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The Stingy News Quarterly (Q2/2006)

New @ StingyInvestor

Monkey Business
"Can an active fund that charges ten times as much as an index fund be expected to outperform the index fund? The case could be made in extraordinary circumstances, but it might be more fruitful to see if index funds themselves could be made even better. Interestingly those clever monkeys might have had the answer all along."

Is that a hole in your IPO?
"It also nicely illustrates why most main street investors should avoid IPOs entirely. Regular investors rarely get quality IPO shares before public trading begins. On the other hand, buying at sky-high prices when trading starts can set up long-term investors for a big fall."

Upside/Downside Market View
"Select a portfolio composed of up to six major asset classes, as per your specification, and find out how it has done since 1970."

The Best of Stingy Links Stingy Links: Academia

The price of conformism
"As previous agency models have shown, fund managers with career concerns have an incentive to imitate the recent trading strategy of other managers. We embed this rational conformist tendency in a stylized financial market with limited arbitrage. Equilibrium prices incorporate a reputational premium or discount, which is a monotonic function of past trade between careerdrive traders and the rest of the market. Our prediction is tested with quarterly data on US institutional holdings from 1983 to 2004. We find evidence that stocks that have been persistently bought (sold) by insitutions in the past 3 to 5 quarters underperform (overperform) the rest of the market in the next 12 to 30 months. Our result is of a similar order of magnitude of - but cannot be reconduced to - other known price anomalies. Our findings challenge the mainstream view of the roles played by individuals and institutions in generating price anomalies."

Founder-CEOs and stock market performance
"Eleven percent of the largest public U.S. firms are headed by the CEO who founded them. Founder-CEO fims differ systematically from successor-CEO firms. They have a higher firm valuation. Founder-CEO firms invest more in R&D, have higher capital expenditures, and make more focused mergers and acquisitions. Moreover, an equal-weighted investment strategy that had invested in founder-CEO firms from 1993 - 2002 would have earned a benchmark-adjusted return of 8.3% annually. A value- weighted investment strategy would have earned an abnormal return of 10.7%. The excess return is robust; after controlling for a wide variety of firm characteristics, CEO characteristics, and industry aliation, the abnormal return is still 4.4% annually."

Stingy Links: Accounting

The trial of Sarbanes-Oxley
"The act was named after its two main sponsors, Senator Paul Sarbanes (pictured right above) and Congressman Mike Oxley (left). Sarbanes-Oxley, or SOX, as it has become known, was unpopular with business people from the start. In recent years it has been hard to find a chief executive of a public company who does not complain vehemently about the burdens imposed by the dreaded SOX. Indeed, rather than diminish as the initial shock wore off, the complaints have only got louder. The SOX-bashers have been joined by such luminaries as Alan Greenspan, the former head of the Federal Reserve and Bob Greifeld, the boss of the NASDAQ stockmarket."

Stingy Links: Brokers

The study of the decade
"Over the next few years, you will be hearing a great deal about a ground-breaking new study that is just now starting to receive nationwide attention. The only notice of it that I have seen in the public media just appeared in a popular money magazine: "A new study compares the cost and performance of more than 4,000 mutual funds--some sold by brokers, some selected by people on their own--from 1996 to 2002. The people won." In other words, do-it-yourselfers outperform financial advisors."

Assessing the costs and benefits of brokers
"Exploring these dimensions, we do not find that brokers deliver substantial tangible benefits. In short, while brokerage customers are directed toward funds that are harder to find and evaluate, brokerage customers pay substantially higher fees and buy funds that have lower risk-adjusted returns than directly-placed funds. Further, brokered funds exhibit no better skill at aggregate-level asset allocation than funds sold through the direct channel. This analysis implies that any benefits that exist must be found along less tangible dimensions."

Stingy Links: Buffett

The Warren & Charlie Show: 2006
"I was in Omaha on Saturday to attend Berkshire Hathaway's annual shareholders' meeting at the Qwest Center there. As they do every year, CEO Warren Buffett and Vice Chairman Charlie Munger spent the bulk of the session answering questions from shareholders. Here are my notes from the gathering"

Buffett solves his cash crisis
"With each passing year, they seem to become a little less interested in buying small stakes of companies that trade in the stock market - and more interested in buying majority holdings in private businesses. That, they believe, is how they can now get the biggest bang for their big bucks. Buffett and Munger are more thoughtful about what to do with cash than any other business leaders in America. That's because they know that cash is like most good things in life: It takes only a tiny bit too much to turn it from a blessing into a curse."

Wit and wisdom of Buffett and Munger
"Selected comments from Warren Buffett and Charlie Munger from Saturday's annual meeting of Berkshire Hathaway shareholders in Omaha, Nebraska."

