Warren Buffet redux

Warren Buffet is worshiped by many investors.  Personally, I respect his ability, follow some of his principles, but remain nevertheless skeptical.  I’ve criticized him for his support of the Obama presidency, saying it was the most costly decision he ever made.  But it turns out I’m wrong, if those who say that he profited from the bailouts, stimuli and generally easy government money that has been handed out, saving the butts of banks in which he had invested (see e.g., Barry Ritholtz).  At Forbes, Drew Mason castigates Buffet aptly over his comments about gold which have apparently led many to forgo precious metals as a hedge against currency inflation, thus allowing government to rob the people through the devaluation of their savings.

But the most damning article that I’ve ever read against Buffet appeared yesterday at the American Thinker.  In it, Christopher Chantrill accuses Buffet of being a robber baron.  The life insurance lobby is apparently vying to have Congress reinstate inheritance taxes in the US.  That’s because life insurance is exempt from taxes at death, and so people with larger inheritances must protect their heirs by taking out expensive life insurance policies.  Chantrill shows how a mega-billionnaire like Buffet feeds upon the small business owners and other little people who manage to put together a nice little fortune through risk, sweat and sacrifice–at their death Buffet buys up their business which the heirs must sell to pay the death tax, or before they die, he rakes in the big bucks through expensive life insurance policies.  It should be criminal, but instead, it is the government which enforces this robbery.

In Canada we don’t have death taxes. No, the law here states that immediately upon death the estate must pay the full amount on RRSP (retirement) savings accounts and retained earnings in any companies that the deceased may have built up.  “Retained earnings” refers to the increased book value/equity that the business owner has in his business.  Let’s say you started a business from nothing 50 years ago and today it is worth $10,000,000 and you own a 100% stake in that business.  Your retained earnings could be as much as $10,000,000 and you would have to pay all the tax all at once the day you die (only a spouse, as with the RRSP, may inherit it without paying the tax).  This has the same evil effect on business in Canada as does the death tax in the US.  I know because someone close to me is forced to pay for a large life insurance policy because when he and his wife have finally both died, all the taxes on the retained earnings are immediately due, and the heirs, his children, would have to shut down the family business to pay the taxes, putting 30 people out of work; his life insurance policy thus is to pay these taxes so that the company can remain intact.  This is a great thing to fear if you are working in a second generation family company, but to be welcomed, if you like Buffet, are selling life insurance.

If that is what it takes to invest like Warren Buffet, then please count me out.  I think righteous investors should steer clear of investments which prey upon hard working business people in collusion with state power.  That just doesn’t seem righteous at all.

Dennis Gartman’s first rule of trading: A commentary

Dennis Gartman’s first rule of trading:  “Never, under any circumstance add to a losing position…. ever! Nothing more need be said; to do otherwise will eventually and absolutely lead to ruin!”

Horizens AlphaPro Gartman Fund (source TD Waterhouse)

Dennis Gartman is a colorful media figure who apparently has a trading business on the side.  Fabrice Taylor, in an article in the Globe & Mail, “Dennis Gartman needs less talk, more action“, points out that for all of Gartman’s media presence, he doesn’t do all that well as a fund manager.  The Horizens AlphaPro Gartman Fund (HAG.to) closed at $9.00 yesterday.  Fabrice Taylor, critical that Gartman’s fund was still at only $9.12, wrote almost a year ago (Nov. 30, 2009):

But the market is up 30 per cent since the fund launched. What’s up with that? Mr. Gartman didn’t get back to me, but the people at Horizons AlphaPro tell me the fund is intended to be market neutral, meaning it won’t move with the market. Why? Because it’s long and short, and supposedly constructed in such a way that the market’s performance has no net effect on the returns. The only thing that does have an effect, in theory, is the manager’s skill. It may be early days, but Mr. Gartman’s performance has been found wanting.

He’s expected to return between 6 and 12 per cent regardless of the market. Eight months in, he’s nowhere near that. …

Nearly a year later, he’s still nowhere near that point.  I thus view Gartman with a great deal of skepticism, particularly because he shorted Berkshire Hathaway, calling Warren Buffet an “idiot” on account of his (Buffet’s) buy and hold strategy.  Gartman explains his first rule:

Averaging down into a losing trade is the only thing that will assuredly take you out of the investment business. This is what took LTCM out. This is what took Barings Brothers out; this is what took Sumitomo Copper out, and this is what takes most losing investors out. The only thing that can happen to you when you average down into a long position (or up into a short position) is that your net worth must decline. Oh, it may turn around eventually and your decision to average down may be proven fortuitous, but for every example of fortune shining we can give an example of fortune turning bleak and deadly.

