Monthly Archives: June 2009

Value Focus Newsletter – Issue II

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The second issue of Value Focus, our monthly investment newsletter will be published on July 1, 2009. The newsletter is only available to Valuehuntr Premium Members. For more information, see here.


Back to the Future with Benjamin Graham

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In early 1970′s Ben Graham wrote a prophetic piece about future threats to equities, where he rightly predicted that Wall Street greed would always be the biggest threat to equity investors. In some ways, the picture Graham paints of the 1969-1974 market sentiment is similar to today’s. A fragment of the article is included below.

Experience suggests therefore that the various threats to equities are not very different from other obstacles that common stocks have faced and surmounted in the past. My prediction is that stocks will surmount them in the future.

But I cannot leave my subject without alluding to another menace to equity values not touched on in my terms of reference. This is the loss of public confidence in the financial community growing out of its own conduct in recent years. I insist that more damage has been done to stock values and to the future of equities from inside Wall Street than from outside Wall Street. Edward Gibbon and Oliver Goldsmith both wrote that, “History is little more than a register of the crimes, the follies and the misfortunes of mankind.” This phrase applies to Wall Street history in the 1968 to 73 period, but with more emphasis to be given to its crimes and follies than to its misfortunes.

 I have not time even to list all the glaring categories of imprudent and inefficient business practice, of shabby and shoddy ethics perpetrated by financial houses and individuals, without the excuse of poverty or ignorance to palliate their misdemeanors. Just one incredible example: Did anyone ever hear of a whole industry almost going bankrupt because it was accepting more business than it could handle? That is what happened to our proud NYSE community in 1969, with their back-office mix ups, missing securities, etc. The abuses in the financial practices of many corporations during the same period paint the same melancholy picture.

It may take many years—and new legislation—for public confidence in Wall Street to be restored and in the meantime stock prices may languish. But I should think the true investor would be pleased, rather than discouraged, at the prospect of investing his new savings on very satisfactory terms.

To pension-fund managers, especially with large and annual increments to invest, the prospects are especially inviting. Could they have imagined five years ago that they would be able to buy AAA bonds on an eight to nine per cent basis, and the shares of sound companies on a 15 per cent or better earnings yield? The opportunities available today afford a more promising investment approach than the recent absurd idea of aiming at, say, 25 per cent market appreciation by shifting equities among institutions at constantly higher price levels—a bootstrap operation if there ever was one.

Let me close with a quotation from Virgil, my favorite poet. It is inscribed beneath a large picture panel at the head of the grand staircase of the Department of Agriculture building in Washington. It reads:

 “O fortunati nimium.. .(etc.) Agricolae!”

Virgil addressed this apostrophe to the Roman farmers of his day, but I shall direct it at the common-stock buyers of this and future years:

“O enviably fortunate Investors, if only you realized your current advantages!”

- Benjamin Graham

Our Alternative to CAPM

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Some readers have been asking about the CAVM model we derived as an effort to be used in place of CAPM. Our model simply helps evaluate the expected return for a particular investment given the risks involved. Contrary to what most investors believe, risk cannot be quantified by a single number, so the goal is not to evaluate risk to a high degree of certainty. Instead, it provides a picture of the symmetry (or asymmetry) of the investment payoff we are trying to evaluate. This method is similar to the method used by gamblers to asses a wager’s payoffs. 

According to Edward Thorp, the fundamental problem in gambling is to find positive expectation betting opportunities. The analogous problem in investing is to find investments with excess risk-adjusted expected rates of return. This simple premise is what allowed us to develop the Capital Asset Value Model (CAVM), which we first explained on a previous post.

The model is derived from the following thought experiment:

Imagine that we are faced with a wager on a biased coin. Namely, our job is to bet money on the probability that a coin lands heads when in fact, both sides of the coin are tails. How much should we bet? Common sense dictates that no bet is placed, or wager is zero, because the probability of loss (risk) is 100%. Therefore, our expected winnings would be zero at maximum risk. Now imagine that we are to place a wager on the probability that the same coin lands tails. On this case, common sense dictates that we wager 100% of our money, since the probability of loss (risk) on such biased coin would be zero. In other words, our winnings would be maximized when the risk is zero.

As we pointed out in our introductory post, we have derived an equation for this line. Generally, the expected return is a function of both the margin of safety and the certainty to which our analysis on the investment is correct. The result can be visualized graphically as presented below.


