as of late have been huge). At an industry high employee compensation-to-revenue ratio of 60% +, any reduction of business (investment banking is down 32%), cash on hand will get eaten up as the Cowen continues to operate as a going concern. If I were management, I'd look for a bigger player to buy me.



Papa John's

Wheat and cheese prices are rising fast (100%+ and 26% year-over-year). 35-40% of Papa's cost is cheese. The pizza world is too competitive to pass those price increases on to customers. This will pressure margins. Look for the cheapest (Little Caesar's) and the highest-end niche players (The Pie Pizza where I live) to do less poorly. I love pizza. I'm not to keen on pizza economics.


Perini

It's growing somewhere, oddly enough in Cali. and Vegas. That's saying something in today's environment. Revenue is up 21% and its backlog book of construction business is at $6.8B. With an enterprise value of $400M and $5B in sales, coupled with a pristine balance sheet and $460M in cash in the bank, it may be time to say hello to construction.



Beazer

It's adjusted balance sheet is still a mystery. If you're looking at placing a bet with a home builder, try DR Horton or NVR. Both are in better financial shape and run businesses I'd rather operate. They're also the builders I'd be least enthusiastic about competing against.


-----------
Disclosure: None

Earnings Time

Corporate executives are great salesmen. Many have climbed the ladder through actually sales talent, or by selling themselves. One of their preferred pitches once they reach the top is the case for their stock: it's always undervalued by the market.

Quarterly earnings releases are important market signals since a company has to earn real money (either now or in the future) to be worth something. But earnings reports can also be rife with overly optimistic management speak and fuzzy accounting assumptions. Management will border on dishonesty to prove their case. That's why, with no significant research budget, Faro relies on basic economics, common sense, and financials as the foundation for investment decisions.

So when analyzing the earnings releases, look for companies with potential economic signals (Are people eating out less? Do moviegoers habits change in a bad economy? Are people paying their credit card bills?) True, these are lagging economic indicators, but econ is not known for its predictive value. Since learning is cumulative, even if management is full of it, you'll be able to take away useful bits of info. And, you'll be able to hang this on your problem solving matrix framework (PSMF). I just made that up.

As we're in the middle of "earnings season," each day of this week there's a call which is probably worth paying attention to.

-------------------------
Monday

Orbitz (online travel). How bad are leisure and business travel bookings?

Tuesday

Cowen (boutique investment bank). Why is this company trading at close to cash? 116M net cash vs. 122M market cap.

Wednesday

Papa John's (pizzas). How are commodity costs affecting margins?

Thursday

Perini (general contracting and construction management). What's changed in the last 12 months?

Friday

Beazer (home builder). What would its adjusted balance sheet really look like?

-------------------------

Enjoy.

$1 Trillion

This article, written by famed bond guru Bill Gross of PIMCO, paints a bleak picture of the current financial environment.


In my opinion, banking, at least over the next generation, will be drastically different:

1) gone are the days of no-doc teaser home loans.
2) banks are now much more risk averse (less willing to lend to anyone with just a pulse).
3) many more banks will fail.

What America needs is the Leave-it-to-Beaver era of thrift, honesty and a 20% down payment. I would not lend to someone who didn't pass that filter. I don't have much faith in people not wanting to keep up with the Joneses.

Sadly, however, this crisis means Uncle Sam's place in our lives just got bigger. America will live with much of this. Remember, some of the most odious Acts and Laws were passed several decades ago (e.g., Social Security). So be leery of any measures to 'save' homeowners. Few find it politically expedient to speak the truth: the banks lied; the borrowers lied; the mortgage lenders lied. That's a scary combination. But all should pay the price before the taxpayer carries the burden.

As Buffett said: "Be greedy when others are fearful and fearful when others are greedy." There's blood in the streets now, but expect more. Nevertheless, I am optimistic about the long-term ingenuity of America's creative engines.

