My Thank-You Letter to John Paulson

Dear Mr. Paulson:

Thank you for electing to donate $400 million to science, by way of Harvard’s engineering school.  As I’m sure you know, Harvard has one of the most stellar scientific records of discovery in the world, discoveries and advancements that have benefited all of humanity immensely.  

As the New York Times noted: “[i]n recent years, the engineering school’s labs have developed an organ-on-a-chip platform that can be used for drug testing, self-organizing robots, nanotechnology devices that are changing optical electronics, [and] an implantable cancer vaccine,” among other things.

I think that if one cares about efficiently promoting science and engineering with the hope it will result in a big impact on all of us, then denoting to Harvard’s engineering programs is a good idea.  

Your gift is especially meaningful because, like many other billionaires do, you could have spent this money on a(nother) multi-hundred-million-dollar yacht.  Or, like Larry Ellison, you could have bought a major Hawaiian island like Lanai – what a guy.  Or, like fellow hedge fund guru Steve Cohen, you could have picked up a couple of $100 million Picassos and $100 million homes in the Hamptons and Beverly Hills.  I think we can all agree that you are a person to be celebrated, in comparison to the Walmart heirs, the Waltons, who have historically given extremely little to education or charities of any kind, even though they are each far wealthier than you are.  

I certainly hope that your $400 million donation to science and engineering prompts people like the Waltons, or the Russian billionaires who compete over yacht size, or the royals of Saudi Arabia, who likewise compete over yacht size (as well competing over absurdly extravagant properties in London and New York), to do something more productive and lasting with their money.  

It is a shame that so much of the focus on this gift has been on it being a gift to “Harvard,” which “doesn’t need the money.”  Of course, I think we’re both aware that dissing Harvard generates a lot of page clicks and Twitter retweets, and way more people are interested in that, than are interested in whether Steve Cohen bought another Picasso.

I know that you’re going to get the engineering school named after you, and you probably also did this in part for the fame and legacy.  I know you get a titanic tax deduction.  Personally, I’m fine with all of that.  As a moderate Democrat, I certainly am happy that you’re not plowing this $400 million into supporting extreme Republican candidates as the Koch billionaires are!  

I think there is probably a time to think about the efficiency of the tax deduction scheme for charities in this country, and whether it benefits all of humanity.  Maybe that time was when an Eli Lilly heir gave $100 million to supporting Poetry magazine in 2002.  Or maybe we should be questioning why so much money is allowed to be donated to “charitable” religious organizations that seem more interested in controlling other people’s lives than in improving people’s lives.  So maybe there is a time for such a discussion.  Not this week.

My only hope is that the vitriol you have faced since this was announced does not convince other billionaires that maybe they should just buy another super-yacht.  After all, nobody seems to care when they do that.

Have a nice day,

TDM

My Idea for A Keynesian Balanced Budget Amendment

Over time, America seems to want to spend more than it can afford.  Democrats seem always willing to spend more.  Republicans seem always willing to spend more when they are in power.  Republicans nevertheless mistrust Democratic attempts to spend more during times of recession/crisis, because they hate the spending that comes in good times, even though they have historically contributed to it.

What if there were a way to end this nonsense, in which neither party consistently applies Keynesian principles to national budgeting?  I believe there is.

Proposed Budget Amendment:   The United States shall not in any year have a yearly deficit that exceeds the prior year’s GDP % growth rate.  Two exceptions shall apply: 1) when Congress makes a declaration of war, yearly deficit spending shall not be limited during the time period of that war; and 2) if the National Bureau of Economic Research declares a recession, annualized yearly deficits may exceed GDP % growth for one year after that recession is declared over.

That’s the simple version.  What about in our recent circumstances where arguably deficit spending was quite necessary even after the recession ended?  You could add a third proviso that deficit spending after a recession may exceed GDP % growth for up to four years after a recession is declared over, provided that GDP growth remains below 2% during that time.  Or something like that.  One could theoretically also exempt unemployment benefits.