Buffett: Real estate slowdown ahead
"I don't think there's a bubble in agricultural commodities like wheat, corn and soybeans. But in metals and oil there's been a terrific [price] move. It's like most trends: At the beginning, it's driven by fundamentals, then speculation takes over. As the old saying goes, what the wise man does in the beginning, fools do in the end. With any asset class that has a big move, first the fundamentals attract speculation, then the speculation becomes dominant. Once a price history develops, and people hear that their neighbor made a lot of money on something, that impulse takes over, and we're seeing that in commodities and housing...Orgies tend to be wildest toward the end. It's like being Cinderella at the ball. You know that at midnight everything's going to turn back to pumpkins & mice. But you look around and say, 'one more dance,' and so does everyone else. The party does get to be more fun -- and besides, there are no clocks on the wall. And then suddenly the clock strikes 12, and everything turns back to pumpkins and mice."

Age and acquisitions top Berkshire agenda
"But the shares have stagnated over the past two years, as Buffett has struggled to find big acquisitions that meet his strict value-investing criteria. In his 2004 shareholder letter, Buffett admitted that he'd "struck out" by not making any multi-billion dollar acquisitions that year. "Berkshire therefore ended the year with $43 billion of cash equivalents, not a happy position," he wrote, promising to try to "translate some of this hoard into more interesting assets during 2005." By the end of last year, Berkshire had made more than $10 billion in acquisitions, but its cash pile still stood at more than $40 billion because the company's current businesses generate so much profit."

Harley-Davidson, Mattel fit Buffett purchase criteria
"Buffett repeats his acquisition criteria each year in Berkshire's annual report. Companies must have at least $75 million in pretax profit, consistent earnings, 'good' returns on equity and 'little or no debt' to be considered. Managers must stay with the company, which should be in a 'simple' business. The valuation of $5 billion to $20 billion has stood since 1998. The range was $5 billion to $10 billion before then. The Bloomberg News search looked at more than 5,000 publicly traded U.S. companies. To qualify, stocks needed a price-to- earnings ratio of 15 at most, less generous than the 17 times earnings Berkshire is paying for Russell. They also had total debt to common equity of less than 50 percent and five-year geometric earnings growth of 10 percent annually. "

Buffett shares wisdom with students
"Warren Buffett is known for shrewd financial deals, but the world's second-richest man also invests some of his time to help guide business students. Buffett's Berkshire-Hathaway Inc. made an average of $23.4 million a day in 2005, yet he plans to spend the better part of 20 days this year answering questions and offering advice based on decades of stunningly successful experience. It's time the Oracle of Omaha thoroughly enjoys."

See's, Buffett's candy shop, pushes across U.S. again
"Berkshire Chairman Buffett bought See's in 1972 for $25 million at the urging of Vice Chairman Munger. With its first new chief executive officer in 34 years, See's is taking another run at becoming as familiar across the U.S. as International Dairy Queen Inc., also a Berkshire unit, and Coca-Cola Co., whose biggest shareholder is Berkshire. Brad Kinstler, CEO since January, is cultivating Internet sales and operating more gift shops during the Christmas season, when See's gets half its revenue. The drive follows a failed effort 30 years ago to put See's black-and-white-tiled stores in malls from St. Louis to Houston. After 85 years in business, See's still has more than three-quarters of its 200 stores in California."

Buffett makes $14 Billion bet on global stocks
"Berkshire sold a form of insurance to buyers who wanted protection from a drop in 'four major equity indexes' over the next 15 to 20 years, according to a U.S. Securities and Exchange Commission filing. Instead of buying the individual shares, Buffett is wagering the indexes, three of which are outside the U.S., won't tumble and force Omaha, Nebraska-based Berkshire to pay a claim."

Stingy Links: Crime

After Enron, corporate wrongdoing still thrives
"Now, it would be nice if the Lay and Skilling convictions marked the end of this kind of fraud. The terrible part is that it's still going on in a huge way. Lately, investigative reporters at "The Wall Street Journal," aided by university professors, are discovering that top executives at some of the biggest companies in the nation are looting their companies in an almost unbelievably brazen way."

Stingy Links: DRPs

Drop by drop, DRIPs build your wealth
"Companies offer DRIPs to help raise capital and broaden their shareholder base. Some companies are eager enough to pursue these goals that they build a discount into the price of shares that investors buy through dividend reinvestment or SPPs, or they provide a small bonus of extra units. Discounts run from 2 to 6 per cent of the market price at the time the shares are purchased, while the bonuses are usually in the 3-per-cent range and apply to the amount being reinvested. "It's a pretty sweet deal and well worth using," Mr. Rothery said."

Stingy Links: Dividends

One-stop dividend shopping
"How should you choose among these options? If you're seeking foreign dividends, PowerShares International is for you. If you value transparency, avoid the Mergent/Vanguard offering. Among the others, choices involve trade-offs. Indexes weighted by yield generally provide higher income than those weighted by market capitalization, but after-tax net can be lowered if the index includes REITs."

Stingy Links: Dorfman

Book value bargains
"About 2 percent of all U.S. stocks sell for less than book value -- that is, less than the company's per-share assets minus liabilities. This might appear to be a paradox. After all, if a company were liquidated -- selling all assets and paying off all liabilities -- there would seem to be more cash than the market value of the stock. What's the catch? Liquidation may be unlikely. And it's always possible that the liabilities are understated or the assets overstated. Therefore, buying stocks below book value isn't a sure-fire strategy. Yet it is often a good one."