On Timeshares and Psychology

There's something about mostly tan, thin, vacation-theme clothed, and universally happy sales people that breeds distrust. This past weekend, my wife and I sat through our third timeshare presentation in as many years. We're not interested, but companies now dangle bigger rewards as incentives to come sit for 90 minutes; sales presentations can also be a great education in psychological persuasion and in how to see through fuzzy math. It was a 4th of July weekend well spent at a Worldmark office, a subsidiary of Wyndam (Ticker: WYN).

The picture

4.4 million US households own vacation ownership interests (a euphemism for timeshares). For Worldmark, The average age is 52 and the median household income is $74,000; this is the middle class, the I-can-feel-retirement-coming crowd. Again, this is the median number so half are older and have are younger. All are bad at math, however.

We were probably referred by a friend or acquaintance (they offer extra perks for referrals). The sales building was located in a typical office park but in an upper-middle class area of town. The parking area was newly paved and partially shaded with immature trees. The entrance was simple yet attractive and on 95 degree day, the cool office air felt almost too cold. The facilities had the disadvantage of being located off-site. There was no personal tour to entice would-be buyers with extra big jet tubs and high thread count sheets (or whatever they have). On-site tours account for 90% of Wyndam's timeshare sales though only 80% of sales close on-site.

Once settled in the office our sales rep (a twentysomething mother of two) offered us cookies and soda--an odd and unsatisfying menu given the mid-morning hour of our appointment. 10-15 couples of middle and young family age, joined us in what I'll call "why everyone needs to buy a Worldmark timeshare."

The Economics

Worldmark should make a profit, but it's how they present that bothers me.

The direct cost to the consumer are: 1) a lump sum payment, generally 10% down; financing is pre-approved at 17.9% (a stratospheric rate) though the average interest rate on 277,000 loans ($3.3 billion in total loans) is 12.5% (source: 2007 10K). This is still extremely high; 2) Maintenance fees* of $500-1,000 per year depending on the number of vacation credits (these are exchanged for days at any one of the company's 67 resorts.)

The numbers presented to us were vacation credits roughly equivalent to ten days per year for 55 years. The one time fee was $31,340 with an annual maintenance fee of $947.00, or $94.70 per day. The key factors in doing the math are the estimated average room rate increases over the next 55 years and the assumed alternative rate of return (the opportunity cost of capital) of the lump sum payment. Opportunity cost is one of the most important principles of any economics class.

Wordmark's assumed room rate inflation is 7.6% and is based on past 30 years. This number seems high and unlikely to continue. This is economic red flag number one in the presentation. Room rate inflation, according to form 10K, over the last 8 years has been closer to 4%. I make the assumption of an opportunity cost of capital based on the stock market (S&P 500) recent 30 year compounded annual growth rate of approximately 9%. 7-8% would probably be more appropriate.

In the pitch, she told us room rates averaged $150.00+; a higher hotel room rate makes it more appealing to lock in the rate today; it's also very dishonest. This is economic red flag number two. With a base room rate of $108 (the average daily hotel room rate for 2007 was $103.00 per 2007 10K) and 7.6% room rate inflation over 55 years at 10 days per year you will have paid $725k for hotel rooms assuming you 'vacation' as they say you should.

But what would you have given up (what's the opportunity cost for saying yes)? If you invested the $31,340 lump sum payment in the S&P 500 over the course of the same 55 year period, with an assumed return of just over 9% you'd have over $3.1 millions dollars. Add the yearly fixed maintenance fees of 947.00 and you'd have another $1.3 million.

The pitch compared future dollars to present dollars (the lump sum payment you'll make up front)--an apples to soggy watermelon comparison. This is economic red flag number three. Clearly $725k in future hotel bills looks cheap next to the $4.4 million opportunity cost. (This assumes the $31k lump sump payment is made in cash; to finance 90% of this and to add the 12.5% rate financing to equation would look even less favorable from the consumers perspective.

