Entries categorized as ‘Analysis’

Using Altman’s Z-Score to Create a Short-Only Portfolio

January 8, 2010 · 7 Comments

We aim to use Altman’s Z-Score model to create the Valuehuntr Short-Only Portfolio and track the effectiveness of Altman’s regression.

The Z-Score

The Z-Score is a predictive model created by Edward Altman in the 1960s while serving as an Assistant Professor at NYU.  The model combines five different financial ratios to determine the likelihood of bankruptcy amongst companies. In general, these financial ratios are used to predict corporate defaults or financial distress status of companies.

The model’s regression is as follows:

Z –Score = 1.2*A+1.4*B+3.3*C+0.6*D+0.999*E


A = Working Capital/Total Assets

B = Retained Earnings/Total Assets

C = EBIT/Total Assets

D = Market Value of Equity/Total Assets

E = Sales/Total Assets

According to Altman, companies with Z-Scores above 3 are considered to be healthy and, therefore, unlikely to enter bankruptcy. Scores in between 1.8 and 3 lie in a gray area. Scores of 1.8 or less indicate a very high probability of insolvency. This is because each of the variables, A to E, was found to be significantly different among bankrupt and non-bankrupt groups in the original study.

In its initial test, the Altman Z-Score was found to be 72% accurate in predicting bankruptcy two years prior to the event. In a series of subsequent tests covering three different time periods over the next 31 years (up until 1999), the model was found to be approximately 80-90% accurate in predicting bankruptcy one year prior to the event. Althought the model has performed well over the years, it is important to keep in mind that it is only a statistical regression. In fact,  plenty of businesses with dangerously low Z-scores have come back from the brink, producing extremely attractive performance. Therefore, investors should not rely solely on this model to find investment opportunities.

ValueHuntr Short-Only Portfolio

Our short-only portfolio consists of companies with Z-scores less than 1.8, as specified by Altman, with an additional screen requiring a current ratio of less than 0.5 as reported by the companies on the latest quarter. We believe this additional requirement shortens the time period of expected bankruptcy occurrence, as the ratio is an indication of whether or not a firm has enough resources to pay its debts over the next 12 months. Furthermore, we limit our screen to stocks trading in US exchanges with market capitalization greater than $1 million.

The result of our screen is shown below:

Our short-only portfolio consists of 30 companies, ranked according to their respective Z-scores. Most of the companies in the portfolio have Z-scores that are much lower than Altman’s lower limit of 1.8. Such negative scores indicate a much higher probability of bankruptcy than the average company studied by Altman for his original study.

The ValueHuntr Short-Only Portfolio can be tracked real-time HERE.


Categories: Academic · Analysis
Tagged: altman, bankrupt, bankruptcy, model, portfolio, regression, short, z-score

The Best Company in America

January 5, 2010 · 5 Comments

We typically post investment ideas that we like enough to add to our portfolio. However, we have not been able to find a lot of bargains out there lately, so we’ll start posting ideas that are close to meeting our requirements.

A Valuehuntr near miss is Church & Dwight Co. Inc. (CHD). CHD is one of those boring companies we would love to own. It also happens to be the largest producer of sodium bicarbonate (baking soda) in the world, and likely one of the best run companies in America.  The company was founded in 1846, and (as Coca Cola) it still uses the original company formula today.

The company develops, manufactures, and markets a range of household, personal care, and specialty products under various brand names in the United States and internationally.  Its top brands include ARM & HAMMER, TROJAN, and OXICLEAN.  The company meets a lot of the characteristics we look for when searching for good businesses, such as wide barriers to entry and great management, but the stock seems overvalued, which is the reason why it has not been added to the Valuehuntr Portfolio. Although CHD is not being added to our portfolio, we will like to highlight the company anyway.


The company operates in three segments: Consumer Domestic, Consumer International, and Specialty Products.

The Consumer Domestic segment offers household products for deodorizing, such as ARM & HAMMER baking soda, cat litter products, laundry/cleaning products, and consumer care products such as TROJAN condoms and ARM & HAMMER deodorants and toothpaste.  The Consumer International segment sells the personal care products highlighted above in international markets, including France, the United Kingdom, Canada, Mexico, Australia, Brazil, and China. Finally, the Specialty Products segment produces sodium bicarbonate, which it sells together with other specialty inorganic chemicals for a range of industrial, institutional, medical, and food applications. This segment also sells a range of animal nutrition and specialty cleaning products. Operating data for FY 2004-2008 is shown below.