The point is that by doing something like this, Republicans and conservatives would have some comfort that Keynesian deficit spending during times of crisis was not simply the Democrats/liberals’ latest excuse for constant additional spending.  Democrats would have some comfort that appropriate fiscal stimulus would be allowed during economically appropriate times for it.

Why does it matter that yearly deficits in times of growth not exceed GDP growth rates?  Because whenever they do not, the total deft-to-GDP ratio of the United States naturally declines over time, as it did after the Second World War even without drastic cuts.

Some may say that this is basically what we do anyway.  Maybe so, to a certain extent.  But adopting a rules based approach would take the politics out of it and reduce the risk of catastrophic mistakes, as happened in Europe, which disastrously imposed austerity on peripheral countries in the wake of the Great Recession.  Don’t think it could not happen here.  It would also reduce if not eliminate the risk that we ever end up with 250% debt-to-GDP.  And the constant “nudge” to restrain spending during boom times would provide a natural brake on the tendency of Democrats and some Republicans to act as if growth will go on forever.

The Constitutional View of Abortion

I’m a moderate (i.e., fact-based and unorthodox) Democrat.  I’m also an Ivy-League educated guy and a lawyer with a fair bit of education in Constitutional law. I also support a ban on late-term abortion (I’m unclear on the cut-off date, maybe as early as 20 weeks, maybe 16, maybe 25, I don’t know).  I do not support efforts to limit abortions entirely by, e.g., making it impossible to have an abortion clinic in an entire state.

I think a lot of the problem in this debate is that it is viewed as a black-or-white issue, and very few people view it as a very typical fluid, Constitutional-rights balancing issue. 

There is virtually no such thing as an unlimited Constitutional Right, except for the right to a jury trial in criminal cases (and even that may be waived). Free speech has always been limited by the doctrines of incitement, defamation, etc. Fourth Amendment and Sixth Amendment Rights have always had limits. A conservative majority on the Supreme Court more recently confirmed that the Second Amendment says what conservatives think it does, but is subject to rights balancing and limitations – both of those conclusions are, I think, correct.  Any Constitutional lawyer worth his or her salt, Left or Right, can quote chapter and verse on how rights-balancing applies to Constitutional Rights, which are typically not absolute.

Which brings us to Roe v. Wade, which found a right to abortion founded in a Constitutional “penumbra” (one of my favorite words) of privacy rights. The Supreme Court has already long ago recognized the rights-balancing and limited nature of this right in subsequent decisions such as Planned Parenthood v. Casey.

Unfortunately, the public debate has not caught up. People are described as “Pro-Life” or “Pro-Choice.” The very terms are misleading, nonsensical, and destroy the possibility of rational debate. Many conservatives seek to deny any idea of a woman’s right to choose what goes on in her own body for nine months of her life, not to mention the impact this will have for the rest of her life. Many liberals seek to deny that there can be any idea of person-hood until a baby pops out of the shoot. To me, both of these positions are morally and pragmatically problematic. I am both “Pro-Life” and “Pro-Choice.”

To me, a woman does have a right to choose, based on what is going on in the privacy of her own body. It is ludicrous that she cannot choose to abort a tiny clump of cells four days after conception, or a small fetus a month or so in, before it can feel pain. On the other hand, to me it is equally ludicrous to suggest that a woman may abort a basically grown and wholly viable baby eight months into her pregnancy, unless her life honestly is in real danger.

What is going on here, is that while the woman has privacy rights, the fetus gains rights as it grows closer to viability and true person-hood and birth. At some point (nobody knows where), the fetus’ right to life as a baby trumps the woman’s privacy rights entirely, unless her own life is legitimately in danger. (This is just like how a person’s free speech rights are trumped by the public’s right not to have someone yell “fire” in a crowded theater.) Much of the American public at a lovely common-sense level basically gets this, even if many people don’t understand the Constitutional basis for their opinions. The activists on all sides either do not get it, or they refuse to acknowledge it, either because it conflicts with non-scientific religious convictions, or because being extreme at either end is what brings in donations and generates moral outrage and activist enthusiasm.