In our opinion, the strength of CAVM is that it defines risk properly. As such, risk on a particular investment cannot be quantified with definite precision, but the slope of the risk-return line can be helpful in evaluating whether our odds are favorable or not. Specifically, the bigger the slope of the risk-return line, the bigger the possibility of above-average returns. As shown below, the asymmetry (good payoff even at high probability of loss) of the investment represented by the green line makes it more favorable than that represented by the red line.


The model’s application to a stock portfolio has been presented on previous posts. But the same type of analysis can be performed with other investment vehicles such as real estate and private equity.

Warren Buffett on his Investment Strategy

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We recently ran across an interview where Warren Buffett discusses several small strategies he employs when valuing a stock, in particular PetroChina, one of his investments at the time. An interesting suggestion on Buffett’s part is to read a company’s annual report before knowing anything about the company’s price or market value. According to him, this helps him get a more objective idea of how much a company may be worth.

When the interviewer asked something along the lines of: “How did you find Petrochina’s report when no one knew about it”? Buffett responded: “Well, some men read Playboy, I read annual reports”.

Pendulum Swings for Mr. Yacktman

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By Aja Carmichael (WSJ)

Once well respected among mutual-fund heavyweights, portfolio manager Don Yacktman in recent years has been buffetted by critics taking swings at his conservative investment strategy.

But the 67-year-old may be quieting that criticism. Yacktman Fund’s (trading symbol YACKX) recent asset growth and healthy returns have once again put Mr. Yacktman on an all-star path.

Despite last year’s plummeting market, Mr. Yacktman’s flagship large-cap fund has managed a loss of about 2% during the past 12 months; the Standard & Poor’s 500-stock index has dropped roughly 30% in that period. Mr. Yacktman, along with son Stephen, who co-manages the fund, has also restored the fund’s assets to a competitive level at $530 million. The growth is driven by the Yacktmans’ efforts to protect the fund’s investments and exit from a few consumer names to focus on the media sector.

The elder Mr. Yacktman, who was pegged as a top stock picker in the 1980s for his management of Select American Fund, credits his recent success to staying true to course. He said he hasn’t altered his investment strategy much during the past 20 years.

“It hasn’t changed dramatically; it’s just that we have been able to refine it more,” he said. “I think our batting average has improved and that comes from our number crunching and refining the process.”

But things weren’t always so rosy. The fund in 2000 had assets of $69 million, and it produced single-digit returns. Experts called Mr. Yacktman’s value-management style outdated during the peak of the bull market and tech-stock boom.

Also, Mr. Yacktman took criticism from financial advisers over the past two years for holding too much cash, reaching about 25% at one point in early 2007.

The five-star fund buys profitable stocks that have struck out with the market. The firm recently reduced its long-standing consumer focus and grabbed shares of Viacom, Liberty Media and News Corp., owner of The Wall Street Journal.

Mr. Yacktman said he is now “Dumpster diving,” putting cash to work and scavenging for fallen stocks that could have high rates of return. He recently swooped in on Pfizer as well as a couple of battered retail names, Abercrombie & Fitch and William-Sonoma.

The Texas-based fund holds 31 stocks, including Coca-Cola, Microsoft and eBay. It requires a minimum investment of $2,500 and doesn’t have a front load. Year to date, the fund is up 21%; the S&P 500 is down 0.2%. Over a three-year span, the fund has risen 1.4%, versus the S&P’s 8.5% decline.

Soapstone Networks submits Preliminary Proxy

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Soapstone Networks Inc. (SOAP) just submitted its preliminary proxy with the SEC regarding the Board’s plan to dissolve the company. The section of the proxy we have posted below, in particular, provides some insight on the management’s estimated range of cash distribution to shareholders. Footnotes are included, some of which explain the assumptions behind the specified range.


(1) Estimated balance is net of cash used for the period April 1, 2009 through June 30, 2009 for estimated operating expenses ($4.2 million), severance costs ($1.7 million) and accounts payable and accrued liabilities ($1.5 million), partially offset by interest income ($0.1 million).

(2) Estimated Extraordinary Dividend payments of $55.8 million are associated with 14,886,107 shares of our common stock outstanding as of June 16, 2009 and Extraordinary Dividend payments of $1.7 million are associated with 460,828 shares of our common stock subject to currently vested options that are in-the-money at $4.13, the per share closing price of our stock on the Nasdaq Global Market on June 16, 2009, which options are assumed to be exercised prior to the dividend payment.