Low-debt appeal
"In picking stocks, low debt may sound like an old-fashioned virtue from the time of crinoline skirts and hand-tied bow ties. It's not. The low-debt stock lists I've presented in this column annually for the past eight years have shown an average 12-month total return of 45 percent. By contrast, the average return for the Standard & Poor's 500 Index for the same eight periods has been 5.3 percent."

Allstate and CBS have joined the do-nothing club
"Take a look at the last five stocks you bought. Before you took the plunge, were they moving up, down or sideways? Many people instinctively gravitate to stocks that have been moving up. Others, like me, are drawn to those that have just fallen. Not many investors are interested in the 'sideways' stocks. People see them as dull, directionless and boring."

The old faithful screen
"Seven times beginning in July 1999, I've compiled a list of stocks from the Old Faithful screen. The average one-year gain has been about 30 percent, compared to an average loss of 1.1 percent for the Standard & Poor's 500 Index. The average three-year gain (for the five lists that have three-year results) has been 115 percent, compared with a 5.6 percent loss for the S&P."

Undiscovered bargains among the cheapies
"The average U.S. stock sells for about $26 a share. For some investors, that's too much. They prefer stocks selling for $5 to $10. Intuitively, these investors believe that a $5 to $10 stock has 'more room to grow.' You can call this irrational if you want. There's little difference between owning 10 shares of a $40 stock and 100 shares of a $4 stock. Yet there is some method to the madness of people who prefer cheap stocks in the sense of raw price. It comes down to the difference between institutional investors and individuals. Institutions such as mutual funds, insurance companies and pension funds typically pay commissions of 1 cent to 6 cents a share. And they deal in thousands, or tens of thousands, of shares at a time. For them, $5 to $10 stocks run up a higher commission tab because they need to purchase more shares to equal, say, 2 percent of their portfolio. Small investors, by contrast, often pay a flat fee to trade. To them, there is no harm to them in buying low-priced shares. Some institutional buyers also regard lower-priced stocks as less respectable than higher-priced ones. So $5 to $10 may be only scantily covered by Wall Street analysts. That's why individuals can sometimes find undiscovered bargains among the cheapies."

Cheapskate walks, quicksilver runs
"The Cheapskate Portfolio is entering its fifth year, and is on probation. Its record isn't bad -- just not as good as I had hoped. If results don't improve, I'll probably discontinue it after the fifth year. The Quicksilver Portfolio is just a sophomore. It is off to a terrific start, up 30 percent in its first year."

5 Nasdaq stocks that might rise
"Cincinnati Financial (CINF), based in Fairfield, Ohio, sells property & casualty insurance, engages in leasing and financing activities, and offers investment management services. Cincinnati Financial stock sells for 15 times earnings, 1.3 times book value and 1.8 times revenue, all reasonable multiples in my opinion. It yields 2.9 percent in dividends. Yet the picture is better than it appears. Cincinnati Financial owns almost 13 percent of Fifth Third Bancorp, a banking company with a market value of more than $20 billion. If you adjust for that holding, Cincinnati Financial sells for only 10 times earnings from operations."

Intel, Pilgrim's Pride have joined the casualty list
"Pilgrim's Pride Corp. and Westwood One Inc. were knocked around in the first quarter. I think they have substantial potential to bounce back. I also see rebound potential in Intel Corp. and Swift Energy Co. All four of these stocks declined significantly in the first quarter. I have put them on my Casualty List."

Doubled, still cheap
"Don't automatically sell big gainers, unless it's necessary to achieve adequate diversification in your holdings. Instead, make a judgment call in each case. Is the stock still cheap? Do its prospects still look good? If so, let your big winner ride, unless it exceeds 10 percent of your portfolio. "

Think twice before purchasing these stocks
"Last weekend I screened the Bloomberg database for stocks that sell for more than three times revenue, even though they posted a loss in their latest fiscal year and their revenue has been growing at less than a 3 percent annual pace in the past five years. I found 13 such stocks, and will discuss seven of them in this column. The seven are the largest, the most indebted, and those with the worst losses recently."

Stingy Links: Dreman

The long view
"There's a brass telescope set up in David Dreman's spacious Jersey City office, and it's trained on Manhattan's southernmost tip, just across the Hudson River. That's exactly how the 70-year-old veteran investor looks at Wall Street - with a long view, a high level of scrutiny and from a very different perspective than most money managers."

Unpleasant surprises
"How smart are analysts at forecasting earnings? I have a long-running debate with the analyst community on this point. The analysts (and the people who circulate their numbers) think they're pretty good. I think they all too often miss by a wide margin, especially on high-multiple growth stocks, where a disappointment can send a stock reeling."

Dreman and Davis interview
"This week on WealthTrack rare in depth sessions with two of the most successful fund managers in the business ... David Dreman and Christopher Davis explain how they invest for the long term with such sterling results ... learn about the value of value investing."