Conservatives have been bemoaning the fact that a recent Congressional bill to ban late-term abortions was shelved. But the reality is, as long as bans on late term abortion are simply viewed as a prelude to a total ban on abortion imposed out of absolute religious conviction (which they correctly are, due to the stated policies of the people advocating them), they will not typically succeed, and they absolutely will not succeed at a national level. Ever. People who advocate them will – justifiably – also pay a political price with many voters. That is true despite the fact that polls consistently indicate that, viewed in isolation, the majority of the common-sense American public is not cool with truly late-term abortion.  

What needs to happen is that people on both the conservative and liberal side of this debate need to come together in an intelligent, American spirit of compromise, and acknowledge in a bipartisan manner that this is really a very common Constitutional rights-balancing issue like any other.

Of course, the chances of that happening are low to zero, or possibly negative 1,000. But at the very least, conservative politicians in purple areas of the country would do themselves a lot of good with female suburban voters if they would simply make clear that they do not ever want to completely overturn Roe v. Wade, that they acknowledge a woman’s privacy right to choose does exist, that they are not imposing their religious views on the entire country, that they don’t want to legislate out the ability of any clinic to exist, but that they do think that at some point, the fetus/child’s rights trump the woman’s privacy rights, and that 16 or 20 or 25 or 27, or whatever weeks, is a reasonable scientific estimate of when that becomes the case Constitutionally and morally, based on the current state of scientific knowledge. 

And Democratic politicians would similarly do themselves a lot of good in reddish areas, and more importantly would be on far better moral ground, if they would acknowledge something similar, starting with the fact that they acknowledge how wrong the idea of allowing women to abort eight-month, nearly grown babies is, unless the woman’s life really is in danger. The whole country would be much better off politically, and morally, if abortion were viewed in this way.

Reevaluating My First Significant Public Post and Whether to Buy More Walmart

This is a slightly-edited version of a post I did on fool.com yesterday.  I was doing some stock research yesterday to determine whether Walmart still offered value for an add (I’m still holding, and have been since at least 2010), and it occurred to me to go back and look at some of my old posts, from when I mostly posted on Fool.com.  My first really detailed post was from May 2010, nearly five years ago.  In it I asked whether Walmart (then trading around $53/share) was undervalued.  I concluded it was, but a lot. You can see the post here.

Some of the things I said in the post strike me now as hopelessly clueless.  First, I thought I knew a lot more than I did about the business. Second, I was too optimistic, even a little wild-eyed in my willingness to extrapolate the recent past. Three, I did not know that using a company’s estimated WACC was a very good starting point for a discount rate.  I could go on, but it’s too painful.

One thing I didn’t get wrong was the basic story, which was that Walmart was strong and would survive, and do okay, at a time when voices were much stronger in favor of terminal decline, and everyone was even more enamored of AMZN than the are today, as well as the dollar store competitors.  I also did not get the basic valuation wrong (more below).

I was shocked, shocked (!) I tell you, to find that WMT might be worth as much as I thought it was worth then, which was about $65/share.  

But here’s the funny thing. I was basically right about that, probably even significantly low. WMT has paid out about $6/share in dividends since then.  That gets you to $71 (I’m kind of ignoring time value of money, since it’s a pretty short time span, but let’s kick that down to say $69). It’s going to pay out more money for a long time. It starts to add up.  As of Friday’s close, the stock trades at $89.35/share and, astoundingly, WMT has matched or beaten the market since that post (depending on the day you examine  it – it’s close), even though it is a titanic company in a major bull market, which is not when such companies are expected to match the broader market.  And WMT has done so even though it has not really grown free cash flow much at all since 2010 (though FCF/share is up more, due to buybacks, and the TTM figure is very positive).

Here is another thing though. I got lucky. In my primary calculation, I set my WACC too high (a better estimate, even then, was around 6%) and I assumed a growth rate that was way too high. But since a correct lower discount rate obviously would have raised the estimated value of the company, my WACC mistake cancelled out my growth-assumption mistake. 