Securitizations

After too many cokes, the opaque math and bombardment of vacation imagery, a middle age couple decides to go for it. Of a motley group of 15-20 or so couples, they are perhaps the only to buy. The others will either sleep on it (rarely a bad policy), or just say it's too much money.

A check for 10% down is cut, the contract is signed and the couple walks with gifts equal to some reimbursement of their time. The salesman smiles looking for approval from his now content supervisor, while other sales reps curse that others were too cautious and rational.

When a deal is closed the firm sells the loan within 30-90 days as part of a receivables securitization (loans packaged and sold to investors). With a spread of 7.1% (WYN borrows at 5.4%--per 2007 10K--and lends at 12.5% for vacation ownership loans) over the standard 10-15 year period for such a loan, banking becomes the bread and butter of the business.

The present value of such a loan is worth 33% more than if the lending were done at 3.00% above borrowing costs (more reasonable given the credit of timeshare owners).

Over the last three years, securitization of customer receivables has generated $1.5 billion in gains for Wyndam, the parent company. The pursuit of profit is hardly shady, but free cash flow (what the company makes from it's core business of hotels, vacation rentals, and timeshares) over the sames period has netted a mere $148 million. To sell pools of loans is 10 times as profitable as the company's general operations. This helps to understand the motivation of receivables financing.

The psychology

So why would someone buy a timeshare if the numbers look so bad for the consumer and so great for the company?

As we proceeded through the sales pitch, I took down mental notes of some of the principles touched on in Cialdini's book, Influence: The Psychology of Persuasion. I also jotted down numbers, as the sales rep nervously observed, since this drives the rationale for accepting or rejecting decisions of this kind.

Every sales experience is deeply rooted in human psychology. Cialdini's book is so influential that upon reading it, Charlie Munger of Berkshire Hathaway, gifted the author one Berkshire Class A share. I've recommended this book to no fewer than 10 people. I've outlined some key points used in the timeshare sales-pitch.

Social Proof

Everyone is doing it. A common refrain from high school, this is ubiquitous in the world. When I said that this didn't make economic sense, she replied: "If this didn't make sense, we wouldn't be in business."

Reciprocation

There's a powerful example from the book: In a WWI battle situation, a German surprised an enemy soldier in no-man's land while the enemy was eating a sandwich. The enemy soldier surprisingly reached out and gave the German some of his food. The stunned German soldier, under command to bring back any captors for interrogating, returned alone to face the wrath of his superiors

Worldmark offers free cookies, coke, two or three nights in a resort, gas cards, and $100.00 restaurant gift card: the least you could do is become a "vacation ownership" member as a return for all these favors.

Scarcity

We received a call the day before wanting to push back our time 2 hrs. When we declined they offered us a $50.00 gas card. We kept our original reservation. They tried to create the aura of scarcity. Panicky financial decisions are rarely good ones.

Liking

We like others like us. Timeshare pitchers are young, attractive, tan, and tend to favor Hawaiian shirts over more traditional dress since we all like the idea of worry-free vacationing.

Authority

Worldmark uses AAA as the authority source for future room rate inflation. But you should ask: Is this authority truly an expert? And, are these statistics misstated or cherry picked?

How can we say no?

The easiest was to say no is avoidance. If that's not an option, then we must accept offers only for what they fundamentally are. Hence, the focus on the economics. Timeshares at best are a ripoff, at worst, sales associates (or sales executives as they may be called to inflate the importance of their jobs) present a skewed view of the world through contemptibly misleading numbers.

--------

Disclosure:

None

Notes:
*"These fees generally are used to renovate and replace furnishings, pay operating, maintenance and cleaning costs, pay management fees and expenses, and cover taxes (in some states), insurance and other related costs. Wyndham Vacation Resorts, as the owner of unsold inventory at resorts, also pays maintenance fees to property owners’ associations in accordance with the legal requirements of the states or jurisdictions in which the resorts are located. In addition, at certain newly developed resorts, Wyndham Vacation Resorts enters into subsidy agreements with the property owners’ associations to cover costs that otherwise would be covered by annual maintenance fees payable with respect to vacation ownership interests that have not yet been sold."