Stingy Links: Economy

When protecting jobs only destroys them
"I like France. The language is beautiful. The food is inspiring. And I appreciate topless beaches as much as the next guy. Still, I sometimes wonder if eating snails doesn't somehow dull one's ability to make sensible economic policy."

Debunking one of the worst ideas in economics
"Economist Arthur Laffer made a very interesting supposition: If tax rates are high enough, then cutting taxes might actually generate more revenue for the government, or at least pay for themselves. (In one of life's great coincidences, he first sketched a graph of this idea on Dick Cheney's cocktail napkin.) If the government cuts taxes, then Uncle Sam gets a smaller cut of all economic activity -- but reducing taxes also generates new economic activity. Laffer reasoned that, under some circumstances, a tax cut would stimulate so much new economic activity that the government would end up with more in its coffers -- by taking a smaller slice of a much larger pie. In fairness to Mr. Laffer, there's nothing wrong with this theory. It's almost certainly true at very high rates of taxation."

Stingy Links: Fun

Detroit sold for scrap
"The decision to demolish and cull Detroit for scrap was approved last month by a 6-3 City Council vote after a cost-benefit analysis revealed that, as a functioning urban area, it held a negative cash value."

Stingy Links: Government

Soft paternalism
"Its champions will say that soft paternalism should only be used for ends that are unarguably good: on the side of sobriety, prudence and restraint. But private virtues such as these are as likely to wither as to flourish when public bodies take charge of them. And life would be duller if every reckless spirit could outsource self-discipline to the state. Had the government deprived Coleridge of opium, he might have been happier. Then again, there might have been no 'Kubla Khan'."

Stingy Links: Growth Investing

Junk-food jihad
"So, we've found a new enemy: obesity. Two years ago, the government discovered that the targets of previous crusadesbooze, sex, guns, and cigaretteswere killing a smaller percentage of Americans than they used to. The one thing you're not allowed to do in a culture war is win it, so we searched the mortality data for the next big menace. The answer was as plain as the other chin on your face. Obesity, federal officials told us, would soon surpass tobacco as the chief cause of preventable death. They compared it to the Black Death and the Asian tsunami. They sent a team of "disease detectives" to West Virginia to investigate an obesity outbreak. Last month, the surgeon general called obesity "the terror within" and said it would "dwarf 9-11.""

Zero to $1 billion
"After interviewing dozens of executives at billion-dollar firms, Thomson boiled down their management practices to what he calls the Seven Essentials. Some of these principles are strategic: Create a killer value proposition. Some are operational: Manage for positive cash flow from the start. And some involve leadership: Hire a second-in-command who can take care of the day-to-day while you think big picture. It has long been a business school staple that successful companies sell emotional benefits, not just products. Yet few entrepreneurs can explain why their business proposition is any better than the competition's. Not so with our Blueprint companies."

Stingy Links: Indexing

Investors choose high-fee index funds
"But the students "overwhelmingly fail to minimize index fund fees," the researchers write. "When we make fund fees salient and transparent, subjects' portfolios shift towards lower-fee index funds, but over 80% still do not invest everything in the lowest-fee fund." In fact, the mean fee paid by the students was 1.22 percentage points above the minimum they could have paid -- enough to dramatically reduce long-term gains." Warning: irrational investors at work.

It's better to do it yourself with ETFs
"A persuasive case can be made that indexing as carried out with ETFs is an ideal strategy for do-it-yourself investors. By tracking the major indexes and avoiding the advice costs folded into mutual funds, it's possible to make returns that compare favourably with most mutual funds. But the appeal of indexing is diminished, if not nullified, when the cost of advice is added in."

Fundamental indexing and the three-factor model
"Fundamental indexing is a promising technique, but its advantage over more conventional cap-weighted value-oriented schemes, to the extent that it exists at all, is relatively small."

Stingy Links: Law

No defense for this insanity
"Open societies flourish because they are driven by intelligence and information; the U.S. tort system creates an enclave of idiotic whimsy in the heart of the most open society in the world. But the Vioxx litigation does not merely celebrate dumb prejudice. It's extraordinarily expensive. For this year alone, Merck has set aside a legal war chest of $685 million. The Vioxx lawsuits could eventually cost it between $10 billion and $50 billion. Did those numbers sink in properly? The midpoint of those estimates -- $30 billion -- is six times more than the federal government spends annually on cancer research. Or, to put it another way, $30 billion is about five times Merck's annual earnings, meaning that one of the world's top pharmaceutical research establishments is fighting for survival. At a time when Americans fret over relative decline in science and business, it's insane to sink a flagship scientific company in order to line the pockets of unscrupulous lawyers."

So sue me
"Rather, I'm interested in the issue of litigation as part of an investment decision. Too few investors look at pending litigation when deciding what stocks to back. That's too bad, because lawsuits can have a big impact on stock prices over the longer term, positive and negative."

Stingy Links: Management

Do company founders make better CEOs?
"Of course, 27 companies is a small sample, and we might have written this off as a statistical fluke had we not come across the research of an Ohio State University finance professor named Radiger Fahlenbrach. Fahlenbrach analyzed the performance of the 2,300 largest U.S. companies from 1993 through 2002, and he discovered that those run by founder-CEOs (11 percent of the total sample) outperformed the broader stock market by eight percentage points a year."