(3) Estimated proceeds from the exercise of currently vested options for 460,828 shares of our common stock that are in-the-money at $4.13, the per share closing price of our stock on the Nasdaq Global Market on June 16, 2009, which options are assumed to be exercised prior to the dividend payment.

(4) Estimated range of cash proceeds from sale of assets, including technology, intellectual property, furniture, fixtures and equipment.

(5) Estimated operating expenses for the period of July 1, 2009 through June 30, 2010 for personnel, facilities and other expenses to conduct our wind up operations but exclusive of all other line items specifically allocated in the table above.

(6) Estimated severance costs for remaining employees involved in the wind up operations.

(7) Estimated accounts payable and accrued liabilities as of June 30, 2009.

(8) Estimated range of cash payments associated primarily with lease and lease related commitments for our headquarters facility.

(9) Estimated range of cash use for the purchase of insurance, including Directors and Officers liability insurance covering the six years from the date of stockholder approval of the plan of dissolution

(10) Estimated range of cash use for professional fees related to our liquidation and dissolution, as well as ongoing SEC reporting requirements.

(11) Estimated range of cash use for unanticipated claims and contingencies, including potential deductibles and retentions associated with potential insurance claims.

Active Managers Get the Cold Shoulder

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By Craig Karmin (WSJ)

A growing number of big investors are concluding that stock and bond pickers failed to add any value during the market turmoil and are shifting to index funds, a move that threatens to cut profits for asset managers.

“Active managers have not given us the added performance in a down market that we hoped for,” says Bill Atwood, executive director of the $9 billion Illinois State Board of Investment. Disappointing returns by some large- and small-stock managers led his fund to move about $400 million to index funds.

“Now that we think we’re close to the bottom, we feel we can access the upside just as well with index managers,” Mr. Atwood says.

The move toward more-passive investments is part of a broader reconsideration by many investors about what went wrong in 2008 and how they can reposition their portfolios to avoid a rerun of that dismal performance. Active managers promise to beat, rather than match, the market’s overall returns and charge fees that can be at least 10 times higher than those of index funds.

In a recent survey by Greenwich Associates, a Greenwich, Conn., consulting firm, about one in five institutional investors said they have recently shifted money away from active managers and into passive index strategies. That is up from just 4% who expected to make that shift when asked from July to October 2008.

The active-versus-passive debate is shaping up as a driving force behind industry consolidation. When BlackRock Inc. agreed this month to acquire Barclays PLC’s Barclays Global Investors, the giant index and exchange-traded-fund business, BlackRock CEO Laurence Fink cited investor efforts to cut costs through passive strategies as an impetus for the deal.

“For big money-management houses that underperformed, this trend is bad news,” says Mark Keleher, chief executive of Mellon Transition Management, which helps investors switch managers.

Thanks in large part to a growing preference for index funds, the Bank of New York Mellon Corp. unit is forecasting a record number of asset managers will be replaced in the second half of this year.

Mr. Keleher says the moves primarily involve switching from traditional “long-only” active asset managers who invest in stocks and bonds but generally don’t hedge or use derivatives, rather than from hedge funds or private-equity firms.

A change of heart in the $2.3 trillion public pension industry could quickly slice profits for the large asset managers that serve them. Stock index funds may charge annual fees of less than 0.1% of the money they manage, rarely topping 0.5%; stock pickers charge fees that can range from roughly 0.3% up to 2% of assets. Fees for bond managers are generally lower.

Greenwich Associates says that not all of the switches to index funds will be permanent and that some investors will stash their money in index funds until they find new managers.

That is partly true for the Fire & Police Pension Association of Colorado, a $2.5 billion pension fund. Chief Investment Officer Scott Simon says he is winding down a derivative-related program, known as portable alpha, and holding those assets for the time being in stock-index funds. The Colorado fund has about 60% of its stock holdings in index funds, up from 40% in 2008.

While that figure may come down, he says he intends to maintain a greater index bias going forward. “I see passive being a bigger piece of the portfolio than it has been in past,” he says. “More managers seem unable to beat their index.”

Mellon has found that some pension investors are doing the same thing with their debt holdings. Historically, the difference in performance between the top quartile and bottom quartile of bond funds was about half a percentage point, Mr. Keleher says.

Last year, that gap widened to about six percentage points. Rather than try to pick winners, many institutional investors are more worried about being stuck with losers, so they now are choosing index funds.