By contrast, if you buy a stock or a commodity or a currency at progressively higher prices, the only thing that can happen to your net worth is that it shall rise. Eventually, all prices tumble. Eventually, the last position you buy, at progressively higher prices, shall prove to be a loser, and it is at that point that you will have to exit your position. However, as long as you buy at higher prices, the market is telling you that you are correct in your analysis and you should continue to trade accordingly.

With all due respect, I doubt that averaging down is what killed those companies.  Usually what destroys investment companies is unwise use of leverage.  In my view, the goal of business is to be in business tomorrow.  So I don’t tend to use leverage for momentum stocks but for income stocks.  That way, short of a dividend cut, I will always be able to pay the interest and I won’t have to go bankrupt.  In addition, it is probably unwise to depend on the margin in your account to cover the leverage.  More credit (such as a HELOC) has to be laying in wait to cover a margin call, if God forbid, the market drops to that point.

Averaging down vs. Gartman

So Gartman says never to average down.  Never buy more of stock when it goes down–the market is telling you that you are right when you buy stocks on the rise.  Yet my experience teaches me that this is wrong.  Consider the following positions that I averaged down on during the last two years since the beginning of the crisis:  Western Gold Fields (WGI.to, now NGD) up 252.33%; Crescent Point (CPG.to) up 37.28%, plus 7% dividend; NAL Oil and Gas (NAE.un.to) up 16% plus 8.6% dividend; Barrick Gold (ABX) up 45%; Midway Energy (MEL.to, formerly TFL) up 294%; Great Plain Exploration (GPX.to) up 30%.  Some of my picks are still weak, but nothing is losing me any substantial capital.  Overall, the current positions in the portfolio are up over 62.3% above my book value.  By Gartman’s rule, I should pick my own style of trading over his, since his fund is still in a net zero position over the same period.

Why does averaging down work for me?  Here are some rules for averaging down:

(1) It is not a good idea to average down on stock that is in trouble. I did not average down on BP.  Nor Nortel.  Nor would I have averaged down on BreX or Enron. I sold my Enbridge (ENB.to) after the first oil pipeline spill (though that turned out to be wrong); I dropped Centerra Gold (CG.to) after the coup in Kyrgyz Republic (also wrong).  And I am thankful that the dot.com stocks collapsed before I began trading, but I doubt seriously I would have been caught in that mania.

(2) Begin with an appreciation of the value of a company. Perhaps it is an income stock like CPG.to or NAE.un.to.  Perhaps a junior oil company with a good team of proven oil men (like MEL.to).  I like commodities because my hunch is that fiat money will diminish in value while commodities will retain their value.  So I like trading gold mining stocks.  I now begin by easing into a long position or selling a put option to reduce the cost of entry.

(3) Understand that the market is not only sometimes wrong but often wrong.  Gartman’s point that a trader should let the market tell him whether he is right must be refined.  The market may be right over the long haul but in the short run, it is usually over buying or over selling.  The dictum of Buffet is better, “Be fearful when others are greedy and greedy when others are fearful”.  This is clearly saying a contrary message to Gartman’s first rule of trading.  The reason Buffet’s advice works is that, as  he learned from Benjamin Graham the author of The Intelligent Investor, publicly traded companies have two values:  (i) the value that the market places on it; (ii) the value it has based upon an evaluation of its balance sheets and its potential earnings going forward.  This second value, which is the most overlooked during periods of market insanity, represents the worth of the company if it were to be bought in a private sale.

(4) Pay attention to book value. Book value (a.k.a., shareholder’s equity) is an very important consideration.  Graham recommends that a defensive investor never buy stocks that are selling at a price to book of more than 1 1/2 times. He also taught that buying a company at a  price to book ratio of 1.0 means that the buyer is getting the company for nothing, for the buyer pays only for the shareholders’ equity, at a one to one value, but pays nothing whatsoever for the company’s future profits.  During the 2008 market crash, many stocks were selling at below shareholders’ equity.  An averaging down strategy makes it possible to take advantage of such deals.  But paying attention to book value saves the investor from sinkholes like the dot.com companies which often had negative book values.