Some thoughts concerning timeshares

There's something about mostly tan, thin, vacation-themed clothed, and universally happy sales people that breeds distrust. This weekend, my wife and I sat through our third timeshare presentation--not because we're interested, but because companies dangle bigger carrots as incentives to come sit for 90 minutes, and it can be a great education.

I'm compiling some industry and company specific figures on the economics of timeshares to share with friends, family, and eager readers. Results will post within a few days.

The verdict: don't buy one (this shouldn't be a giveaway for most).

Executive Writing

Nothing in the business world draws more ire than "high" executive pay. Ask a doctor what they think and they'll most likely declare: "I save lives. What do execs do?" Faro discussed management pay in a previous post and argued in favor of rational, shareholder-friendly payouts for top talent. Like a good exercise program, the advice is rarely heeded.

How executives get their jobs is worth pondering. In addition to talent (for most) and energy, much of the rung-climbing success is due to politicking and affability. Companies understandably gravitate to likable people. Though being a nice guy shouldn't be as big of a part of the equation. Clear communication and honesty should be near the top of the list.

You don't want a CEO who's just a consensus builder and good golfer. But that's how many do it. Too many, perhaps, come from smooth talking sales backgrounds. These are 'yes' people.

You have to wonder, why these 'yes' people want to be CEO of a big company. Is it the power, the money, the ego? The lifestyle and the lavish houses, however, are appealing. In an interview with Fortune, a famous rich guy named Warren said he'd rather be a paperboy than be the CEO of GE. Whether he meant this post- or pre-billionaire status is kind of irrelevant. People should place a high value on their time.

Well, what do CEOs do? They lead the strategy of the company. They motivate. They make sure all the pieces of the puzzle fit and that, ideally, the value of the firm increases over time. They attend meetings. They have secretaries who arrange their schedules. They golf. They attend fancy dinners. They hire and fire. They are scapegoats. They put in long hours (however productive they may be). They also should write the annual shareholders' letter. This seemingly easy task is, more often than not, plagued with ambiguity and buzzwords.

Below is the Fresh Del Monte 2007 letter to shareholders. Cleaning this up would be messy. The astute reader should be leery when only GAAP figures are mentioned, but also skeptical of language like "excluding", "other charges", "accretive" (though this term is not used below, it is very common when justifying a potential acquisition), etc. This doesn't mean the business is poor; the presentation is just bad. The poor writing also reflects unclear thinking. It doesn't have to be poetry, but it should be better than MBA-level "strategic" writing. But maybe strategic is what Wallstreet is looking for.

Areas of concern in the letter are in red. Faro's comments are bolded and in brackets.

__________

"Two thousand and seven was one of the best years in the history of Fresh Del Monte Produce. During this period, we benefited from the many improvements we made in all of our business lines, which restored Fresh Del Monte’s track record of creating enhanced shareholder value [I'd mention the 2007 stock performance of +125%. That's impressive.] To achieve this goal, we continued to streamline our fresh and fresh cut businesses, eliminating unprofitable products in our fresh-cut line, while maximizing production and driving efficiencies in our logistics networks. In addition, we improved banana contract pricing in North America, countering higher production and logistics costs. We expanded our global customer base, and we began to serve a number of new markets [I like numbers].

We also continued to leverage the power of the Del Monte® brand to create new inroads in fast-growing Middle East markets. Much of our success in these and other markets is due to enduring consumer confidence in our 115-year-old brand, which symbolizes quality, freshness and reliability. In addition, we aggressively repositioned our prepared food business by streamlining production and distribution [how? don't give away your secrets, but how].As a result of our solid operating achievements in 2007, we were able to deliver substantially improved performance across a range of financial metrics. Earnings per diluted share climbed to $3.22, compared with $0.10 per diluted share for the year ended 2006, excluding asset impairment, restructuring and other charges [i.e., exluding the bad stuff]. Net sales for the year increased to $3.4 billion, compared with $3.2 billion in 2006. Gross profit for the year rose to $364.9 million, compared with $189.4 million in the prior year. Net income for the year increased to $179.8 million, compared with a net loss of $142.2 million in 2006.