The next big scandal
"At issue is whether those options grants were backdated. For example, if a company grants options on May 22, when its stock price is $20, but records the date of issue as April 22, when the stock price was only $15, it would have given those who were granted options a "sure thing," or at least a leg up, on a very lucrative "gift" of corporate assets. Already, CEOs of several companies have resigned, been discharged or been placed on administrative leave pending the outcome of internal and governmental reviews."

A study in CEO greed
"The problem, in brief, is that executives at some companies were backdating their stock options to dates when the stock was at its low for the year or the quarter, tilting the odds of profiting on those options heavily in their favor. Backdating isn't necessarily illegal, but following the complicated rules would largely eliminate the advantages of doing it. As actually practiced, it was stealing, pure and simple. Executives looked back over several months and chose the date on which they wanted the right to buy shares of the company they were being paid to manage and - surprise! - they chose the date when the price was lowest. Wouldn't you like to decide in retrospect when to buy a stock?"

Pay for failure should stick in investors' craws
"Funny how a bull market puts us all in such a forgiving, mellow mood. Paycheques for the country's top CEOs went up 39 per cent last year, according to a Globe and Mail study, and does anyone raise a peep?"

Spinning CEO pay
"Strange, but true: One company actually receives positive press for its executive compensation. Media reports frequently tout Whole Foods' pay policy, which caps the chief executive's salary and bonus at 14 times the average worker's pay. The Wall Street Journal,, Harvard Business Review and BusinessWeek have all mentioned the pay cap, generally in favorable terms. But they all omitted one thing: stock options."

CEO Paycheck: $42,000 a day
"Last year, the average CEO of a company with at least $1 billion in annual revenue made $10,982,000, or 262 times what the average worker made, according to an analysis by the Economic Policy Institute (EPI) released Wednesday. Put another way, the average worker -- who earned $41,861 in 2005 -- made about $400 less last year than what the average large-company CEO made in one day. That assumes 260 days of pay (52 weeks x 5 days a week)."

Stingy Links: Marketing

I sold it through the grapevine
"The method is also causing controversy. Last October consumer group Commercial Alert filed a complaint against Tremor with the FTC, criticizing P&G's policy of not requiring that connectors disclose their affiliation with the marketer. Without such disclosure, Commercial Alert Executive Director Gary Ruskin sees the danger of the basic "commercialization of human relations," where friends treat one another as advertising pawns, undercutting social trust."

Stingy Links: Markets

1Q 2006 Bill Miller commentary
"The reason to own commodities may be that one believes they provide equity-like returns with little correlation with equities. The time to own commodities is (or at least has been) when they are down, when everybody has lost money in them, and when they trade below the cost of production. That time is not now. The data showing the returns of commodities will look very different if you start measuring just after prices have tripled. Every commodity we can get data on trades significantly above both the average and the marginal cost of production. Copper, for example, has an average cost of production of around 90 cents per pound, and a marginal cost of about $1.30 per pound. The marginal cost should approximate the equilibrium price over time. The current price is around $3.25 per pound. It is not a question of if copper prices are going down, it is a question of when."

The merchants of red ink
"In recent years, with interest rates low and credit easy, U.S. companies have gorged on high-yield debt. There was more than $1 trillion worth of high-yield issues in the U.S. last year, up from $750 billion in 2002. That has attracted the attention of a flock of private-equity investors and hedge funds, who are looking for investment opportunities as these debt-laden companies run into trouble. They're looking for companies with distressed debt, typically companies that have either filed for bankruptcy or are headed in that direction. The hedge fund and private-equity investors are looking for fundamentally sound companies that have taken on too much debt, so they can restructure them and sell them to another buyer for a profit. But will these opportunities of ill fortune materialize?"

Old school stocks teach new lessons
"One of the most common pieces of advice stock investors hear is the importance of "updating" their equity portfolios to keep in step with the ever-changing economy. As older industries shrink, the conventional wisdom goes, one should weed out those stocks in declining industries like steel manufacturers, chemical firms, paper producers, and railroads and add new firms in industries that are expanding. Advocates of updating point out that all the popular stocks indices, from the Dow-Jones Industrials through the S&P 500 Index, routinely add new companies and delete old ones to keep their index representative of the changing economy. Despite the ubiquity of this advice, I had seen little empirical evidencing documenting this claim."

There's a sucker born every IPO
"It took me several years to fully understand the sagacity of this insight, which really restates the famous poker adage: When you play poker, look around the table and try to identify the sucker. If you can't, then you are it. Now, why am I mentioning this? Because the past two weeks provided two wonderful examples of suckers at the market table, when panicky buyers threw money at some stocks without regard to price."

The disappearing mid-market
"Each of these companies is trying to profit from what are arguably now the two most noteworthy trends among the swelling ranks of middle-class consumers around the world - trends that appear to be, at first glance, at odds with each other. These are the tendencies for consumers to be more cost-conscious; but simultaneously more willing to splurge money on luxury items."

