Value Investing - Buffett, Graham, et al

Ok, there's a thread on technical analysis on here so I guess a thread on value investing won't harm. So lets start with a nice little article I picked up earlier on in the year on where Buffett invests his money when he doesn't have his Berkshire hat on. Might surprise some, saw someone post something on a thread here saying Buffett doesn't do turnarounds. That so????

The Profitable Hobby of Warren Buffett
Tuesday July 6, 12:30 pm ET
By James Altucher, Special to RealMoney.com


Yesterday, a little-noticed event took place, and it wasn't even mentioned in the financial media. A small, $11 million market-cap, over-the-counter company called Laser Mortgage (LSMM:OTC BB) announced that stockholders of record as of July 5 would receive a dividend of 86 cents per share. The stock closed at 84 cents Friday. This distribution represents the dissolution of the company.
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Why is this interesting? Over the past several years, one of the company's largest shareholders was Warren Buffett. No, not Berkshire Hathaway (NYSE:BRKa - News), but Buffett in one of the few dalliances he takes with his personal portfolio.

Although it represents only a small portion of Buffett's overall net worth (0.25%, according to him), his personal portfolio over the past 10 years sheds some interesting light on his views on investing. With more than $30 billion that needs to be put to work, Berkshire Hathaway is too big for Buffett to get into the type of situations he loved when he was running his hedge fund from 1957 to 1969.

These "Workout" situations, as Buffett called them at the time, often represented up to 50% of the profits in his fund, depending on the year, and were heavily influenced by the writings and teachings of Buffett's mentor Ben Graham. In most cases, they were small companies, trading below liquidation value, or where Buffett thought liquidation was in the works or, in some cases, had already been announced. When Buffett expanded his repertoire to buying growing companies above their breakup value, he likened the Graham-Dodd approach to buying "cigar butts -- you can pick them off the ground and smoke one more puff, but that's about it."

I'll take a look at a few trades in his personal portfolio over the past decade. For all of these trades, it's impossible to know all of the details because Buffett never discusses them and is only obligated to file his ownership when it exceeds 5% of the company. However, we can still pick through the SEC filings and news reports on the companies and try to examine what happened, when and why.


Laser Mortgage
This company was a mortgage-backed real estate investment trust that quickly got into trouble in 1999 and 2000 when interest rates spiked up. It used heavy leverage and made very concentrated bets that backfired horribly when mortgage lenders defaulted, causing it to mark down book value significantly.

Because of these defaults and markdowns, investors lost faith in management's ability to value its portfolio correctly, and the stock soon plunged below book value. In October 2000, management threw up its hands and announced it was looking into a possible liquidation of its portfolio and ultimate distribution of proceeds to shareholders.

Buffett began acquiring stock most likely in early 2000, when the stock was trading around $4 and book value was around $4.51. On April 13, 2001, Buffett filed a Schedule 13G with the SEC stating that he owned 979,000 shares, or about 6.98% of the company.

On April 25, 2001, Laser's board of directors approved the liquidation and dissolution of the company, immediately approving an initial distribution of $3 per share. In 2003, it made another distribution of 50 cents, and yesterday, holders of the stock became entitled to the final 86-cent distribution. I'm not sure when -- or if -- Buffett exited the stock.


JDN Realty
This REIT owned 15 million square feet of shopping centers. The company attempted to anchor each of its shopping centers with a "value" tenant, such as Wal-Mart (NYSE:

Westie,

Have a look at NUH.NZ thread. That was my attempt at a cigar butt play on an out of favour stock in an out of favour sector. I believe the trustees sold it out for too little too early. But if you got in early enough you are okay. I received about 15% return on my investment at pay out time.

What I learnt is that NTA is not as reliable a figure in forestry as I thought . But investing in Opio Forestry on the same basis earned a return of 44%.

These don't seem to be great examples of outstanding returns...

Laser mortgages? he received how much per share? 3.50 + .86 = $4.36.... and we think he payed $4? Thats less than 10% in a year...

Quote:

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quote:Originally posted by thereslifeafter87

These don't seem to be great examples of outstanding returns...

Laser mortgages? he received how much per share? 3.50 + .86 = $4.36.... and we think he payed $4? Thats less than 10% in a year...

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The problem with analysing a stock play like that is that, in retrospect, the risk is always zero, and the return you could have got has a ceiling.

To understand what Buffett was doing you have to put yourself back in his shoes at the time he made the investment. Did Buffett know that his ultimate return would 'only' be 10%? No, of course he didn't!
Buffett knew the assets had been written down to well below market. He did not know how much Mr Market would ultimately pay for those assets. But Buffett took a bet that if he bought at the time of maximum market uncertanty, there was a very good chance that Mr Market would ultimately pay more for those assets than he did.

Buffett also knew that because the real estate had already been heavily marked down it would have been unlikely to have been marked down much further. So Buffett was looking at a potential loss of say 10% of his capital verses a potential gain of say up to 30%. If the risk of the gain and loss I have just outlined were about equal that equates to an expected gain (in ther statistical sense) of around 20%. If that were the case Buffett would have been disappointed with his final gain of only 10%, but so what? There is no way Buffett would have *known* what his final gain would be. Buffett was simply playing the probability numbers.

A so called 'expected gain' is the result you might expect averaging a number of similar stock plays. In this case there was only one stock play. So despite 20% being the 'expected gain', the result of a single stock play is quite unlikely to exactly conform to this figure.

I would say, *without* the benefit of hindsight, that this looks like a very smart play. Particularly when bank interest rates in the US are hovering at forty year lows of 1-2%. 20% would have been an outstanding result. 10% is an OK result, especially when considering the small probability of making a loss on the deal.

Buffett is about balancing *potential* risk and returns If you look at the exercise with hindsight only, you cannot judge the risk return balance. With Buffett it is the risk return balance which is the whole point of the exercise.

SNOOPY

You are right of course Snoopy.
But such stories do not make for as interesting reading as the 1000's of percent gains some other stocks yield.

I think the interesting part of the story is not so much the gains made on the investments but the type of investments Buffett has choosen to invest his individual portfolio in.

As the writer of the article has noted, virtually every article & book on Buffett drones on about his investments in Coke & Gillette and his development from Ben Graham's style of investing to a mixture of Fisher & Graham etc. So it is interesting to see where & how Buffett invests privately and how this appears quite different from what you read in "Buffettology" and the like.