We are justifiably proud of our performance in 2007, particularly as the prior year had been one of the most difficult we had ever endured. In 2006, we faced a number of hurdles, including higher energy and production costs [you state it later in the 10k, why not mention impact of energy costs in $. What about foreign currency? That's on my mind too] . The fact that we were able to overcome the lingering effects of those factors in 2007 is a testament to the expertise and commitment of our management team and the dedication of our 35,000 employees around the world. It is also a powerful endorsement of our business model. Our mission is centered on increasing shareholder value [who's isn't]. To fulfill this mission, we set out each day focused on offering products and services that meet the needs of our customers and enable us to improve profitability. While this mission requires disciplined implementation, it also calls for flexibility and resilience—two inherent qualities that we demonstrated yet again in 2007, when in spite of continuing cost pressures, we delivered some of the strongest financial results in our history [examples would be great].

As we advance through 2008, we are optimistic about our future. Fresh Del Monte Produce continues to perform well around the world, in part because of our concerted efforts to improve our operating efficiencies and reduce costs. These efforts continue, and we remain vigilant about meeting the continuing challenges of fluctuating costs related to production, transportation, fuel and packaging. We also remain firmly committed to prudently growing the Company, improving our operations, expanding in new geographic areas and developing new products to meet consumer demand. As we steadily pursue these measures, we warmly thank all of our shareholders—including those of you who took a first-time stake in our Company in 2007—for your continued support."

__________

Source: http://library.corporate-ir.net/library/10/108/108461/items/285073/FDP07AR.pdf

Disclosure: none

The Problem with Being Active

This site was originally spinofftracker.blogspot.com. Spinoffs are still a great place to dig. Though I'm sure one of the rules of a successful blog is focus, this site meanders from the rare company analysis to random musings on markets and human nature. The principle reason is fear of activity. In most situations in life, the scorecard is based on how busy we look, not on how productive we are.

Society supports and rewards activity. Only in times past it was harder to fake. If you lived in the Great Rift Valley, it was impossible to pretend to hunt. Today we have IM and meetings to mask our slacking.

In the online financial world, sites that give advice, particularly stock advice, bore the reader with mundane lists and yesterday's news. They try to hard to be active. The Motley Fool is an example of a site with an occasional standout story or opinion piece. The rest is mediocre. (Important note: I did interview unsuccessfully--by some measures--with The Fool.) Their analysts try too hard to create the next big headline: "Why you need to buy these 5 stocks today", "3 mistakes Buffett made." Those headlines are not real. But most articles are overly hedged, obvious, or too promotional.

Hyperactivity is a great argument against subscribing to a stock newsletter. I'd guess that most newsletters are marketed to individuals not institutions. Institutions have research departments and sophisticated TPS reports.

A person, we'll call him Bill, is 45 years old and enjoys a modest income. Bill occasionally listens and cares about what Ben Bernanke says. He peruses the business section of the paper. He knows what LIBOR means, that the S&P is a market-weighted index, and that nobody really understands credit default swap exposure. He's ahead of the pack.

Most stock newsletters publish monthly picks of 1-2 stocks. You can imagine if Bill subscribes to just one letter, over the course of five years--the minimum time frame to establish a solid track record--that he'll have seen 60-120 recommendations. And surely he's not puting all his extra cash in one newsletter's picks. He'll pay 200-300 dollars per year for the letter and he'll cherry pick stocks he's familiar with. His performance will be very different from the letter's reported numbers.