The core product of the company has historically been baking soda, which is used in products within every business segment. The main advantage of baking soda is in its versatility of use. For instance, it is estimated that 95% of US households have a product containing baking soda at their home. Baking soda is not only used for cooking, but it is also an active ingredient in tooth paste, laundry detergents, pool cleaners, fire extinguishers, chemotherapy machines, deodorants, among many others.

(For more information about the versatility of baking soda, we recommend reading: “75 Extraordinary uses of Baking Soda”)


  • Market share gains:  Throughout the financial crisis, CHD has been the only company in the home and personal care products sector that has seen its weighted average market share increase, according to ACNielsen.
  • Better manufacturing: new $170m plant is slated to open in York, PA, by the start of 2009 Q4, replacing an older factory in Brunswick, NJ. It’s expected to be at least 25% more efficient than the old location.


  • Manufacturing Advantage: The baking soda manufactured by CHD is more than 99% pure, which requires proper materials, equipment, and personnel training.
  • Government Regulation: baking soda must meet the requirements specified by the FDA as a substance that is Generally Recognized as Safe (GRAS). Distribution of baking soda is prohibited unless the product meets the GRAS specifications.
  • Supply Advantage:  soda ash deposits at the Green River Basin are large enough to meet the entire world’s needs for baking soda for thousands of years.
  • Cost Efficient: mining operation in the Green River is less expensive for production of soda ash than the synthetic soda ash process that predominates in the rest of the world.


We could use DCF to come up with company value estimates for the next few years to perpetuity. Instead, we’ll make our lives simpler by assuming the company will be able to generate earnings equal to at least its 3-year average EPS. The two quick calculations we show are the value of CHD with no growth, and its value with growth assuming terminal growth roughly equal to historical U.S. GDP.

PV = (Avg. 3-Yr EPS)/WACC = $35/share

EPV= (Avg. 3-Yr EPS)(1+G)/(WACC-G) = $63/share

(Assuming WACC~7%, G=3%)

Currently trading at $61/share, these quick calculations show the company may be currently trading at the top of its valuation range. Additionally, the stock price implies a 5.3% earnings yield, which is only slightly higher than the 4.6% 30-Year T-bill. Based on this price, there are likely other opportunities where investors could get a better return for their money. This is mainly the reason why CHD has not been added to our portfolio.


In our view, there are two things every potential investor should take a closer look at before investing in CHD.

1)     Cost of Raw Materials: the cost of soda ash, surfactants, diesel fuel, corrugated paper, liner board and oil-based raw and packaging materials used in the household and specialty products businesses  are not hedged (only diesel fuel costs for transportation are).

2)      Off-Balance Sheet Liabilities: Pension Plan was underfunded by USD -14mm in 2008 based on a discount rate of 6.58%. Company’s Post Retirement Benefits Plan was also underfunded by USD -22mm (We were not able to find 2009 numbers).


CHD has one of the best independent boards in America. This is evident in the governance policies the company has developed over the years for executive compensation.  Over the years, the rewards given to company executives have been highly correlated with the stock price, as shown below.



Church & Dwight operates and manages some of the most trusted brands in the world. Although the company is not trading at a bargain price, the earnings generated from its assets are protected by wide competitive advantages expected to continue in the future. The level of usage and versatility that CHD baking soda enjoys is hard to replicate, but because the stock is a bit too pricy we are not adding CHD to our portfolio.


Categories: Analysis · Investing · Value Investing
Tagged: america, arm & hammer, barriers to entry, best company, CHD, church & dwight, compensation, competitive advantage, moat, obama, sarah palin, Value Investing

VIC Submission: La Jolla Pharmaceutical (LJPC)

November 9, 2009 · 1 Comment

Submitted: October 5, 2009

Accepted: November 1, 2009


I have encountered a great shorting opportunity within the nanocap universe with La Jolla Pharmaceutical (LJPC). LJPC is a biopharmaceutical company that engages in the discovery and development of orally-active small molecules for the treatment of autoimmune diseases, and acute and chronic inflammatory disorders. Because the company is currently trading at 5X net cash value ($0.22/share) and it is in the process of liquidating, this is a great shorting opportunity.


In February 2009, the company was informed by an Independent Monitoring Board for the monitoring board that continuing the study of the Riquent drug was futile. LJPC had previously devoted substantially all of its research, development and clinical efforts and financial resources toward the development of Riquent.