Short-term performance is a meaningless metric
"The market is chock-full of short-term performance chasers. These are investors who steer their capital toward investment managers who have generated recent hot performance. By the way, I consider anything less than five years to be short-term. Short-term performance chasers tend to be emotional and impulsive. When an investment strategy is not working investors get frustrated. Switching to a different strategy (or manager) is seen as a fix. The problem is that short-term performance-chasing leads to underperformance, not outperformance."

Rising gasoline = trouble for retailers
"Some people can cope by skipping a cup of Starbucks coffee or a movie. But the recent increases have been so dramatic that they'll probably take an even bigger bite out of discretionary spending. "Last year consumers on average spent $500 more for the year on gas. This year it could go up to $1,000. This is what Lee Scott is worried about," Cohen said. "The average American has $2,400 in discretionary spending. A Wal-Mart shopper probably has $1,500. Now take out the $1,000 extra and what does that leave them?" If gas prices don't retreat, Cohen said, he'd be worried about retail sales for the rest of the year, and possibly even during the holiday shopping season, which typically accounts for as much as 50 percent of retailers' annual profits and sales."

Don't hedge your bets after all
"Pinkernell and Bernstein analyzed rolling five-year correlation data and found that the only asset classes less in sync with the S&P 500 today than they were in 2000 are T-bills and Treasury bonds. Commodities like oil, grains, and metals have gone from being negatively correlated in 2000 - a good thing for diversification - to a modest "positive correlation" today. Real estate has gone from a correlation low of negative 60 percent in 2003 to a positive 77 percent today. But perhaps their most surprising findings involve investments most often recommended for sound diversification: small-cap stocks, foreign stocks, and hedge funds. Over the past five years, these one-time loners walked almost hand in hand with the S&P 500, with correlation rates of 94 percent, 96 percent, and 96 percent, respectively. Pinkernell's worry: They might not provide much of a buffer should large U.S. stocks tank."

Stingy Links: Munger

A lesson on elementary, worldly wisdom
"Here's a model that we've had trouble with. Maybe you'll be able to figure it out better. Many markets get down to two or three big competitors-- or five or six. And in some of those markets, nobody makes any money to speak of. But in others, everybody does very well. Over the years, we've tried to figure out why the competition in some markets gets sort of rational from the investor's point of view so that the shareholders do well, and in other markets, there's destructive competition that destroys shareholder wealth."

Notes from Wesco
"Welcome to the annual meeting of Wesco, for the die-hard groupies." [Note: I can't verify the author, but the lengthy notes correspond to less detailed ones that I've seen]

Buffett's alter ego
"Ask folks about Berkshire Hathaway, and most will tell you that it's Warren Buffett's company, which is true as far as it goes. But those in the know recognize that Berkshire's success is actually the product of a tag-team effort by Buffett and his long-standing partner, Charlie Munger."

Stingy Links: Real Estate

Foreclosures may jump as ARMs reset
"Unfortunately, during a runaway market, many buyers, sellers and mortgage brokers were more excited about making deals than making smart deals, and the fallout has just begun. "We are on the front of this ARM problem. It will roll out over the next several years," Boas said. "Owning a home is the American dream, but losing one is the ultimate nightmare.""

Stingy Links: Stocks

Bad for GM, bad for America
"General Motors has launched a time bomb that could push the company into Chapter 11 -- and take down the financial markets with it."

Last tango in Detroit?
"The reason is that GM's cash mountain is not so much an asset, but something for the UAW to fight over. Selling the stake in GMAC adds to the available cash. That is likely only to postpone the day of reckoning and may thus prove a huge and costly mistake, says Dale Oesterle, a law professor at Ohio State University. Far better, he thinks, would be for GM to seize the day by handing its cash mountain back to shareholders in the form of a special dividend, and filing for Chapter 11 right away."

Stingy Links: Value Investing

Muhlenkamp's methods
"Yes. I've been going to auctions since I was five years old. We sold calves and pigs at auctions when I was a kid. We'd do our Christmas shopping at auctions. I find myself telling people more and more, 'If you want to understand the stock market, go to auctions.' When I ask someone why he goes to auctions, he usually says something like, 'Every now and then you can get a good deal' Nonetheless, if one of something you own happens to sell for half price at an auction - and that auction is in the stock market - the headlines read, 'Stocks Cut In Half!' Bullshit. That day, there just happened to be no buyers. That happens at auctions all the time. But you can also get carried away at auctions. I've seen used bicycles sell for more than Sears charges for a new bike, just because two people happened to want that blue bicycle that day. That's just normal at auctions. A lot of people nowadays look at you sort of funny when you suggest going to auctions to understand the stock market, but back in the Midwest, where you and I come from, there didn't used to be much mystery about auctions. They were commonplace, anytime a farm was sold or a house broken up, there was an auction. And the bottom line is that people go to auctions for the volatility. If you want to avoidvolatility, you go to Wal-Mart. You literally go to auctions to take advantage of the volatility."