Oh and by the way, here is my latest valuation spreadsheet for Walmart, here. Today, after four years of lowflation, dividend payments, stock-repurchases, etc,. I think Walmart is worth somewhere in the range of $90-95/share. (This is, as all of these things are, nothing more than an estimation, which incorporates numerous assumptions. This is not science.)  In other words, the undervaluation is gone. I have made a hefty amount of money since I first entered this stock, and I think I’m pretty likely to retain and grow a lot of those gains, but I won’t be adding any more money at this time.

A few things could get me to change my mind: 1) growth picks up (see the recent TTM FCF figures); 2) the stock declines to around $75/share as part of a general market decline; 2) the company starts tanking (substantively, not the stock price) and I decide I need to sell.

Peace.

How Long Term Investors Can Use Price AnchoringTo Their Advantage

Many people have called attention to the psychological phenomenon of “price anchoring” as it applies to investing. In fact, it’s at least tri-yearly fixture of any decent investment writer’s repertoire. But with yesterday’s (update: and today’s) stock market swoon upon us, I wanted to highlight how one can use this psychological bias to help oneself.

Let me back up. In 2010 I purchased shares of United Health in the low $30s. For a long time, as they rose (way faster than I expected), I was subject to anchoring bias. I simply could not imagine buying more, so soon, at $50/share, or $60/share. Then I ran the numbers and did the analysis again, and in May 2013 I drastically increased my holding, when United Health traded at around $64/share, essentially double what I had paid for my original shares less than three years earlier. Today as I write this, United Health’s shares trade at nearly $100/share, even after today’s sell-off. I made money. I would have made more if I had bought in 2011 or 2012.

But anchoring bias can also protect you – assuming you are a long-term investor. Take again the example of United Health. I know I am losing money when the stock market tanks, as it has just done. I know that there was a 1.65% decline in this stock, yesterday alone. Let’s say the shares have gotten ahead of themselves and the stock declines to $80/share (I happen to think the company is somewhat overvalued). Let’s say the broader market goes in the toilet, and the shares decline to $70/share. I’ll be upset, sure. But I’ll also be remembering my low-$30’s purchase price on my original shares, and my low/mid-$60’s price on my later addition.  That’s a form of anchoring bias. 

If you are a trader, and the stock looks like it has downward momentum, you sell. That is a valid strategy, in the sense that there are traders who consistently make money, assuming they have proper risk-mitigation strategies. But if you are a long term investor, you can use the memory of your old, low-price purchases to ameliorate the pain you feel during temporary, and contemporary, drops, which might make others feel compelled to sell.

This is just one of the ways in which being a long term investor helps you protect your psychological/emotional capital, and soldier on. Just be sure you don’t fall asleep at the wheel and neglect to evaluate your original buying thesis for the company.

I’m Sticking With Coke Stock ($KO) For Now

I bought a very small amount of stock in Coca Cola in 2009, at around $50 share, before the split.  We’re talking less than $500 when I bought.  It was and remains one of my smallest positions. I considered getting rid of it, but I’m not going to at this time.

Since I bought the stock, it has appreciated by around 80%, including dividend reinvestment. That has lagged the S&P by a few points during that time-frame, nothing horrible, and with a low beta. Such stock price performance during a great bull market is nothing to sneeze at when coming from such a massive stalwart stock like this. (If you had bought (or did buy) the stock in 2006 you’d be or are crushing the market.)

I remain worried about the “story” that soda is going out of fashion, but I think it is a bit overblown. I remain concerned about Coke’s cost structure being more bloated than some of its peers, and I do not think the recently-announced $3 billion cost-cutting plan will do much to alleviate that.

