“Every day you’re not selling an asset that’s in your portfolio, you’re choosing to buy it.”

The idea is that managers have to look at everything fresh every day in light of all new information, so that holding a position is no different from buying it, especially if there are no tax implications for selling (e.g. positions in retirement accounts, endowments, etc.). That perspective helps prevent managers from falling in love with their positions. It’s akin to Sir Arthur Quiller-Couch’s admonition for writers to “Murder your darlings.”

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1. He’s super-smart;

Yet, as Buffett himself has said, if you have more than 130 IQ points you should sell the excess because you won’t need it to be a great investor. In fact, that extra IQ may be detrimental if it leads to behavioral flaws such as overconfidence or lack of discipline.

2. He’s guided by an overarching philosophy;

That philosophy is value investing, which can be executed in several forms.

3. He’s mentally flexible;

It may seem as if Buffett had a change in philosophy when he transitioned from Ben Graham’s “Net Net” and “Cigar Butt” approaches to investing to Charlie Munger’s “wide-moat” approach. However, all three approaches are guided by the value-investing tenet that requires a Margin of Safety.

Graham’s margin of safety was found in businesses trading at less than the net value of their assets. Munger’s approach of investing in under-appreciated companies with wide moats found a margin of safety in well-run business with pricing power and even growth. The key is in the qualifier “under-appreciated.”  Value investors love growth, but tend to be more skeptical of growth projections than glamour investors, and are usually better at maintaining discipline when pricing growth, and rightly so.

Hence, value investors usually buy fast-growing, wide-moat companies only when the market does not fully appreciate their wide moats as much as it should. One example: Buffett paid $1.02 billion for shares of Coca Cola by the end of 1989 after the 1987 crash had damaged Coke’s shares. By 1999, that investment was worth $11.6 billion according to Hagstrom.

4. He’s unemotional;

Marks: “Many of the obstacles to investment success relate to human emotion…perhaps worst of all, (most investors) have a tendency to judge how they’re doing based on how others are doing, and to let envy of others’ success force them to take additional risk… (Warren) doesn’t care whether others think he’s right or whether his investment decisions promptly (my emphasis) make him look right.”

My Take: Warren is disciplined, which can make a person appear unemotional. I would be willing to bet that on more than one occasion in his career he lost sleep over a decision, but that his discipline allowed logic to triumph.

5. He’s contrarian and iconoclastic;

As Charlie Munger likes to say, I have nothing more to add.

6. He’s counter-cyclical;

Marks: “Many of the best investors accept that they can’t predict what the macro future holds in terms of economic developments, interest rates and market fluctuations…the greatest bargains are accessed by buying when the economy and companies are suffering…how many acted as boldly (as Buffett) when fear of financial collapse was rampant (in 2009)?”

7. He has a long-term focus and is unconcerned with volatility;

One should only invest in the equity or long-term debt of businesses to cover long term liabilities such as college tuition that is due in twenty years, retirement liabilities, and bequests, so volatility is the friend of the long-term value investor. Volatility gives the long-term value investor the chance to buy low and eventually sell high, in contrast to what most investors do; that is, buying when rising prices make them feel good and selling when plummeting prices are too painful to bear.

This is where a good wealth advisor comes in for an individual investor or family office. He or she will help such investors identify their goals and estimate when the invoices for those goals need to be paid. Then, a good advisor will allocate assets to broad asset categories that “immunize” those liabilities and help make the euphoria of rising prices and pain of plummeting ones easier to ignore and bear because short-term goals are covered in cash or high-quality short-term debt, and opportunities to cover long-term goals will arise over a multi-decade run.

This is known in High Net-Worth Investor (HNWI) Wealth Management circles as Goals-Based Investing (GBI).  The underlying assumption is that all investors would be happy to simply meet their goals and avoid their nightmares so that they can focus on their careers and the things that make them happy.

In GBI, capital for near-term goals is held mostly in cash and short-term bills, and capital for long-term goals is invested in less liquid or more volatile (in the short run) investments such as equities, long-term debt, real estate, and alternatives in order to exploit the return premiums that are available there.

Within asset categories a good advisor will help clients find investment managers who understand each asset’s risks and who can manage those risks well. He will also find managers who can exploit specific premiums in those asset classes such as the value premium in equity investments.

8. He’s unafraid to bet big on his best ideas;

So many active investors have capital spread thinly, and almost all of it is allocated to S&P 500 companies. They have low “active share,” so they are essentially closet indexers who charge higher fees than indexers.

9. He’s willing to be inactive;

According to a speech that Seth Klarman delivered at a Grant’s conference in the fall of 2013, Baupost Group has about 50% in cash. Klarman is fearful of returning cash to his investors because he believes that they may go out and invest it with a hot-hand manager and will suffer during an inevitable shakeout.

PAR views cash as an investment in an option on every asset, an option that has no expiration date. That option is worth quite a lot right now.

10. Finally, he’s not worried about losing his job;

Professional portfolio managers who work for large firms lose their jobs if they underperform. That is why many make the rational decision to become closet indexers in order to hug their benchmark and avoid underperformance.

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http://amarginofsafety.com/2013/03/01/the-equity-market-annual-return-histogram-updated-for-2012/

Yesterday’s Wall Street Journal Ahead of the Tape column by Spencer Jakab had a chart titled  ”Unhinged,” in which Jakab showed average stock market returns relative to average GDP growth during the last eleven recoveries from a recession. The market return is almost FIVE times GDP growth in the current expansion, but averaged only 1.47 times GDP growth in the previous ten recoveries.