In July 2009, LJPC announced that, in light of other alternatives, a wind down of the business would be in the best interests of stockholders.


The Company has no other drugs in the pipeline, and has scheduled a stockholders meeting for october 31, 2009. The board expects the shareholders will approve the liquidation of the business at the stated date. Below is an estimate of the liquidation value of the company, not including the expenses to be incurred in the process of liquidation.

Cash and cash equivalents                              $8,509 (as of June 2009)
Total Liabilities                                                    $3,836
Off-Balance Sheet Obligations                        $0
Net Cash Value                                                     $4,673

Est. Additional Operational Expenses       $2,096 (through October 2009)
Adj. Net Cash Value                                           $2577

Adj. Net Cash Value per Share                      $0.04

I estimate the company’s liquidating value to be at $0.04/share at best, compared to the company’s market value of $0.20/share. Because expenses will have to be incurred to liquidate the business, we expect the actual cash distribution to shareholders to be below the estimated $0.04/share.

In a DEF14 form filed with the SEC on October 1, 2009 the company provided its estimates of stockholder distributions. The company’s management estimated that distributions will range from $0.028/share to $0.045/share, significantly below the current market value of $0.20/share.


Several reasons why I believe the company’s liquidation is certain:

- For over 6 months, LJPC explored strategic alternatives, including undertaking efforts to identify a merger, reverse merger, stock or asset sale, strategic partnership or other business combination transaction that would have a reasonable likelihood of providing greater value to our stockholders than they would receive in a liquidation, which did not result in the identification of any likely transaction.

- The board believes that there is a low probability that LJPC would be presented with, or otherwise identify, within a reasonable period of time under current circumstances, any viable opportunities to engage in an attractive alternative business combination or other strategic transaction that would provide enhanced value to stockholders.

- LJPC has only three full-time employees remaining, two of which make up the management team consisting of a President and Chief Executive Officer and a Vice President of Finance and Secretary.


The biggest risk is the possibility of a merger or buyout above the current market value. This is unlikely, as the company has no patents nor other intellectual property that would encourage potential buyers to pay a value above LJPC’s net cash. The 5X premium to net cash value in unwarranted, as the likelihood of liquidation is high. This presents a great shorting opportunity for investors.


In July 2009, LJPC announced that, in light of other alternatives, a wind down of the business would be in the best interests of stockholders.



Categories: Analysis · Liquidation · Value Investing
Tagged: La Jolla Pharmaceutical, LJPC, nanocap, short, value investors club, VIC

The Big Winners of 2009…So Far

September 28, 2009 · Leave a Comment

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According to Bespoke Investment Group, 332 stocks in the Russel 3000 have more than doubled this year…that’s more than 10% of the index! The top 40 names are in the table below, all of which have gained more than 400% so far this year.


Categories: Analysis · News
Tagged: bespoke, micro caps, nano caps, russell 3000, ten-baggers, Value Investing

Grant’s Interest Rate Observer – Free Issue

August 22, 2009 · Leave a Comment

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A free issue of Grant’s Interestrate Observer, one of the best investment newsletters around, is available here.

Categories: Analysis
Tagged: free trial, grant's interest rate observer, investments, Stocks

A Warning on International Value Investing

August 3, 2009 · Leave a Comment

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Jason Zweig’s latest article explains why international value investing works, but also wh most international investors fail at achieving great returns in emerging markets. Contrary to what most investors think, the highest returns have historically been achieved in slow-moving ‘emerging’ markets. This is because value depends on both quality and price. When investors buy into emerging markets, they get better economic growth – but usually not a good price.

Under the ‘Emerging’ Curtain

By Jason Zweig (WSJ)

Behind the world’s hottest markets is a cold truth many investors don’t want to hear.

Emerging markets — those developing countries that used to be called “The Third World,” like Chile and China, Turkey and Thailand, Brazil and India — have been hotter than a potful of habanero peppers. The MSCI Emerging Markets index has gained 45% so far this year, versus 9% for the U.S.

And investors have noticed, pouring $10.6 billion into emerging-markets mutual funds so far this year, or more than 34 times the total they added to U.S. stock funds. The iShares MSCI Emerging Markets Index Fund is now the fourth-biggest of all exchange-traded funds, with $30.8 billion in assets.