Far superior to the newsletter model is money management. The idea of being a mere observer and learner and reaping the huge paydays is probably diverting many geniuses from cancer research and mentoring. That's not to say funds don't justify their "work" in some way. Nerds create algorithms, and fancy charts with Greek letters attempt to validate the lucrative 2 and 20 (2% of assets and 20% of returns) fees.

The ideal model is simpler. It would be a team of one or two. An ambitious unpaid intern could be of use in filtering and going through boring SEC filings. Office space would have to be free at the start, run out of an apartment or house. There'd be no company car, perks, or "strategic lunches." Portfolio turnover would be minimal, leverage nil, and picks rare (maybe 3-5 stocks in most years) but uncommonly good. 1.5% of hedge funds (loosely regulated investment firms) manage less than $100M. The fund would be small, have a one-time 100 basis point fee, and a performance fee of 20%, but only after profits of 5%. Size would be an advantage as the investment universe would be tilted toward $10-500M companies (too small for the big boys). The majority of the founder's net worth will be married to the fund.

Productivity, as measured by long-term returns, is the key. Bull shit activity is the curse of the modern corporation. A lot of big dumb problems can be avoided if we continually learn and work intelligently. Who cares if someone wears a nicer tie and walks faster than you.

Disclosure: see statement at bottom of screen.
Image: http://www.vtt.fi/kuvat/cluster1_tieto_ja_viestintatekniikka_elektroniikka/sw_testing_kuva_big.jpg

Life as a balance sheet

Albert Einstein famously referred to compound interest as the 8th wonder of the world. Double-entry book keeping arguably deserves a spot in the top 10.


Developed by Luca Pacioli, an Italian monk and mathematician, double-entry book keeping is the foundation of accounting. Pacioli established any transaction as a set of two transactions. If you're not yet bored, keep reading. This is a basic T-account, a favorite for accountants.

On the left of the T is the debit, on the right is the credit. Note: debit is not universally negative as many use it. A debit increases an asset; a debit decreases a liability and owners' equity. A = L + OE, to remember, think of the cold green gel that cools sunburned skin. Assets = Liabilities + Owners' Equity.

Assets are defined by SFAC 6 (Statement of Financial Accounting Concepts) as "probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events." A liability is "probable future sacrifices of economic benefits arising from present obligations or a particular entity to transfer assets or to provide services to other entities in the future as a result of past transactions or events." This seems fun enough. An asset is usually good; a liability is usually bad. We'll spare the accounting details here.

Owners' equity, we'll just call it equity for our purposes, is the net of assets and liabilities. This is simple. The goal of companies is to consistently increase the equity piece of the pie, and the market value of the stock (again, we'll spare the accounting lesson of book value and market value details). Berkshire Hathaway has increased it's equity per share (book value per share) from single digits to tens of thousands. A compound annual growth rate north of 20%.

The personal finance jungle

Financial planning advice, outside estate and tax issues, is usually pretty bad. So though this is more qualitative in it's approach, Faro ventures to be one of the few to add valuable personal financial advice: treat your life as a balance sheet.

It goes something like this. And you can break this down however you'd like. Every period, be it a day or a month, has a series of debit and credit transactions. I'm getting into accounting terms; don't be too scared. Good sleep is a debit to assets--it has a positive future benefit. It also increases the equity in the long-term health account. Smoking would do just the opposite.

Time, and how it is spent, is a trickier one to estimate. Rest and fun are good, but in excess are a liability and decrease the equity in your quality of life account. Don't get lost with this.

How we spend our time becomes critical to our equity account. And anyone with competing interests--families, "careers", hobbies, reality TV schedules, and others--knows this. If in a day, you take out the uncontrollable factors, (sleep, work, etc) your time to have a material impact on your equity account is limited. It may be as few as 4-6 hours per day. So if you spend most of your time worrying about how cool your car is, what to watch on TV tonight, or planning the next credit-funded vacation, you'll discover your equity account is small.