Soapstone Networks: Preliminary Liquidation Analysis

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Our preliminary liquidation analysis for Soapstone Networks (SOAP) indicates that the company has the ability to grants shareholders with initial distributions ranging from $3.84 to $4.38 per share, based in excess cash the company holds. This shows that management opted for the lower range of initial distributions. Our estimates of total distributions, including the value of property, plant, and equipment net of depreciation range from $4.09 to $4.68. We are still awaiting for management estimates, which should be submitted to the SEC soon.


Settling for Par: Pros More Likely to Play It Safe

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(This is an article, which appeared in the Sports section of the NYT, has lessons beyond the golf course)


By Alan Schwartz

When PGA Tour golfers from Tiger Woods down to the greenest rookie draw back their putters this week at the United States Open, their scorecards will be sabotaged by a force as human as it is irrational: risk intolerance.

Even the world’s best pros are so consumed with avoiding bogeys that they make putts for birdie discernibly less often than identical-length putts for par, according to a coming paper by two professors at the University of Pennsylvania’s Wharton School. After analyzing laser-precise data on more than 1.6 million Tour putts, they estimated that this preference for avoiding a negative (bogey) more than gaining an equal positive (birdie) — known in economics as loss aversion — costs the average pro about one stroke per 72-hole tournament, and the top 20 golfers about $1.2 million in prize money a year.

Contrary to most academic studies involving sports, at which athletes typically scoff, a handful of the tour’s top putters did not dispute this finding. Simply put — if not putt — they admitted to being spooked enough by bogeys that they will ultimately cost themselves strokes to avoid them. Call it the bogeyman.

“Par putts just seem to be more critical because if you miss you drop a shot — if you miss a birdie putt, it doesn’t seem to have the same effect,” said Jim Furyk, one of the tour’s best putters.

Added Justin Leonard: “When putting for birdie, you realize that, most of the time, it’s acceptable to make par. When you’re putting for par, there’s probably a greater sense of urgency, so therefore you’re willing to be more aggressive in order not to drop a shot. It makes sense.”

Of course, it makes no sense at all: each stroke counts as one on a scorecard, whether for eagle or triple-bogey on any particular hole. The goal is to finish with the fewest strokes, regardless of what each might be artificially termed. All else being equal — distance from the cup, one’s proximity to the lead or cut, the course difficulty and so on — putts should be handled the same way.

But they are not, according to the study of almost 200 tour professionals from 2004 through 2008. Using data the tour regularly records on every ball’s green location accurate to the nearest inch, the professors found that birdie putts were made about 3 percent less often than otherwise identical putts for par. (In effect, players tell themselves before birdie attempts, “Let’s just get close,” rather than, “I have to make this.”) Given that players typically attempt nine birdie putts per round, this cost each golfer about one stroke per tournament — which can translate to hundreds of thousands of dollars in prize money.

The professors, Devin Pope and Maurice Schweitzer, seemingly anticipated every “But what about?” reflex from golf experts. The tendency to miss birdie putts more often existed regardless of the player’s general putting or overall skill; round or hole number; putt length; position with respect to the lead or cut; and more.

As would be expected, the difference decreased on routine short putts and also decreased very far from the hole, where the chance of making the putt is small to begin with. It peaked on putts from about 6 to 12 feet. Even Woods, roundly considered the best putter ever, exhibited the trait at roughly the tour average.

The finding may become significant among behavioral economists, many of whom have suspected that the loss aversion found through contrived experiments might not be demonstrated by actual, expert competitors vying for high stakes. The paper is being submitted this week for publication in an economic journal.

“Even experienced professionals playing for high stakes are not rational,” Pope said. “Tiger Woods, the model of perfection and what an economist would think of as a rational agent, even he exhibits these biases. And if he exhibits these biases, why not business leaders? There are a lot of applications.”

Rather than resist any insight from ivory tower academics, several golfers admitted to handling identical birdie and par putts differently — and appeared somewhat amused at being found out. Geoff Ogilvy, who made par putts 4.1 percent more often than birdie putts from the same distance, said: “A par putt seems more final. It shouldn’t make any difference, should it?” And Paul Goydos, who showed the effect at 4.4 percent, said it probably affected him even more on putts for eagle.

“If I’ve got a 25-footer for eagle, it seems like I’m more conservative than with a 25-footer for either birdie or par for whatever reason,” Goydos said. “I think the worst thing you can do is three-putt for par on a par 5. That’s one that drives me more crazy than anything else. Maybe that’s why I’m at the very bottom of the tour in eagles made.”