Investors hope to capture the stunningly high growth of the developing world, especially with the U.S. economy shriveling. In the second quarter of 2009, China’s economy officially grew 7.9%, while the U.S. likely contracted about 1.5% in the same period. For all of 2009, Barclays Capital forecasts, the developing economies of Asia will grow 5.2%, while U.S. gross domestic product will shrink by 2.3%.

Unfortunately, high economic growth doesn’t ensure high stock returns. “People have hopelessly got the wrong end of the story,” warns Elroy Dimson of London Business School, who is one of the world’s leading authorities on financial markets.

Based on decades of data from 53 countries, Prof. Dimson has found that the economies with the highest growth produce the lowest stock returns — by an immense margin. Stocks in countries with the highest economic growth have earned an annual average return of 6%; those in the slowest-growing nations have gained an average of 12% annually.

That isn’t a typo. Over the long run, stocks in the world’s hottest economies have performed half as well as those in the coldest. When Prof. Dimson presented these findings recently in a guest lecture at a Yale University finance program, “a couple of people just about fell off their chairs,” he says. “They couldn’t believe it.”

But, if you think about this puzzle for a few moments, it’s no longer very puzzling. In stock markets, as elsewhere in life, value depends on both quality and price. When you buy into emerging markets, you get better economic growth — but, at least for now, you don’t get in at a better price.

“It’s not that China is growing and everybody else thinks it’s shrinking,” Prof. Dimson says. “You’re paying a price that reflects the growth that everybody can see.”

In other words, economic growth is high, but stock valuations are even higher. In 2008, as U.S. stocks fell 37.6%, emerging markets crashed 53.3%, according to MSCI. At year end, emerging-markets stocks traded at a 38% discount to U.S. shares, as measured by the ratio of price to earnings. Now that both markets have bounced back, emerging markets are at only a 21% discount. And make no mistake: They should be much cheaper than U.S. stocks, because they are far riskier.

“The logical fallacy is the same one investors fell into with Internet stocks a decade ago,” says finance professor Jay Ritter of the University of Florida. “Rapid technological change doesn’t necessarily mean that the owners of capital will get the benefits. Neither does rapid economic growth.”

High growth draws out new companies that absorb capital, bid up the cost of labor and drive down the prices of goods and services. That is good news for local workers and global consumers, but it is ultimately bad news for investors. Last year, at least six of the world’s 10 largest initial public offerings of stock were in emerging markets. Through June 30, Asia, Latin America, the Mideast and Africa have accounted for 69% of the dollar value of all IPOs world-wide. Growth in those economies will now be spread more thinly across dozens of more companies owned by multitudes of new investors.

The role of emerging markets, says Prof. Dimson, “is to provide diversification, not to add to returns.” Having up to 15% of your total U.S. and international stock assets in emerging markets can make sense. But before you jump in with both feet, look at the holdings of the international funds you already own; many keep at least 20% of their assets in developing markets.

Like all performance chasing, this latest investing binge is doomed to disappoint the people who don’t understand what they are doing.

Categories: Analysis · News · Value Investing
Tagged: emerging markets, international value investing, third world

GE Capital Presentation to Investors

July 29, 2009 · Leave a Comment

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Yesterday, GE Capital executives updated analysts and investors on GE Capital’s progress on shrinking its balance sheet and reducing leverage. The presentation can be downloaded below.


Categories: Analysis · Update
Tagged: GE Capital, General Electric

Failure of a Fail-Safe Strategy Sends Investors Scrambling

July 10, 2009 · Leave a Comment

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By Tom Lauricella (WSJ)

Carl Mahler stood before a group of fellow financial advisers recently and voiced frustration and fear that a fundamental tenet of investing had been proved wrong.

“Hi. My name is Carl, and I’m a recovering asset-allocationist,” the Raymond James Financial adviser quipped.

Asset allocation, a bedrock of investing for decades, appeared to fail miserably in 2008. The conviction shared by most investors — that they should spread their money across myriad asset classes to minimize losses — was shaken as nearly all markets tumbled in unison.

The financial crisis has sent many financial advisers, academics and investors back to the drawing board. Mr. Mahler told the group he was rewriting the playbook he had followed for much of his 41 years in the markets. “Asset allocation did not work,” he says. “Everything went into the abyss.”

Many investors came away from the carnage believing that last year was an anomaly — that, in times of severe stress like that experienced in 2008, disparate markets will all tumble together as investors scramble to sell whatever they can and move into cash.