(5) Maintain sufficient cash or credit to be able to average down.  When I first started trading I would shoot my wad and then there would be nothing left with which to average down.

(6) It is permitted to “average back up”; i.e., to take profits from the stocks as they come back up, especially when it helps to reduce leverage.

The successful DIY investor


Would you have bought this stock in January 2009? If yes, you too could become a DIY investor

Both Preet Banerjee at the Globe and Mail (see also his Lap of the blog) and Jonathan Chevreau at the National Post have written recent articles recommending that DIY investors use financial advisers.  I chose to step out completely on my own a few years ago, moving all our assets from full brokerage accounts to DIY discount brokerage accounts–the transfer fees were all paid by the receiving firm as a incentive to move our assets.  That was February, 2007.  Since that time, our retirement accounts are up a total of 154%.  I have also done well in our TFSA’s (up 40%) as well as our non-registered accounts.  Thus, I am not in the least tempted to follow their advice because I am confident that I can do well without a financial adviser.

I have learned through experience and here are some things that make DIY investor successful:

(1) Financial education:  I’ve learned through reading as much as I can from blogs and internet Newspapers including the Financial Post and Global and Mail financial page.  I’ve a limited number of books.  Benjamin Graham, The Intelligent Investor and Neill Ferguson, The Ascent of Money.  This is time consuming work, and those who don’t have the desire or the time to do it, should probably stick with index funds or a full-service financial adviser.  I’ve also occasional taken advantage of seminars or webinars to increase my knowledge–but these can be expensive so I am careful about them.

(2) Control of cash flow and leverage:  It is important to understand and control cash flow.  For example, it is probably a bad idea to buy a momentum stock using leverage.  You can never tell whether it is going to go up or down and the hold period may be much longer than expected.  By the time it goes up, the return may be greatly diminished by the interest paid.  However, it is much safer to use leverage to buy a dividend stock–as it can cover or exceed the interest rate during the entire period that it is held.

(3) Accurate tracking of results:  I keep track of such things as total net worth, total net sales of stocks, total value of stock portfolio and its net gain or loss, total debt to equity ratio, and the total amount invested in each sector (e.g., oil & gas, mining, food, banks, cash-GIC-bonds).  This makes it possible to know whether my strategies are effective or losing money and it helps me to manage risk.

(4) Specialization.  I can’t know everything about every sector.  So I invest most heavily in the oil and gas sector and am becoming more comfortable with how to evaluate the risk of buying into an energy company.  I do rely on published reports by professional analysts (at TD Waterhouse and Scotia Capital).

(5) Familiarity with different trading and investing strategies.  I use the following strategies:  Averaging down, selling of cash covered puts, and value investing–particularly the attempt to buy companies close to book value, a.k.a. shareholder’s equity.

(6) Control of emotions.  The best investors are probably not always geniuses; it is probably incorrect to say that the reason Warren Buffet succeeds is because he is smarter than everyone else.  Rather, it is his ability to control fear and greed.  He can bring himself to buy when everyone else is selling and to sit on cash while everyone else is buying.  A DIY investor must be cool and collected and must be able to buy into market when all the numbers are red and sell in a market where all the numbers are green.  My most successful move was averaging down on a company whose book value per share was $3.40 but its market price had dropped to a tenth of that: that was Trafalgar Energy (now MEL).   One day it fell so low that I called their office in Calgary and the investor relations guy said that they were still generating positive cash flow.  So I overcame my utter fear of loss and bought thousands of shares that day and the next.  It turns out that it may have been the trade of a lifetime.

The worst investment decision Warren Buffet ever made

Or: On Outperforming Warren Buffet

Warren Buffet is hailed as the best investor in the world. His net worth as an investor is generally regarded as proof.  I started 100% DIY investing in March 2006 when we transferred our remaining holdings from our full-service investment adviser to our discount brokerage. We are currently standing at 31% over book value. In the same period, BRK-A, Buffet’s holding company has gone from trading at US $90,625 to yesterday’s close at $103,000. That is a 14% gain. Does that make me twice as good an investor as Warren Buffet?