But just as quickly as pro golfers admitted to their costly habit, they dismissed the idea of being able to do much about it. Stewart Cink, who showed a 3.3 percent effect, said that try as he might, he would never be able to convince himself that every putt is the same.

“You can’t fool yourself,” Cink said. “But this is one of the reasons why we use sports psychology, and we try to have a preshot routine so we do the same thing, approach every putt the same way. It’s not always glamorous, and it’s not always possible in reality.”

The psychological preference to avoid a perceived penalty (losing a stroke relative to par) rather than go for a perceived gain (gaining a stroke) has some benefit. Golfers tended to leave their conservatively stroked birdie putts slightly closer to the cup than more aggressively missed pars — leading to their making their follow-up shot more often. But that temporary gain was far outweighed by the overall cost in strokes.

The birdie-versus-par effect varies in ways that many golfers would instinctually predict. The tendency to make similar birdie putts less often than pars becomes less prevalent with each tournament round as players are judged more against one another than against par. The elite tour players generally show less of the trait than marginal ones. And the difference decreases as a player sees himself or his partners handle a particular green.

But the effect is always there, even if a good reason for it is not.

“A 10-footer for par feels more important than one for birdie,” said Goydos, a two-time winner on the tour. “The reality is, that’s ridiculous. I can’t explain it in any way other than that it’s subconscious. And pars are O.K. — bogeys aren’t.”

Soapstone Networks (SOAP) to Liquidate

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Soapstone Networks announced yesterday that its Board of Directors has unanimously approved a plan of dissolution and liquidation of the Company.

We added SOAP to the Valuehuntr Portfolio on March 9, 2009, after the company announced it was seeking strategic alternatives to enhance shareholder value. At the time, the company had nearly $6.0/share in cash, but trading at a market cap of $2.8/share.

As part of the decision to liquidate, SOAP has ceased the development and marketing of the Soapstone Provider Network Controller (PNC) product and has reduced its workforce by 50 to a total of 14 employees. Moreover, if the Company’s stockholders approve the Plan of Liquidation, the Company intends to file a certificate of dissolution, delist its shares from NASDAQ, sell and monetize its non-cash assets, satisfy or settle its remaining liabilities and obligations, including any contingent liabilities and claims, terminate its remaining employees throughout the wind down period, and make one or more distributions to its stockholders of cash available for distribution.

SOAP also announced that its Board has unanimously approved an extraordinary cash dividend of $3.75 per share, provided that the Board may adjust such amount at a later date to ensure there is remaining cash to satisfy potential liabilities. Such dividend will be payable after the stockholder meeting at which the Plan of Liquidation is approved by the Company’s stockholders and in connection with the filing of a Certificate of Dissolution with the Delaware Secretary of State.

The Company has analyzed its liquidation value and currently estimates that the amount of subsequent distributions to stockholders will range from $0.25 to $0.75 per share, for a total distribution, including the extraordinary cash dividend, of between $4.00 and $4.50 per share. The amount of these distributions, however, may vary substantially from these estimates based on the resolution of outstanding known and contingent liabilities and the possible assertion of claims that are currently unknown to the Company. If, prior to its dissolution, the Company receives an offer for a transaction that will, in the view of the Board, provide superior value to stockholders than the value of the estimated distributions under the Plan, taking into account all factors that could affect valuation, including timing and certainty of payment or closing, credit market risks, proposed terms and other factors, the Plan of Liquidation and the dissolution could be abandoned in favor of such a transaction.

The Board made this decision after completing an exhaustive evaluation of various strategic alternatives available to the Company for enhancing stockholder value, including but not limited to, continued execution of the Company’s business plan, the payment of a cash dividend to the Company’s stockholders, a repurchase by the Company of shares of its capital stock, the sale or spin off of Company assets, partnering or other collaboration agreements, a merger, sale or liquidation of, or acquisition by, the Company or other strategic transaction. The Company and its external advisors, including its financial advisor Morgan Stanley & Co. Incorporated, devoted substantial time and effort in identifying potential buyers or strategic partners and entered into negotiations with several potential partners; however, that process did not yield a potential transaction which the Board viewed as reasonably likely to provide greater realizable value to its stockholders than the complete dissolution and liquidation of the Company in accordance with the Plan of Liquidation.