But a number of influential investors and analysts, from managers of massive funds such as Pacific Investment Management Co., or Pimco, to those at small school endowments, argue that asset-allocation strategies are fundamentally flawed. This wasn’t a one-off failure, they say, but one that’s been long in the making.

“You were increasingly seeing a breakdown” of perceived relationships between asset classes, says Mohamed El-Erian, co-chief investment officer at Pimco. “And that was way before the latest phase in the markets, which accentuated the problems.”

Investors like Mr. El-Erian contend that the problems warrant rethinking those relationships to account for broad changes in the global economy and financial innovations that change the way people invest.

Not everyone agrees. Last month, Fidelity Investments issued a report to clients defending the strategy. “Diversification didn’t fail in the recent market downturn. It worked — just to a lesser degree,” the report said.

A Simple Concept

On the surface, diversification is a simple concept: Combine investments that don’t move up or down at the same time, or at least by the same degree. The goal is to smooth out returns, to hedge portfolios against big losses on single investments, and to position investors to benefit if one corner of the market posts outsize gains.

Diversification spawned a whole range of investment options. Among the most popular are target-date mutual funds, which offer a mix of stocks and bonds tailored to the investor’s age, wealth and risk tolerance. Some investors in these funds lost so much money last year that they would have been better off putting their money into a stock-index fund.

By the time the Standard & Poor’s 500 stock index hit its recent low on March 9 — a decline of 47% from a year earlier — nearly four dozen target-date funds had done even worse, including funds from Goldman Sachs Group, OppenheimerFunds and Alliance Bernstein. At Fidelity, one of the leaders in such funds, the Freedom 2050 Fund lost 48% in the 12 months ended March 9.

The theory of asset allocation emerged in the 1950s when economists such as Harry Markowitz, who would later win a Nobel Prize for his work, developed mathematical models for ways to improve investment portfolios.

Along the way, asset allocation became ingrained in nearly every corner of Wall Street. For brokers, tinkering with asset allocations was among the basket of services for which they charged clients flat fees year after year. Pension-fund consultants built a lucrative business screening money managers.

For mutual-fund companies, asset allocation was a cornerstone of their buy-and-hold philosophy, which helped them hang onto assets. They expanded their businesses beyond plain-vanilla stocks and bonds to funds that reaped higher fees. Target-date funds have become the centerpiece of most 401(k) plans.

Yet in recent years, while Wall Street was promoting diversification and formulas that purported to capitalize on it, the relationships among asset classes were changing. Investments that weren’t supposed to move in sync, such as stock markets on opposite sides of the globe, had begun moving in similar ways. That reduced the benefits of diversification through asset allocation.

Correlation is a statistical measure of the degree to which investment returns move together. Between 1991 and 1994, the correlation between the S&P 500 index and high-yield bonds was low, at 0.2 or 0.3, according to Pimco statistics. (A correlation of 1 means returns move in perfect sync.) International stocks had a correlation with the S&P 500 of 0.3 or 0.4, and real-estate investment trusts had a correlation of 0.3, according to Pimco data. Commodities showed little correlation to U.S. stocks.

By early 2008, investment categories of just about every stripe were moving significantly more in sync with the S&P 500. The correlation on international stocks and high-yield bonds rose to 0.7 or 0.8, and real-estate investment trusts to 0.6 or 0.7, according to Pimco’s data for the previous three years. Commodities were showing a slightly negative correlation — returns were moving in opposite direction — of 0.2 or 0.3, the data indicate.

Then came the meltdown of 2008. In a year when the S&P 500 lost 37%, the MSCI index of major markets in Europe, Asia and Australia lost 45%. The MSCI emerging-markets index fell 55%. Real-estate investment trusts declined 37%, high-yield bonds lost 26% and commodities fell 37%.

At Pimco, the firm’s head of analytics, Vineer Bhansali, points to commodities as an example of how diversification strategies can break down. Even as stocks and bonds struggled in early 2008, commodity prices were in the midst of a historic rally. Wall Street rolled out research showing the lack of correlation between stocks and commodities.

But that history didn’t take an important point into consideration. Prior to this decade, investing in commodities was a complicated process due to the complexity of the futures markets. The advent of exchange-traded mutual funds, or ETFs, allowed investors to buy and sell commodities with the click of a mouse. By the summer of 2008, ETF investors had poured billions into commodities in just a few months.

As the financial crisis worsened and stock and bond prices collapsed, ETF investors who needed to raise money found it easy to bail out of commodities, too. That contributed to a 37% drop for 2008 in the Dow Jones AIG Commodities Index.

