Michael Price at Columbia: Profitable Lessons from a Great Investor

By Greg Speicher (Gurufocus)

The following are my notes from Michael Price’s lecture at the Columbia business school in the spring of 2006. I thought his remarks on how he values pharmaceuticals, how he uses the newspaper to generate investment ideas and how he sizes his positions were noteworthy. He pays great attention to publicly disclosed data in acquisitions calling it a treasure trove of information for valuing companies.

Here is Michael Price’s profile from gurufocus.com:

Michael F. Price is the 271st richest person in the world, according to Forbes. A renowned money manager, he learned finance as a $200-a-week research assistant under Max Heine. Mr. Price earned reputation for buying undervalued companies, and raising he. He has often tussled with management of companies held in his portfolios. He sold Heine Securities in 1996 to Franklin Resources for $670 million. Now, Price manages the private firm, MFP Investors, with $1.6 billion under management, much of it his own money.

Bruce Greenwald mentions that Price helped train Seth Klarman when he worked for Max Heine.

Price thinks that the capital structure comes down to two things: 1) equity, where you own part of a company, and 2) debt, where you lend money to a company. Everything, in Price’s view, else has been invented by Wall Street to rip you off and generate fees.

He tries to boil down a potential investment to these two components to help him evaluate the opportunity. He tries to simplify things and focus on the essentials.

He likes to focus on the balance sheet and the notes to the financials. He is not interested in complex securities such as CDO’s. It is hard enough to figure out what is cheap and buy it. He tries to focus on the steak, not the sizzle. He tries to figure out the worth of the steak and buy it at big discount – $.60 on the dollar. He doesn’t like to pay anything for sizzle.

He does not believe that Graham’s net-nets are generally available, but they do show up from time to time. In general, you will wait a long time – perhaps too long, if you limit your investments to net-nets.

If you can’t find cheap stocks, you wait.

He gave the example of 3M that was doing well in 2006, but the stock had been knocked down from $90 to $70 because Wall Street was focused on how 3M was going to keep up its performance. My takeaway was that Wall Street’s focus on this type of superficial headline risk can make stocks available at a bargain (Mr. Market).

He doesn’t mind style drift if you are pursuing the best value available. The context here was that he usually focuses on smaller companies and special situations, but, at the time of lecture, a number of large caps offered compelling value not usually available.

Proxy Statements Hold Value

You must read the proxy statements because they reveal the self-dealing and cheating. The merger proxies also give rich data that you can use to do comparables of other companies. Price likes to compute intrinsic value using what smart investment banks pay for companies after doing lots of due diligence. This is a lot more meaningful than Morgan Stanley saying a stock should be trading at 17x earnings and you can buy it for 13x earnings.

To Price, when a businessman buys control of a business using cash or securities, that indicates intrinsic value. He does not approach valuation by discounting a stream of future earnings which he views as much too hard to do, nor does he use price-to-book or price-to-EBITDA, which he views as awful. You have to go to where there are transactions and see what companies are doing with their cash flows.

Read the merger proxies and bankruptcy disclosure documents which are a treasure trove of industry data. Typically many buy and sell side analysts are not going to read these documents. As an analyst and investor, you must read these documents.

The real way to make money is to do original research. This is different from inside information. Meaningful data from original research are hard to find. It takes getting creative – reading trades, going to court, talking to reporters, etc.

His mentor was Max Heine who did not like buying shares without voting rights. Price is sympathetic to this viewpoint. Two classes of stock can become an issue if the company is an acquisition candidate. You can buy two-class shares if you have high confidence in the management or family that controls the company. He carefully considers the incentives of the controlling parties. Are there 4th generation family members who are creating pressure to monetize their holdings?

On How He Reads Newspapers to Generate Investment Ideas

He reads the WSJ, New York Times and Financial Times every day. He also suggests reading trade papers such as American Banker. He loves the Lex Report in the FT. He is looking for examples of change – new management, restructuring, restatements, acquisitions, busted deals, lawsuits, etc. Also, he looks at who is wasting money on large ads. He likes to look at the worst performing groups domestically and globally. He looks at tender offer tombstones and dividend cuts.

You need to do your work when a stock starts going down on news so that, if it opens down a huge amount, you are in a position to buy – preparation meeting opportunity.