Is 2013 going to be one of the once-every-nineteen-years when the market rises over 40%? Can a market rise that much on Federal Reserve balance sheet growth alone? Perhaps, like in 1928, this party is still in the ten o’clock hour. What will happen when the clock strikes midnight?

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LinkedIn (LNKD) announced that they met Thomson Reuters analysts’ expectations for earnings at $0.16 per share this quarter. In addition, second quarter revenue at $228.2 million, beat analysts’ expectations of $215.7 million. The stock is currently up over 12% on that news.

Then there is the pesky bit about profits and cash flows; you know, those items that compensate investors for allocating capital to a firm. Net income was $2.8 million, down 38% from the same quarter a year ago. Why? Well it seems earnings took a big hit when executives congratulated themselves with large option and stock payouts this quarter compared with one year ago. In fact, the $0.16 EPS figure was a non-GAAP measure.

When taking executive comp in stock and options into account, EPS was actually $0.03. The company would like investors to look the other way on the latter number. I would too if I just confiscated 81% of my firm’s profits in the quarter.

If we extrapolate these best-ever quarterly revenue numbers over a whole year, then LNKD is trading for 10.6 times sales (it is actually trading at 15 times TTM sales). LNKD has a market capitalization of nearly $10 billion. In order for LNKD to turn itself into the next growth story like Apple and bring its price-to-sales ratio in line with Apple’s very high 3.8 multiple, LNKD would have to almost double its sales. In order to bring that multiple in line with the rest of the large-cap market, it would have to increase sales 768% (almost 8 times!!!!).

Don’t get me wrong, I like LinkedIn’s services. I am already contemplating abandoning Outlook contacts. But, aren’t all unemployed professionals already on LinkedIn? Where is growth going to come from?

Then there are the other pesky metrics. Trailing PE of 952. Forward PE of 152 (not including the 38% decline in profits). Price-to-cash flow multiple of about 100. Price-to-book of about 100. And, a 2% net profit margin after management takes its exorbitant cut. If you are an investor in LNKD and don’t know who the mark is at this poker table, it is you.

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In Hedgehogging, among other topics, Biggs writes of the trials and tribulations of starting a fund, the difficulties of shorting (the hedge in hedge fund) and he reminisces about how he appeared as a dunce to the young, upstart managers (and some of his fund’s investors) because he warned repeatedly in the late 1990s that the internet bubble was going to end badly and so he refused to participate in it.

To many young guns he was past his prime, out of touch, should be put out to pasture, he did not understand that “it was different this time.” And, of course, the knowledge that he accumulated over the years–wisdom–turned out to be absolutely correct in the end. Unfortunately for many fund managers, value managers in particular, the bubble inflated for too long and it put them out of business as their investors redeemed to put their money in the latest, hottest fund.

One of the most insightful parts of the book for me was his discussion of the value of gold and other jewelry. As a value investor, I find it hard to appreciate precious metals and stones because I find it hard to place a value on them. Their value is almost completely subjective. Biggs drove home the point that they are literally lifesavers in the most distressed of periods–e.g. the get-out-of-Nazi-Germany kind of periods when the only assets that you can keep are the jewelry you can carry and hide on your person.

Unfortunately, I strongly disagreed with Biggs in the last chapter, so it stayed with me and allowed me forget the value of the previous chapters. Biggs defended Keynesianism with the kind of vigor reserved for zealots, as in this sentence (emphasis mine), “To be truly taken as the economic savior of civilization, Keynes needed to present a conventional face to the world” which discussed his marriage to Lydia. Biggs attributes the end of the Great Depression to Keynesian economics.

I suspect that when the current debt crises that are cascading in practically every western economy are finally resolved, objective minds will have an entirely different view of Keynesian economics. It was Keynesianism that justified large government spending after all, and a sheep-like political class was only too happy to use Keynesianism in their re-election bids. There is no easier way to get re-elected than to spend taxpayer dollars (not your own) on your constituents. Keynesianism will have had a century-plus run, but century-plus runs are not uncommon for many failed ideologies. The latest century-survivor to fail is communism, which was considered by many in its day as more economically efficient than western capitalism and therefore unstoppable. It was considered efficient in the west in part because of Keynes.

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Good Stuff.

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At our request, William Bernstein, an investment manager at Efficient Portfolio Advisors in Eastford, Conn., reviewed Rep. Paul’s portfolio as set out in the annual disclosure statement. Mr. Bernstein says he has never seen such an extreme bet on economic catastrophe. ”This portfolio is a half-step away from a cellar-full of canned goods and nine-millimeter rounds,” he says.

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The extraordinary events we’ve seen these past months are now threatening the euro project, and calls for its dismissal, which were laughable a year ago, are becoming more mainstream. Risk aversion has increased dramatically and we are arguably in as bad a shape as in 2008/2009. Peripheral bond yields are now much higher than they were back then, as are all sovereign CDS. The low yields of the safe haven bonds (Bunds and US Treasuries) also highlight the sharp risk aversion in the markets and while the tensions in the money markets are not as bad as they were back then, they remain at extreme levels.

Kyle Bass on CNBC today essentially said the following:

“Europe is trying to fix a solvency crisis with liquidity. Liquidity is not the problem. No one is saying the payments system will fail; it did not fail in the US when Lehman went under, either. However, bills are coming due in Europe that no one can pay.”

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I do not believe Bass is a permabear like Roubini and Shilling. I think he has thoroughly analyzed developed western economies, sees a disaster coming, and is willing to place a large bet on his convictions. Enjoy…

http://watch.bnn.ca/the-street/december-2011/the-street-december-13-2011/#clip584881

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