An article in Canada’s Globe and Mail recommends that individuals invest like Buffet. There are many articles of this kind floating around; Buffet is considered a prophet of investing, the Oracle of Omaha. I’ve also shared here some of my tips of investing and there is some overlap between the way the Buffet invests and my style.  Yet in the commentary section of the Globe and Mail article I wrote:

I cannot invest like Warren Buffet. He breathes and the market reacts. It is harder for him to buy shares on the open market too, since if he were to let it be known that he wanted a billion dollars of shares of something, the price would go up uncontrollably. That’s why he often buys preferred shares which aren’t available to guys like me. He can’t invest like me either. Unlike Buffet, whenever I buy something the price seems to go down immediately. I buy very small stakes in companies that I think have promise or which have good yield. But it’s too small for anyone to pay much attention. I like it that way.

So perhaps comparing myself to Warren Buffet is a bit of bravado on my part, a testosterone-filled pissing match. It’s not comparable at all because Buffet is investing billions and I’m like an ant crawling around the big toe of an elephant. And to be fair, there have been times when Buffet’s done much better. I’ve been lucky during this recession, I’ll admit it.

But there is a fundamental difference between Buffet style and mine. He is buying America whereas I’m shorting the US dollar and buying Canada–a strategy that may back fire according to Roubini; but I don’t think it will because all the trends in the US government until the 2010 election are inflationary. Ken Boessenkool in the Globe and Mail writes about Canada’s dollar, the loonie:

… perceptions of future investment returns on a country-to-country basis are often affected by large shifts in fiscal policy. Bad fiscal policy – in the form of unsustainable deficits and debts – will cause investors to expect increases in future taxes and lower rates of return. In that case, the relative attractiveness of that country as a place to work and invest will fall, driving down economic growth. In response to poor fiscal policy, a falling currency can provide the automatic stabilizer to lower growth rates resulting from rising deficits and unsustainable debts.

And this is exactly the picture we are seeing south of the border. Barack Obama has put the United States on a debt and deficit path that is far worse than Canada experienced in the early 1990s, when The Wall Street Journal called Canada an “honorary member of the Third World” and our dollar was flirting with historic lows.

Moveover, our world-view is informed by biblical conservatism. The Bible is a good guide to investing; it affirms risk taking, generosity, unselfishness and not allowing money take hold of you (I am of the opinion that selfish people make bad investors).  It also warns about indebtedness. In my view, the US government’s profligate debt-based spending is a path towards poverty that is immoral and self-destructive. This kind of behavior is not affirmed in the Bible at all.

Warren Buffet knows it is bad in the US. But perhaps he is in denial about the single worst investment decision that he ever made:  his ill-informed endorsement of Barack Obama for President. Ill-informed because had he paid attention to Obama, he would have known that he was a radical leftist–perhaps it is not too far to say that BHO is a Marxist given his background. He would have known also that BHO knows nothing about economics and has never been an executive of a company or any other entity which would have qualified him for becoming the CEO of the United States. The man who is famous for researching companies before risking billions failed to do his research into BHO and it is literally costing Berkshire Hathaway billions in market capitalization.

Is Buffet giving Obama a vote of no confidence?

My friend the Brooks mentioned that Obama’s economic advisers were renown economists and Warren Buffet supported Obama’s ideas. Now I wonder if this is still the case given what Buffet writes in his letter to shareholders of Berkshire Hathaway:

This debilitating spiral has spurred our government to take massive action. In poker terms, the Treasury and the Fed have gone “all in.” Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel. These once-unthinkable dosages will almost certainly bring on unwelcome aftereffects. Their precise nature is anyone’s guess, though one likely consequence is an onslaught of inflation.  Moreover, major industries have become dependent on Federal assistance, and they will be followed by cities and states bearing mind-boggling requests. Weaning these entities from the public teat will be a political challenge. They won’t leave willingly.

“Inflation”, “mind-boggling aftereffects”, “once unthinkable dosages”, major industries dependent on the “public teat” who “won’t leave it willingly”?  These are not words of someone who still agrees with Obama.  By comparing the Federal budget policy to going “all in” in a poker game, Buffet is saying that Obama and the democrats in Congress are making a terrible gamble, echoing David S. Broder in the Washington Post (hat tip:  American Thinker), “When we elected Obama, we didn’t know what a gambler we were getting.”

This reveals the mind of the country’s foremost investor, and is undoubtedly representative of how investors feel and why stock markets continue their downward spiral.