I also am concerned by valuation, as I have been in the past. As my latest sheet shows, my personal estimate of Coke’s value is about $44/share. That is very close to the current price of $42.22. There is certainly no margin of error for adding shares.  I am assuming a WACC of 7% and a 10-year free cash flow growth rate of 5%, which is about the rate that Coke has annually grown free cash flow for the past ten years, and is below the rate of Coke’s free cash flow growth since 2009, which I believe to have been unsustainably elevated due to recovery from the recent recession. I think the 10-year rate is a more accurate reflection of Coke’s earning ability.

Note how all of these assumptions indicate the extent to which valuation of a company is by no means a scientific enterprise.

I also note that Coke's stock-specific CAPE is 27.49. In other words, Coke trades at more than 27 times its average earnings (net income per share) for the previous ten-year period. This does not enthuse me either. Of course, CAPE has embedded within it, to varying degrees, assumptions that profit margins must revert to mean and/or that sustainable growth is unlikely and highly mitigated by the cyclicality of markets.

I prefer simply to focus on valuing future cash flows, but I think it’s useful to consider the stock-specific CAPE, if only to ask, does the measure work for this particular company? I think CAPE is far more relevant to Exxon stock than to Coke stock, because of the more-highly cyclical nature of Exxon’s business (as has been evidenced recently), and I think that CAPE has virtually no relevance to Facebook stock. That is because CAPE essentially treats all companies as moderately cyclical stalwarts (in the Fisher sense of the word). But it’s certainly worth looking at.  (Note, too, that Coke’s profit margins have remained relatively consistent for 12 years, with a slight downtrend.)

On the other hand, I like Coke’s sustainable 2.85% dividend yield and dividend growth, which is approaching 50% higher than the market’s. I (like many, I suspect) am willing to pay for that. I do not think, Coke’s stock-specific CAPE notwithstanding, that it is wildly overvalued. I think it is roughly fairly valued today, to possibly slightly overvalued if my growth assumptions of 5% are too high.

I’m keeping it in my portfolio for five reasons: 1) the stock is not so wildly overvalued (as it was in, say 2000), that I would feel compelled to sell it; 2) I don’t see a lot of spectacularly better opportunities in companies I want to own for a very long time; 3) the dividend yield and historical dividend growth; 4) if the bears are right and markets crater because (take your pick) market CAPE ratios are so high, or the Fed’s actions have been an illusion, etc., then it should wildly outperform as it did in 2008; and 5) it’s a relatively small position. I have no plans to add at this time.

My Thoughts on the Upcoming Year

Let me start by saying I think all predictions are baloney. Nobody knows anything.  At the same time I think it is useful to exercise one’s brain muscles in this way, by attempting to predict the future, if only to show oneself how wrong one really can be.  This is inspired by the (eternally bearish) Doug Kass, and his latest 2015 predictions.  I’m not calling them “surprises,” like he does.  I’ll simply give ten “predictions,” to see how I do.  Note, I’m not planning to trade or invest based on these, except to the minimal extent noted below.  I am a long-term buy and hold investor, and I’m not currently planning to sell anything either.

1) The Fed will respond as appropriate to inflation and employment rates.  What do I mean by that?  The bond-buying has stopped.  Inflation remains below target. Employment in the US is improving, but is not spectacular.  Consensus is the Fed will end ZIRP and raise rates to 0.25% or so in 2015, and I’m seeing dates of anywhere from April 2015 to August 2015 bandied for that. I think the Fed is not mechanical, and under current leadership is agnostic and non-ideological. If we see more deflationary pressures in 2015, the Fed will not raise rates. If inflation starts to kick up above about 2.5%, the Fed will act quickly. Wrote predictions about what it will do will fail.

2) U.S. market returns in 2015 will continue to be robust as multiples expand and economic growth in the U.S. continues to accelerate. I don’t see 2015 as the “year of reckoning.”  Note, this is not a comment on valuations, which I think are generally fairly high, and will remain high. 

3) Twitter will not be bought by anyone. There is constant talk of Twitter being bought out by either Facebook or Google. I think the value of Twitter has gotten too high for it to be bought, nor does it need the capital. It will go it alone, unless and until it runs into serious problems.