Deep value
"We based this screen on what Benjamin Graham recommends for the "defensive investor" in his 1949 classic, The Intelligent Investor. Among other things, we insisted that each stock's price be no more than 15 times its average earnings per share over the past three years, and that the overall portfolio have a P/E of no higher than 13."

Value vs Glamour
"During the 23, rolling five-year periods in our study, among large-cap stocks, the Russell 1000 Value Index ended ahead of the Russell 1000 Growth Index 15 times, representing 65% of the five-year periods. For small caps, the Russell 2000 Value Index outperformed the Russell 2000 Growth Index in 21 of the 23 five-year periods, or 91% of the time."

FPA Annual
"We know we are at odds with most of the mutual-fund industry. As an example, the average liquidity of all equity mutual funds recently hit an all-time low of 3.7%, versus your Fund's record high of 43.6%. While we are being cautious, our competition seems to be very confident, and this is reflected in low stock-market volatility measures. Wherever we look, it appears that most investors are highly confident. Volatility in the bond market recently hit an all-time low as well. Yield spreads are quite narrow throughout all credit segments of the bond market. There seems to be very little worry about credit risk. Again, while others seem to be highly confident, we believe that it is prudent to exercise a higher degree of caution."

Weighing options with Robert Olstein
"Hey home-gamers, don't beat yourself up for missing the options-backdating scandal. Even renowned stock sleuth Robert Olstein says it was nearly impossible to spot."

Value investors speak out
"Last week concluded a nationwide tour for the disciples of famous value investors, such as Warren Buffett and Ed Lampert, that has become an annual tradition in finance circles."

Patient Capital Management Q1
"There is a famous story in investment lore about ambitious young men hoping to get rich. Several young men had just graduated from college in the mid forties. Having seen the hardships of the Great Depression they sought out advice. They wanted to know how to accumulate wealth. They wisely asked the most distinguished and successful investor of the time for a meeting. Surprisingly the gentleman agreed. Realizing their good fortune they diligently researched and prepared several questions expecting a long meeting filled with much advice and many "golden truths". On the day of the anointed meeting these young men presented themselves to the great man's assistant and were shown into the boardroom. They marveled at the oak paneled furniture and luxurious setting. They could barely contain their excitement; they were going to learn the secrets to becoming rich. After what seemed like a very long time a distinguished, grey haired man entered the room and sat at the end of the very long table. One member of the group could not contain his enthusiasm. Much to the embarrassment of his colleagues he blurted out that they were interested in amassing a great fortune just as he had. Without hesitation the investor simply stated . . ."

The magic money machine
"Whatever you think of its Magic Formula strategy, The Little Book offers one of the most succinct and straightforward explanations of value investing that we've read. It's even funny at times. But can it make you rich? Frankly, we're not sure. But what we do like about Greenblatt's system is that it's logical and builds on the writings of Benjamin Graham and Warren Buffett, two of the most successful value investors in history. As we discovered in a recent interview with Greenblatt, he pulls no punches when it comes to defending his strategy.

Miller, Hodges bet on housing slump end
"The biggest slump in U.S. homebuilder stocks since 1994 has spurred investors with some of this decade's best records to snap up shares of Centex Corp., KB Home and Toll Brothers Inc. So far their confidence has been unrewarded."

Global bargain hunter
"From his office in Boston, Horn scours the globe, from Scandinavia to Mexico, in search of dull stocks that happen to be cheap. The first thing he looks for in a company is not net earnings but free cash flow, which he defines as cash flow from operations minus maintenance-level cap-ex. "It's useless to use net profits to compare companies globally," he says, as the figures can be easily manipulated or affected by local accounting and tax rules. A software company, for instance, could capitalize or expense the cost of software development, while steel companies' tax rates could vary based on the country in which they operate. But, says Horn, "There's either cash, or there isn't.""

Weitz letter
"Even though television, radio and newspapers have lost some of their audience and face stiff competition from the Internet and other alternative advertising vehicles, they can still generate huge amounts of cash for their owners. Most of this cash is not needed in the business and management may make acquisitions or return the cash to shareholders through dividends or stock repurchases. Since these media businesses are generally growing slowly, if at all, it is critical that we invest with managers who understand and accept the new reality and whom we trust to allocate the free cash flow wisely."

Leucadia letter
"We have been unhappy with the GAAP reporting of tax assets mentioned above for some time. Early in the 1990's, the accountants adopted a rule, SFAS 109. Under this rule, which we disparaged back then, companies are required to recognize the non-present value of their NOLs and put them on the balance sheet as something called a Deferred Tax Asset. For up to the next twenty years, or as long as we have NOLs, we will report an income tax expense and the Deferred Tax Asset will be reduced by the same amount, but we will not pay cash taxes. This large asset may not become a reality until sometime in the future and we cannot begin to project when that will be. We long for the pre-SFAS 109 days when the NOLs rested peacefully in the footnotes until sometime in the future when they would be called upon to deflect taxation. Too much complexity robs simplicity and thus, understanding."