The average American who watches four hours per day of television should feel this. The difficulty is in realizing and changing this. But treating your life as a balance sheet is a great way to open your eyes. It also helps establish the mindset for analyzing companies' decisions.

Useful Calls

Finance is prone to problems and complaints. There's too much regulation, then not enough. There's the politically valuable common man (the "working class") and there's Mr. Burns. Financial information is abundant; there's too much. Jim Cramer should annoy most sane people.

So when you open floodgates of financial media, you either have to ignore most noise, or only rarely but deeply pay attention. Faro prefers the former. Selecting what is newsworthy is hard given the prevalence of financial data: CPI, Case-Shiller, employment, level of the Dow vs eight days ago (who really cares?), oil, commodities, trade imbalances, inflation, etc.

These all have value. But meaningful short-term economic forecasting is extremely difficult. There is, however, a great source of data that come direct from companies (though you should be selective since most CEOs are salesman). Only pay close attention to companies whose business models you admire or that have a compelling special situation scenario--real "change" in the works.

This site is following three companies during this week's earnings calls: Borders, Costco and Tiffany & Co. All are household names and operate in the easy-to-understand worlds of books, food and electronics, and high-end jewelry.

All should add insight to investors on commodity costs, consumer behavior, and luxury consumers. Borders is in the news as a potential acquisition target for Barnes & Noble. A combination would have 30% of the book market. Costco brought in 1.3B in membership fees, curiously close ((1.2x) to its reported FY2007 profits. That's a fair trade-off for good food, a 90-day return policy, and tasty Saturday samples. Tiffany seems immune to the current economic woes. Drop in USD will be interesting in results, as will expansion plans.

Grab a pen, pay attention and ignore the buzzwords.

Wednesday: Borders

Thursday: Costco

Friday: Tiffany & Co.

Disclosure: None

Image: http://www.bradleygoughdiamonds.com/pictures/diamond.jpg

On Restaurants

Restaurants largely deserve their reputation as poor businesses. Any business with low barriers to entry will never make much more than its cost of capital*. It's capitalism 101. You don't need to read strategy guru Michael Porter to know that.

Long waits and good food don't equal a buy signal. The Cheesecake Factory, other than its bad name, is famous for it's dairy desserts and long waits. I wouldn't salivate over the stock, however. All capital expenditures, in excess of actual cash generated, are understandable plowed back into growing store count. But the incremental returns on capital are mediocre 13% / 8% (levered to unlevered).


Costs across restaurants are fairly consistent: about 1/3 of sales is food, 1/3 labor, 25-30% SG&A and other, and the other 5 cents flow to the bottom line.


Ticker ROE (ttm) ROE (w/o debt) Profit Margin


CAKE 13.0% 8.4% 4.51%
DRI 28.6% 12.6% 5.83%
EAT 24.7% 12.6% 4.71%
MCD 16.7% 10.0% 10.86%
RUTH 20.4% 9.1% 4.76%



Problems

• higher wages: minimum wages will jump 12% in some states this summer.
• low barriers to entry
• exposure to fluctuations of commodity costs while unable to pass on costs.
• consumer fundamentals: there were 524,286 eating and drinking places in the U.S. in 2006 -- a 45% increase from 1990, according to the National Restaurant Association. The U.S. population rose 20% during that period, according to census figures.**"
• People aren't eating out more frequently than 10-15 years ago.
• The solution: crimp on extras, cut hours, or offer specials.

The thought of a smaller burger patty brought by a disgruntled waiter annoys me.

In business, just like airline seats, the middle sucks. The low-cost fast food restaurant (e.g., McDonald's) or the high-end (Ruth's Chris) will be most likely to succeed in the long-term. A restaurant that can earn barely in excess of it's cost of capital is a wonderful restaurant, not a wonderful business.