On How He Sizes His Positions and Trades Around Positions

He won’t buy unless he can identify value. He wants 3-5% in his top five names. He wants 2% in his next ten names and then 20-30 positions with 1%. With the 1% positions he is looking to build larger positions, because if he bought them cheap and they go down he wants to buy more. With the 5% positions – which is his size limit – he is looking whether he should leave them alone or bring them down.

He trades around positions where he has done the research and where the stock will do well over time. For example, if he buys 500,000 shares at $10 and the stock moves up, he won’t buy more. If it goes to $20, he might sell 100,000 shares. If the stock drops back to $11, he won’t buy more because it is not cheap enough. He’s OK with that because he has confidence based on his research that it will do well over time. You need to constantly re-evaluate if you want to be in a given stock; that is why you don’t want to have 300 names – it’s too many to track.

How He Values Pharmaceuticals

Value investors never traditionally looked at pharmaceuticals because they sold at high P/E’s. Price bought Merck when its stock price declined under the specter of HillaryCare.

To value a pharmaceutical company, he takes all the drugs they are currently selling, assumes an 85% profit margin, and does a discounted cash flow projection based on the remaining life on each drug’s patent. Ideally, you want to buy the stock at a discount to these cash flows and get the pipeline for free; this, according to Price, doesn’t happen very often. He noted that pharmaceutical companies have good balance sheets, the prospects of consolidation – because the industry needs it, and strong dividends that provide a floor for the stocks.

The investment business is all about having a point of view, after having done the work, and acting upon it.

Buffett Buys Stake in Fiserv (FISV)

By Melly Alazraki (DailyFinance)

Each quarter, investors and the media await the latest filing from Warren Buffett’s Berkshire Hathaway to see what changes the Oracle of Omaha made to his portfolio. This time, the report revealed a new investment in payment processor Fiserv.

As of June 30, Berkshire reported a 4.4 million-share stake in Fiserv, valued at $200.9 million. Based on Monday’s closing price, the Fiserv stake was valued at about $220 million. Fiserv provides info-tech and electronic-commerce systems to financial and insurance companies. Services include electronically posting checks, opening accounts and tracking loans.

Despite its client base in the financial and insurance industries, Fiserv has managed its operation reasonably well during the financial crisis and recession, increasing its profits primarily through cost-cutting.

In its most recent quarterly report, Fiserv posted an adjusted profit of $1 per share, up from 90 cents per share in the previous year, and above analysts’ estimates of 96 cents per share. Revenue rose to $1.02 billion from $1 billion in the year-ago quarter, topping analysts’ estimates of $1.01 billion. Revenue from processing and services, which accounts for the bulk of the company’s business, rose 3.4%, while product revenue fell 3.5%. Margins continued to improve in the quarter.

But while improved earnings, high margins and good management are definitely requirements for a Buffett investment, they’re not enough. Fiserv also boasts a 37% market share in account processing, and according to Fool.com, nearly 70% of U.S. Internet banking transactions run through one of the company’s technologies. And with its low capital needs, it’s a cash-flow generator, Barron’s adds. Taking it all into account, Fiserv sounds like a classic Buffett investment.

How Fairholme Is Breaking Wall Street’s Rules

By Brett Arends (WSJ)

How is Bruce Berkowitz making your mutual fund managers look bad? Easy. By doing all the things they say can’t be done. Most fund companies say you can’t time the market. He has. They say you shouldn’t hold lots of cash in an equity fund. He does. They say you mustn’t put too much money into a few stocks. He does that, too.

No doubt the time will come when Mr. Berkowitz, too, trips up. But so far, in its first decade, his Fairholme Fund has put most of Wall Street to shame. Fairholme has made an average annual return of about 13%, says Lipper, inc.. That’s turned an initial investment of $10,000 into about $35,000. It’s the top fund of the past decade. Over the same period, the Standard & Poor’s 500 Index has lost money. So far this year, Fairholme is up another 10%. The S&P 500: About 2%.

And the word is out. Fairholme is this year’s fastest-selling domestic equity fund, says Morningstar. Financial Research Corp., which tracks the industry, estimates investors have poured about $3 billion into the fund so far this year, raising its total assets to nearly $15 billion. The rest of Wall Street? Over the same period, U.S. investors have actually yanked billions from other stock funds.

They’ve given up on Wall Street as usual.