New Clipper fund managers put to test
"Finding a replacement was tricky. After all, buy-and-hold value investors are a rare breed. The philosophy is simple: pick a few great companies at great prices and hang on to them. The problem is that few fund managers can resist the urge to juggle a portfolio or change course during the times the market beats up a couple of those hand-selected stocks or bids up everything but. Clipper's board picked Christopher C. Davis and Kenneth C. Feinberg of Davis Selected Advisors, L.P. to manage the fund, effective January. The firm manages $60 billion and the two men were selected as Morningstar's Domestic-Stock Fund Managers of the Year in 2005. Davis, 40, is a third-generation investor. As the Davis Funds' Web site describes it, "through careful and sensible investment practices," Shelby Collum Davis, Christopher Davis' grandfather, invested $100,000 in the early 1940s and turned it into $800 million by the early 1990s."

5-star stocks from the Markel portfolio
"In my view, Markel's success is largely due to its strict adherence to a timeless investment philosophy that seeks to invest only in profitable businesses with ample reinvestment opportunities that are also run by competent management teams. In addition, the executives at Markel have both the long-term orientation and patience to wait for these types of companies to become attractively priced. As a result, Markel rarely overpays, and its investments usually compound at least at the growth rate of the underlying business."

Stingy Links: Whitman

The evolution Of Marty Whitman
"Mutual fund grand master Marty Whitman has a well-deserved rep as an obstinate and cantankerous cuss. For the fidgety Whitman, sitting still in a chair while a subordinate delivers a subpar financial analysis is impossible. Failing to follow Whitman's value-investing dicta would earn the poor slob a humiliating dressing-down. No one dared to second-guess Marty. Whitman's ability to out-think anyone has long been a fearsome thing. No one to this day can keep up with his lickety-split ability to read and analyze a company's 10-K filing."

Third Avenue Q2 2006
"favorable odds alone should not trigger an investment if the consequences of a mistake might be draconian"

Investor is poised to buy C&A
"Third Avenue Management LLC, a quiet yet influential investor in distressed companies, is buying a lot of debt and equity in North American auto companies."

Stingy Links: World

How accurate are your pet pundits?
"Imagine your job as a media executive depends on expanding your viewing audience. Whom would you pick: an expert who balances conflicting arguments and concludes that the likeliest outcome is more of the same, or an expert who gets viewers on the edge of their seats over radical Islamists seizing control and causing oil prices to soar?"

Power without responsibility
"Unions thus have a lot of power, but without being representative. Some suggest that this mis-match causes conflictual labour relations. In effect, the unions are defending the interests not of the many, but of the few."

Steady as she goes
"All this explains why, in the words of Exxon Mobil, the oil production peak is unlikely "for decades to come". Governments may decide to shift away from petroleum because of its nasty geopolitics or its contribution to global warming. But it is wrong to imagine the world's addiction to oil will end soon, as a result of genuine scarcity. As Western oil companies seek to cope with being locked out of the Middle East, the new era of manufactured fuel will further delay the onset of peak production. The irony would be if manufactured fuel also did something far more dramatic - if it served as a bridge to whatever comes beyond the nexus of petrol and the internal combustion engine that for a century has held the world in its grip."

China's reality is both boom and gloom
"A flight into Beijing these days begins the descent into a kind of hell. It's not just the smog, which is pervasive, gray and suffocating on an epic scale. It's not just the weather, which is unseasonably cold and windy. It's not just the sand, which is blowing in from inner Mongolia in thick, yellow sheets. It's not just the traffic, which is inert due to the stunning lack of major cross-town freeways. And it's not just the vibe of the city's residents and laborers, which is often foul and hostile amid the pollution and crowding. It's the sense of alienation and hopelessness that you get from so many of the kind and brilliant people who have grown up there, and who should have the greatest stake in its success."

The rich, the poor and the growing gap
"All in all, America's income distribution is likely to continue the trends of the recent past. While those at the top will go on drawing huge salaries, those in the broad middle of the middle class will see their incomes churned. The political consequences will depend on the pace of change and the economy's general health. With luck, the offshoring of services will happen gradually, allowing time for workers to adapt their skills while strong growth will keep employment high. But if the economy slows, Americans' scepticism of globalisation is sure to rise. And even their famous tolerance of inequality may reach a limit."

"When our economics editor invented the Big Mac index in 1986 as a light-hearted introduction to exchange-rate theory, little did she think that 20 years later she would still be munching her way, a little less sylph-like, around the world. As burgernomics enters its third decade, the Big Mac index is widely used and abused around the globe. It is time to take stock of what burgers do and do not tell you about exchange rates."

Bolton v Gore
"Two years ago, a Danish environmentalist called Bjorn Lomborg had an idea. We all want to make the world a better place but, given finite resources, we should look for the most cost-effective ways of doing so. He persuaded a bunch of economists, including three Nobel laureates, to draw up a list of priorities. They found that efforts to fight malnutrition and disease would save many lives at modest expense, whereas fighting global warming would cost a colossal amount and yield distant and uncertain rewards."

Frugally Yours,
Norman Rothery
ISSN 1499-2787

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