Notes:
*return a firm would earn on an investment of similar risk
**Wall Street Journal
Image: http://www.shyiam.com/wp-content/uploads/2007/06/cheesecake.jpg

Hyping Stocks

Anyone who pretends to give stock tips should report transparent performance. Faro holds itself to that standard. Below is a brief update of all companies recommended on this site, with an unbiased view of how the three stocks have done. There's no massaging the numbers, no justifications or excuses; it's just the performance based on the adjusted closing price as of 5/9/08. All positions are still held in the Faro portfolio with no plans of selling. Additional shares of LOJN were purchased after the stock dropped 25%.

Nordstrom (JWN)
April same-store sales figures came in at -3.8%. That's a bigger decline than the '01-'02 downturn. There could be more shoes to drop. The Nordstrom name and franchise, however, is strong. JWN trades at a forward multiple of 12x earnings, 6.7x ebitda, .85x sales; it earns an enviable return on equity of 43%; Interest coverage ratio is 15x.

-10.8% vs. S&P -8.6%
Recommended: 10/27/07

Discover Financial Services (DFS)
In the current economic environment, few companies--outside mortgage originators, "greedy" banks, and brothels--get more flak than does DFS. Households continue to worry about expenses. Credit card issuers are often the scapegoats for America's vast financial illiteracy. A key indicator of the firm's business, the net charge-off rate, stood at 3.84% for fiscal 2007. Discover is priced at 11x forward earnings, 2x sales, and has 17.29 in cash per share.


39.3% vs. S&P 5.9%
Recommended: 1/20/08


LoJack (LOJN)
People keep stealing cars. Revenue for LoJack, however, fell 15%. The company faces a challenging near-term outlook as cash-strapped consumers delay big-ticket purchases. Car dealers are focused on clearing out sales lots and less on the added revenue from LoJack units.
Shares are at 10x forward earnings and .83x sales. The company earns a slight excess of its cost of capital: return on equity is about 14%.

-28.7% vs. S&P 1.7%
Recommended: 2/23/08


Is this site worth reading? You decide.

Image http://www.edmunds.com/pictures/VEHICLE/1993/Ford/7227/1993.ford.tempo.3624-396x249.jpg

Beyond The Klamath

If it were any other time of year, you'd wonder why 31,000+ went to Nebraska for a single event. This weekend, however, thousands converged on the surprisingly pleasant city of Omaha for the Berkshire Hathaway shareholders' meeting. Most came to hear from Warren. A handful came to protest. The protests did impact the mood.

The event continued. Despite efforts by the misguided few to protest the Klamath river hydroelectric dams of Pacificorp, a Berkshire-owned regulated utility. Capitalism and modernity never please all parties.

The trip to Omaha is a yearly journey thousands make in hopes of hearing the next piece of investment wisdom, thoughts on the economy, and political opinion. Many learn. Most of us, however, listen and forget. Advice, when truly needed, is seldom heeded. To paraphrase Munger's past comments on this, when people ask for advice, they often mean: spoon-feed me advice so I can be rich, only more quickly.

It is valuable time for friends and investment advisors to reflect on the past year and to consider their next capital allocation decisions.

The questions, however, were surprisingly poor given the financial hurdles of ownership and the intellectual make-up of the party-goers. Most of what was asked is found in past annual reports, books, or public comments. The true gems stemmed from the inspiration of the simple economic truths of Buffett's approach of analyzing people and businesses.

Below is a summary of a few points Buffett and Munger (Co-Chairman) made that I pondered both on Saturday, and on the return flight.

Noise

We ignore 99.9% of what we see in the market (stocks)

Communication

Communication--written and oral--is enormously valuable and under-taught.

What determines dividend policy

Whether you can earn more than $1 of market value per $1 of retained earnings.

Integrity

When we make a deal, there are no special clauses.....Whether Ben Bernanke runs off to Brazil with Paris Hilton, or if a nuclear bomb explodes over NYC, the deal will go through.

It's refreshing to hear such simple advice from a candid, smart, but imperfect man. Hopefully we listen. And hopefully we learn when, where, and to whom we protest.

Disclosure: none