Graham And Doddsville

Prior to 2008, it was normal for a value investor to have no particular “view on the economy.”   As Ben Graham said “Analysis should be penetrating not prophetic.”  In The Little Book of Behavioral Investing James Montier explains that “All Investors should devote themselves to understanding the nature of the business and its intrinsic worth, rather than wasting their time trying to guess the unknowable future.”

After 2008, several highly regarded value investors began to argue that while they still might not attempt a detailed economic forecast, they now found it more important to be aware of the economic environment and macro outlook.

As usual, my view is not as black and white.  Whether or not a value investor should have a “view on the economy” is still up for debate.  However, there is no doubt that investors must understand the the impact different economic outcomes can have on the intrinsic value of each stock they own.  Montier goes on to quote Howard Marks of Oaktree Capital who in 2001 wrote:

There are a few things I dismiss and a few I believe in thoroughly. The former include economic forecasts, which I think don’t add value, and the list of the latter starts with cycles and the need to prepare for them.

“Hey, ” you might say, “that’s contradictory. The best way to prepare for cycles is to predict them, and you just said it can’t be done.” That ’s absolutely true, but in my opinion by no means debilitating. All of investing consists of dealing  with the future .

. . and the future is something we can’t know much about. But the limits on our foreknowledge needn’t doom us to failure as long as we acknowledge them and act accordingly.

In my opinion, the key to dealing with the future lies in knowing where you are, even if you can’t know precisely where you ’re going. Knowing where you are in a cycle and what that implies for the future is different from predicting the  timing, extent and shape of the cyclical move.

As usual, I completely agree with Marks.  So how do we know where we are and how do we analyze the effect of a range of economic conditions on the intrinsic value of an investment?  I believe that the best way is to study the only thing we know for certain – the past.  I know, things change, the world is different, we have globalization, a major worldwide debt crisis, a housing market the likes of which we have not seen since the 1930s, and the list goes on…  That being said, we must start somewhere.

One of the important steps in my investment process is what I call “Exploratory Research.” In this phase, I try to arrange all of the data I gathered to analyze how it relates to both each other and also many different variables.  The goal of this exercise is to get as creative as possible, with the hope of developing an analytical edge.  At the very least, this analysis will help me to understand how a business might react considering a range of economic scenarios.

I used to find economic data on Bloomberg, Capital IQ, or dozens of different websites.   However, I recently discovered an incredible Add-In for Microsoft Excel.   It is called the “FRED Add-in” and is provided by the Federal Reserve Bank of St. Louis.  As described on their website:

The Federal Reserve Bank of St. Louis Economic Data (FRED) Add-In is free software that will significantly reduce the amount of time spent collecting and organizing macroeconomic data. The FRED add-in provides free access to over 30,000 data series from various sources (e.g., BEA, BLS, Census, and OECD) directly through Microsoft Excel.

Key Features:

• One-click instant download of economic time series.
• Browse the most popular data and search the FRED database.
• Quick and easy data frequency conversion and growth rate calculations.
• Instantly refresh and update spreadsheets with newly released data.
• Create graphs with NBER recession shading and an auto update feature.

The best part is that the Add-In is free!  It is an amazing and powerful tool that you can download here.

A second resource I recently stumbled upon is Insidertrading.org which can be found here:  http://insidertrading.org/ .  It is another fantastic FREE resource to track insider buys and sells.  While I have found several websites in the past that provide insider buying/selling summaries, insidertrading.org seems to be the most comprehensive free site.  As value investors know, insider transactions can be a great place to find new investment ideas or raise questions about existing holdings.

The Berkshire Hathway Annual Meeting has become an annual rite of passage for investors to hear from the author of The Superinvestors of Graham-And-Doddsville, and his partner, Charlie Munger.  As in the past, I will keep my posting about the Berkshire Hathaway Annual Meeting to a minimum.  In fact, if you want to learn more about the 2011 meeting, you really don’t need more than the two links below:

Ben Clameron’s 2011 Berkshire Hathaway Meeting Notes via The Innoculated Investor

Ultimate 2011 Berkshire Hathaway Meeting Guide via Fat Pitch Financials

As I mentioned before, if you are at the Value Investing Congress in Pasadena today and tomorrow, please make sure to say hello.

I will be attending the Value Investing Congress West on Tuesday and Wednesday in Pasadena, CA.   If you are attending, drop an e-mail at cogitator -@- grahamanddoddsville.net so we can meet.

If you can’t make it – be sure to watch out for details on the New York Value Investing Congress in the fall.

Michael Burry has without a doubt become one of my favorite thinkers.

From the Vanderbilt University Website:

Watch video of Michael Burry speaking April 5 on “Missteps to Mayhem: Inside the Doomsday Machine with the Outsider who Predicted and Profited from America’s Financial Armageddon,” as part of the 2010-2011 Chancellor’s Lecture Series.

Burry, a Vanderbilt University School of Medicine alumnus profiled in author Michael Lewis’ bestselling book The Big Short, is best-known as the first financial analyst to predict America’s financial crisis.

In an op-ed he wrote for the New York Times in 2010, Burry says that he began worrying about the housing marketing in 2003 when “lenders first resurrected interest-only mortgages, loosening their credit standards to generate a greater volume of loans.” By 2005, he was convinced that the housing market would melt down causing “substantial damage to the economy.”

Our leaders in Washington either willfully or ignorantly aided and abetted the bubble“Our leaders in Washington either willfully or ignorantly aided and abetted the bubble,” wrote Burry. “It did not have to be this way.”

Burry was diagnosed with Asperger’s syndrome as an adult, which he credits with helping him bring a unique perspective to the economy and financial markets. Lewis agrees, saying, “He has a great ability to concentrate in just raw data.”

Burry studied economics and pre-medical training at UCLA before enrolling at the Vanderbilt University School of Medicine. He would continue his medical education as a resident at Stanford University Hospitalbefore leaving after his third residency year to found Scion Capital.

Burry’s transition into the world of finance was eased by his years running a finance website that had been chosen as a Forbes “Best of the Web” winner in stock picking.  He also worked as a freelance journalist analyzing stocks for MSN Money in the early days of the internet’s commercialization.

Watch the entire video here.

James Montier of GMO, LLC recently penned a piece titled “The Seven Immutable Laws of Investing.”  These “laws” are certainly not new to adherents of value investing.  However, I believe we need to constantly reinforce these laws, especially since they are often inconsistent with our natural tendencies.

So, now, for the moment of truth, I present a set of principles that together form what I call The Seven Immutable Laws of Investing.

1.  Always insist on a margin of safety

2.  This time is never different

3.  Be patient and wait for the fat pitch

4.  Be contrarian

5.  Risk is the permanent loss of capital, never a number

6.  Be leery of leverage

7.  Never invest in something you don’t understand

You can find the entire report here.  (Free registration is required)

The latest issue of Graham and Doddsville was recently posted to The Heilbrunn Center’s website.   Once again, it is outstanding.

This edition features Larry Robbins of Glenview Institutional Partners, Robert Robotti of Robotti & Company, and Artie Williams, Jennifer Wallace, and Judd Kahn of Summit Street Capital.

You will also find investment write-ups on Blount International (BLT), The Williams Company (WMB), and The Greek Organization of Football Prognostics (ATSE: OPAP).

Check out the newsletter archive here.   Keep up the great work CBS!