“When people start buying an asset, the act of them diversifying ultimately makes the asset less of a diversifier,” says Pimco’s Mr. Bhansali.

Louis Morrell, who until this month oversaw Wake Forest University’s entire $1 billion endowment, felt this firsthand in the school’s portfolio.

A $90 million portion of the endowment, called the Tactical Fund and still managed by Mr. Morrell, held everything from commodities to emerging-market and big-cap stocks. Mr. Morrell, involved with money management since 1968, had honed a strategy based on the idea that you could have a portfolio filled with investments ordinarily considered risky and volatile — but if they didn’t move in sync, you could have higher returns without higher risk. For many years, it worked, even during bear markets. During 2001, for example, the Tactical Fund lost 0.1% while the S&P 500 dropped 15%.


Last June, the Tactical Fund had nearly 30% invested in commodities, 16% in emerging markets, 19% in other non-U.S. stocks, and 24% in U.S. stocks — investments that historically didn’t move much in tandem.

“We got clobbered,” he says. The Tactical Fund lost 44% last year and the overall endowment fell 25%. Late last year, he and his team began working on a new allocation strategy. Rather than treating large-cap U.S. stocks, emerging-market stocks and international stocks as separate categories, the team put them under one “stocks” umbrella. They also switched their view on commodities and gold, which they felt were linked more to inflation than to stocks.

The Tactical Fund still has a healthy slug of commodities as an inflation hedge, and emerging-market stocks now make up 24%. Corporate and government bonds account for 14% of the portfolio, down from 42% at the end of March. Thus far, the new approach is paying off. The Tactical Fund is up 14% this year, through Tuesday, compared to a 2.5% drop in the S&P 500.

“The old strategies were mathematically correct and gave a sense of a lot of discipline,” Mr. Morrell says. However, “they were too backward-looking.”

At Ibbotson Associates, a Chicago firm specializing in asset-allocation strategies for big investors such as pensions and mutual funds, chief economist Michele Gambera also has gone back to the drawing board. It’s been a topic on his mind for the past two years, he says, but 2008 heightened his scrutiny. “There have been reasons to question diversification, no doubt about that,” he says. “It’s been humbling.”

Mr. Gambera says a telling picture emerges by tracking performance during extreme market moves. He found that many investments can do more damage on the way down than they do good on the way up.

Since 1973, in months where U.S. stocks rose more than 6%, European stocks rose on average by three-quarters as much, and Japanese stocks by half as much, according to Ibbotson.

But when the U.S. market fell by more than 4.5% in a month, Europe and Japan tracked the declines far more closely. Stocks in Europe on average posted declines equaling 86% of the U.S. drop, and in Japan, 66%. Real-estate investment trusts matched about half of the U.S. market gains in the best scenarios, but two-thirds of the declines.

“Even if it’s important to add an investment for diversification, people have to consider the costs,” he says. “And we’re learning that there are a lot of implicit stock-market bets in a lot of asset classes.”

As Mr. Gambera sliced and diced the numbers, he concluded that only a few asset classes besides cash proved to repeatedly help a portfolio during a sharp decline. He determined that in the 45 months since 1973 where the U.S. stock market lost more than 4.5%, gold produced positive returns 71% of the time, and intermediate-term government bonds, 67% of the time. During the 20 big monthly declines for stocks since the launch in 1997 of Treasury Inflation Protected Securities — government bonds whose payout is adjusted for inflation — TIPS provided gains 85% of the time.

As a result, Mr. Gambera says, Ibbotson is now recommending bigger holdings of U.S. Treasurys for certain clients.

Hard Lesson

At Raymond James, Mr. Mahler also has retooled the way he builds portfolios. This was no easy decision, he says. Even after the bear market that ended in 2002, he didn’t make any changes to his models.

“It’s what I lived and breathed,” he says. He is keeping the basic structure of his portfolios, but he’s adding money managers with a go-anywhere mandate, including actively betting against stocks by going short.

He is coupling that with greater cash holdings in accounts. His goal is to make a portion of clients’ portfolios more flexible, while at the same providing a greater cushion for whenever stocks next decline.

He says he is convinced there is a way to make diversification work. In fact, after the strains of last year, he says, many investments are behaving more like they did before 2008.

Asset allocation, he says, “might well have been injured….But I don’t think it’s gone forever.”