It is a double irony that Mr. Berkowitz happened to launch Fairholme in 1999, near the peak of the big 1990s bubble. That was the high water mark of two myths: That stocks ‘always outperform,’ and that you can’t possibly beat the market, so you should stop trying and just give in to index funds. The decade since has buried both of those myths. And Mr. Berkowitz, and his investors, have been dancing on their graves.

How has he done it? Morningstar analyst Mike Breen explains that Mr. Berkowitz–like another famous contrarian investor, Warren Buffett–likes to take big bets on a few names he feels strongly about. He puts those names through tough stress tests–”he tries to kill the company,” as Mr. Breen puts it–before buying. (Mr. Berkowitz could not be reached for comment.) Unlike Mr. Buffett, he’s willing to switch around a lot. With remarkable timing, he jumped out of energy stocks near the peak two years ago, hunkered down in defensives for much of the crash, and bought financials last year. “He’s reinvented the portfolio three or four times,” says Mr. Breen.

It’s tempting to say Mr. Berkowitz has been very lucky. The timing of some of his market moves has certainly suggested a charmed life. After all, with many investors trying to outperform, inevitably some must succeed. Fred Schwed, in the Wall Street classic “Where Are The Customers’ Yachts,” notes that if you held a big coin-flipping contest someone would emerge as the victor–at which point they would doubtless be hailed for their coin-flipping genius.

But it’s not just luck. A recent study (“Best Ideas”) by Randolph Cohen at the Harvard Business School, Christopher Polk at the London School of Economics, and Bernhard Silli at Goldman Sachs, found evidence that backs up Mr. Berkowitz’s strategy of taking bigger bets on fewer names–and goes very much against the conventional wisdom pushed by the fund companies (and their marketing departments). In a nutshell: Good fund managers can indeed pick the right stocks. Their highest conviction “best ideas” stocks, often their top holdings, have a good chance of outperforming.

The problem is that the fund industry makes managers pack out the rest of their portfolio with rubbish, so their funds look like everyone else’s and can be marketed more easily.

Right now Fairholme’s portfolio looks all wrong–at least according to the conventional wisdom. Mr. Berkowitz has nearly two-thirds of the money in just 10 stocks. Most of those are names that sound incredibly “high risk” to mainstream investors. Many are battered financials. The top names include AIG, Citigroup, Bank of America, bond insurer MBIA, bankrupt mall-owner General Growth Properties, and Florida real estate stock The St. Joe Co. And he holds 15% of the fund in cash.

Whether he’s proven right or wrong on these bets, obviously, remains to be seen. The stocks may well seem highly risky. But Mr. Berkowitz bought them by going against the crowd. And clearly he believes he got them so cheaply that the likely gains outweigh any likely losses. In several cases, he’s enjoyed an extra bonus. Some of these stocks, such as Citigroup, had been aggressively sold short by speculators who were betting they would fall further. When Mr. Berkowitz and his fund began buying, that pushed the price up–and doubtless subjected some speculators to a squeeze. If those speculators were then forced to buy back stock to cover their bets, that would have driven the stock up even further. A double win.

The results are hard to quantify. But even if that has helped Fairholme recently it’s not a sustainable game. Where does this leave investors? Is Mr. Berkowitz the promised savior? Or is he taking crazy risks with your money? The answer is: Maybe neither. Mr. Berkowitz is an excellent investor, but he has not discovered the Holy Grail. None exists. He will probably make a blunder at some point. Human beings have that tendency. In a concentrated portfolio that will have a big effect. Investors found this out the hard way in the case of the last “super investors” who were thought to walk on water–such as Ken Heebner (at CGM Focus), Bill Nygren (at Oakmark) and Bill Miller (at Legg Mason Value). Each had a terrific run of outperformance, and then fell flat on his face. Investors who had rushed into the fund during the good times, thinking they had found the only fund they ever needed, then dumped it again.

Bottom line? Anyone investing in Fairholme needs to understand what they own. Be prepared for the possibility of a roller coaster. Fairholme is a good fund to own, but only as one part of a portfolio. Nobody has all the answers.

ValueEdge Newsletter and Warren Buffett on Johnson & Johnson (JNJ) and Sanofi Aventis (SNY)

On the 3rd issue of our ValueEdge Newsletter, Johnson and Johnson (JNJ) and Sanofi Aventis (SNY) occupied the first and second place, respectively, among stocks trading at cheap levels according to our Contrarian Strategy screen. The screen is comprised mostly of stocks trading at 52 week lows with no material news. Apparently, Warren Buffett thinks both JNJ and SNY are cheap as well. 