Categories: Analysis · Investing · News
Tagged: asset allocation, diversification, Value Investing

Soapstone Networks: Preliminary Liquidation Analysis

June 18, 2009 · Leave a Comment

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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.


Categories: Analysis · Liquidation
Tagged: Liquidation, SOAP, Soapstone Networks

Proxy Advisory Firms Are Not Objective on Pershing Slate

May 17, 2009 · Leave a Comment

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Egan-Jones Proxy Services came out last Thursday in support of most of Target Inc.’s board nominees in the retailer’s upcoming election, eschewing the slate pushed by Bill Ackman. Egan-Jones stated the following:

1. We believe that Pershing Square has provided no convincing strategic plan that would lead to improvement in long-term shareholder value.

2. We believe that the Company was transparent in its review and ultimate rejection of Pershing Square’s earlier real estate proposals.

3. We have confidence in the Company’s existing management and Board of Directors and the measures that they have undertaken, some relatively recently, to counter the difficult retailing environment.

4. While noting the relevant experience of several of the dissidents’ nominees, we are not convinced that their election would lead to significant improvements in shareholder value, nor work to the benefit of shareholders.

At Valuehuntr, we find these conclusions deeply disturbing.   Egan-Jones, much like Moody’s, depends on its paying clients to keep its doors open. But in the case of Egan-Jones, clients are institutional investors such as hedge funds, mutual funds, etc. Though we do not know for sure, it is conceivable that Egan-Jones might feel some pressure to turn out research that carries investment conclusions that would support its biggest clients’ largest positions. Could it be, for example, that the Egan-Jones’ largest revenue-generating clients are funds that are short the equity of Target, or long on the equity of competitors such as Wal-Mart? It is very likely.

The same applies to another advisory firm, Proxy Governance Inc. The firm said it would support two of the five dissident nominees. Proxy Services supports the election of Pershing Square nominees Michael L. Ashner and James L. Donald, citing Ashner’s commercial real estate experience and Donald’s retail grocery experience.

In recommending use of the GOLD proxy card, Proxy Governance noted the following:

Relevant Expertise: “Particularly in their arguments that thin director experience in areas of increasing strategic importance has led to suboptimal strategic outcomes, the dissidents make compelling points.”

Credit Cards: “The enduring strategic question, though, is not whether to sell or keep the [credit card] business but how to mitigate the substantial risk and capital intensity of a non-core business. To the extent the dissidents, rather than the board, were driving that question in 2007 and 2008, the dissident argument that director experience could be better aligned with strategic challenges seems credible.”

 Real Estate and Food Retailing: “The real strength in the dissident campaign, however, lies in the nominees, whose professional experience is directly relevant to certain strategic challenges the company faces (particularly outside its core retailing operations) yet which seem to be under-represented in the board as currently composed.”

In recommending Michael Ashner and Jim Donald, Proxy Governance stressed the following:

Real Estate: “Because the company’s sizeable holdings will continue to make real estate a significant strategic issue – even as the company has presented compelling reasons to question the TIP REIT proposal – we believe Ashner, who has extensive professional experience in commercial real estate, would add meaningfully to the current board’s composition.”

Food Retailing: “We believe the board’s ability to respond to the core strategic challenges of retailing, especially groceries, would be materially improved by the addition of the long-term grocery executive, Donald, who established Wal-Mart’s grocery business and superstore presence.”

Relevant Expertise: “We believe that J. Donald, with retail grocery experience, and M. Ashner, with commercial real estate experience, would add meaningfully to the board’s ability to assess and meet emerging strategic challenges in these two aspects of the company’s operations.”

Proxy Governance also commended Pershing Square for supporting and pressing the use of a universal proxy card, which would allow shareholders the ability to select the specific individuals it would like to see on the board from both the management and dissident slates.

It is difficult to believe that either Egan-Jones or Proxy Governance would advice against the interests of their revenue-generating clients. Therefore, these conflicts of interest may prevent Target’s shareholders to get an objective third party recommendation on Pershing’s proposal.

Tomorrow, RiskMetrics renders its decision. RiskMetrics typically advises more than 20% of shareholders, while Proxy Governance and Egan-Jones combined advice less than 10%. RiskMetrics’ recommendation will not be without conflicts. For example, The Vanguard Group owns nearly 2% of RiskMetrics, but also nearly 3% of Target.

Categories: Analysis · News
Tagged: bill ackman, edgan jones, Pershing Square, proxy governance, riskmetrics