According to SEC filings, Warren Buffett’s Berkshire Hathaway boosted its stake in Johnson & Johnson by 73 percent between March 31 and June 30, adding 17.4 million shares worth just over $1 billion at today’s closing price of $58.01. The Oracle of Omaha also increased his company’s exposure to Sanofi Aventis by 4.1%, up 159,742 shares to a total of 4,063,675 shares.

We continue to believe both companies are cheap.

Crane & Co: A Private Company With a Moat

Charles Kittredge, the company’s 58 year-old CEO, recently sat down with CNNMoney to talk about company lore and his newest challenge: Finding ways to make his family’s paper company relevant in an increasingly digital world. Below is an edited transcript of the conversation.

In 1850s Dalton, there was the Crane family and the Kittredge family. They all married each other. My father’s grandmother was the granddaughter of Zenas, who is credited with founding the company. I can see the Housatonic River from my desk; Zenas built his first mill here in 1800. The first product was sold in 1801.

The family business was always part of who I was. I wasn’t raised in Dalton, but I was born there and went there on vacation. I worked in one of the mills growing up, but didn’t think ‘this is my career’ as much as ‘this is who I am.’

I had cousins working at the company, but I didn’t come right in, which I think is to everyone’s benefit. I went to work at a financial services firm and in marketing. I learned that focusing on client needs and maintaining strong customer relationships are critical to business success; these lessons were transferable to Crane.

I joined the Crane board in 1995 at age 44, was elected chairman in 2006 and was appointed CEO in 2007. By that time I had a broad view of the business and how Crane fit into it.

How has the business changed through the years?

There once were 65 paper mills in Berkshire County because of its access to water to generate power. Today it’s just Crane.

Our history shows a determination to find relevancy in the marketplace and develop products that customers want and need at any given time. Having a niche really helped us to survive. We used to be the biggest drafting paper makers, the biggest stock certificate makers, the biggest makers of a certain highly combustible rifle paper, the biggest makers of men’s paper shirt collars — which were the wave of fashion in the 1800s. Thankfully they did away with that one!

Not long ago, within the past 20 years, stationery — high-quality stationery products made from cotton — was our big generator. But people don’t need 100% cotton private-watermark paper anymore. Now, 80% of our business in terms of revenue is currency. You need constant reinvention, finding relevancy, spending money on R&D to develop new products.

If I look around a crowded room, I can bet that 98% of the people have one of our products in their pocket. Not many companies can say that. The family story is that Stephen Crane made paper for Paul Revere to print Colonial currency.

We make 100% of U.S. currency paper, so we can’t really grow market-share there, but we’ve grown in revenue because of features used to combat counterfeiting, like de-metalized thread and micro-optic film. We bring the technology to the client and we collaborate.

We print currency for other countries as well. We provide paper for some, provide features for others. Our biggest strategy shift has been moving into the international market. We bought a paper mill and printing plant in Sweden, upgraded it, and now we do all our papermaking and printing for Europe there.

If I look out to the next three to five years, that’s where the growth is — the international market. We had a contract with the Chinese government for the Olympic year. These are the people credited with inventing paper, and they ran out of capacity and came to us.

How bad have e-mail and the Internet been for Crane?

E-mail and social networking have driven letter writing to low levels. We have to adapt to those trends. We can’t focus on strict business or resume paper. We look at notepaper, invitations, paper for occasions.

If we’re good, we can use technology — the Internet — to expand our reach further than it is now. We have the Crane.com site. It’s a bit stale when you look at the range of competitors — TheKnot.com, Shutterfly, and others. There are things we ought to be doing and are not. These are things we will be doing in the next few years.

We should be all over digital products. We want 26-year-olds to buy our stationery, not get it as gifts from their grandmothers. We need good designs that speak to people younger than my grandmother.

We need to transform our Web platform from a site that sells products to one that becomes a destination and a resource for consumers at important events in their lives: Weddings, births, anniversaries, etc. We need a site that will allow the customization of design and images to go along with great paper.

We need to redefine Crane stationery from a paper-based business to a personal communication business. 

David Sokol on Berkshire Hathaway and MidAmerican

Update: Endo Pharma to buy Penwest for $5/Share

Kevin Tang has done it again.

Just a few days ago we wrote an article on Penwest Pharma (PPCO) and the possibility of realizing over-average returns in the near term due to Kevin Tang’s push to wind down the company’s operations . The idea was that shareholders could fully realize the OpanaER royalty payments if research and other operating expenses were brought to zero. In such case, shareholders would have been able to realize roughly $23 mm of annual royalty payments until at least 2013, which represented a 21%annual return on investment over those three years based on the enterprise value of $111mm at the time the previous article was written.

Today, Endo Pharmaceutical (ENDO) said it agreed to buy Penwest Pharmaceuticals for about $168 million in cash, to broaden its pain drug portfolio. Endo said it expects the deal at $5 a share, a premium of 32% percent to Penwest’s price at the time the initial article was written. The purchase translates into a 14% return on investment for Endo for the next 3 years, with the opportunity to further develop and expand OpanaER into foreign markets (OpanaER has only been approved in the US).

Endo also said it filed a new drug application with the U.S. Food and Drug Administration for a new extended-release formulation of oxymorphone to treat moderate to severe pain in patients requiring continuous opioid treatment. Penwest shareholders Tang Capital Partners and Perceptive Advisors, and Chief Executive Jennifer Good, who collectively own 38.6 percent of Penwest common stock have committed to tender their shares in the offer, Endo said in a statement.

Out of all the investors we currently follow, Kevin Tang has been by far one of the most skillful at spotting investment opportunities as well as adapting to the conditions of the equity markets. In March 2009, when everyone was fearful to invest, Mr. Tang took a position in VNDA, which paid off handsomely soon after. There is no doubt that we will continue to study Mr. Tang’s approach to investing and spotting investment opportunities.

Qiao Xing Mobile Communication (NYSE: QXM)‎: Waiting for A Catalyst

Qiao Xing Mobile Communication is $137mm company which develops, manufactures, markets, and sells mobile handsets in China under the CECT and VEVA brand names. The company provides its products to mid-income consumers through its own retail stores, national and provincial distributors, TV direct sales distributors, and Internet distributors, as well as through its Website vevago.com. It currently operates six VEVA retail stores in Beijing, and employees 600 people. The company sold $2 million mobile handsets last year.

The company currently trades at a fraction of its net cash value, and has actually done so for quite some time now. Our estimated liquidation value is in the range of $4 to $5. However, liquidation is extremely unlikely as the company’s Chairman (who owns 60% of the company’s shares) would not approve the dissolution of its company. A more likely scenario would be the payment of a special dividend in the future or simply a convergence between the company’s current prices with at least the lower end of liquidation value estimates, which would yield a 160% return.


There are currently no activist investors pushing management to return the cash to shareholders. A notable shareholder is Andrew Weiss, from Weiss Asset Management, who is known for focusing on obscure, illiquid, and sometimes complex investments.

Excessive cash burn is also unlikely, as there have been no material changes on the regulatory environment or operating capabilities that prevent the company from at least breaking even in the coming years. Therefore, the company offers an asymmetric payoff with the odds of a positive return extremely tilted towards shareholders.  In the meantime, we continue to wait for a catalyst to unlock this value.

Disclosure: We do not hold any positions on QXM

Top Holders Of Berkshire Hathaway Stock

Berkshire Hathaway is a great company, no doubt about that. But some funds are extremely concentrated on the stock. The worst part is that they continue to charge management fees to their investors, even though a big portion of money is essentially managed by Warren Bufffet’s intellect, not necessarily theirs. Below are the biggest holders of Berkshire stock based on total portfolio concentration percentage.

Bill Ackman To Speak at Value Investing Congress

Bill Ackman has just agreed to speak at the upcoming 6th Annual New York Value Investing Congress, October 12 & 13, 2010 in New York City.

In 2004 Ackman founded Pershing Square Capital Management with $54 million. Since then, Pershing’s flagship fund has returned 290.8% net of all fees to investors and the firm now holds over $3 billion AUM.

He’s made headlines for his prescient analysis of MBIA and his active roles in creating value at companies including McDonald’s, Ceridian Corporation, Longs Drugs, Wendy’s International, and most recently General Growth Properties.

We are still offering a 40% discount to the Congress by using code N10VH5. To get your discount tickets, CLICK HERE.