4) The value of the dollar will continue to rise relative to a basket of major currencies. I think ECB and BOJ easing, as well as stronger growth in the US and a modest rise in US interest rates (see below) will contribute to continuing increases this coming year in the dollar.

5) Oil stocks will continue to fall in early 2015 and then rebound as oil prices rebound after OPEC caves and US production/investment slows. OPEC’s production targets are not sustainable for many of its members. It will face extreme pressure to reduce production.  Also, by the end of next year US producers will have felt enough pain to reduce investment and that will kick in with lower production. By Late 2015 people realize that oil is not going to be at $60 or below forever.

6) The value of gold and silver will continue to fall, but the fall will be more modest than in the last year or two; at best they will end flat for the year. I am not a big believer in significant inflation coming our way anytime soon. I also think that real yields will continue to rise. This is negative for these commodities.

7) The US economy will not have a recession next year, and in fact real GDP growth in the US will exceed 3.0% for the year as a whole for the first time since 2005. I see no signs of a US recession in the offing. Note, this is not a comment on how the market – whose performance is largely unconnected with GDP – will do.

8) The interest rates on U.S. treasuries will finally rise. Lots of people predicted this (2014) to be the year, but I think that in 2015 rates will finally rise, but the rise will be quite modest.

9) Russia will invade a Nato member that possesses a significant ethnic Russian population in a shadow fashion, fomenting “revolt,” as it did Ukraine, and the Nato alliance will be unable to respond.  The alliance will use the fact that it is not uniformed Russian soldiers as an excuse to save face and pretend it is not really Russia, and avoid war.  Putin will be forced to do this to retain his position at home as low oil prices continue to crush the country’s finances in the first half of 2015. Nato will be forced to respond as above because neither its members nor Obama will be willing to go to war with Russia.

10) I will not get more than four of the above predictions correct.  Predictions fail. Nobody knows anything.

Coda:

So there you have it folks. I don’t trade based on any of these, with the following caveat. As anyone who has followed me knows, I invested heavily in the market from 2009-2012. In mid-2013 I really slowed down, as it became more difficult to find value in companies that I wanted to own for a long time (ideally forever).

This was motivated both by valuations, and also by the fact that I still had significant student loans to repay.  My priorities changed. To me, it was more justifiable to take long-term buy-and-hold positions in 2011 than it was in 2013. And in early 2014 I announced my intent to focus even more heavily on paying down my student loan debt, and limit stock market purchases to what goes into my 401k and into my kids’ 529 plans. I have done that. Since late 2013 I have paid down about $40K in personal student loan debt, and when I receive my yearly bonus tomorrow I will pay off the remaining $13K or so. I will have no student loans for the first time since I graduated from college at the Millennium, fourteen years ago (I went to law school as well, in the intervening years). 

That is not the end however. My wife also has about $40K in remaining student loan debt (also a lawyer). We have also paid off about $20K of her student loans since the beginning of 2014. Once my debt is gone, we intend to use extra income to pay her debt off as well (hers had lower interest rates, I’m not planning to leave her). Our goal is to have all family student loan debt paid off by the end of 2015, or at the very latest, if life intervenes, by March 2016.

If we did not have this outstanding debt, I would be more constructive about adding long-term stock-holdings, despite my worries about general valuations. But I have thought since about mid-2013 that it was psychologically better for me to just pay off debt as a family.

This does derive from my general views about the markets and valuations as described above, and so can be said to be a “trade” based on my predictions. It is a bit more personal than that, however, since it is also about protecting psychological capital and putting my family in a more secure financial position at a time when my crystal ball is FAR LESS clear about where the market is going than it was from 2009-2012, when it seemed fairly clear to me that the economy was recovering, and that that recovery was just starting, and when it was fairly easy for me to find individual high-quality companies that I could reasonably estimate were undervalued.

Here’s wishing everyone a happy and healthy 2015. 

What Exxon’s Cyclically Adjusted Earnings Ratio and Buffett’s Actions Can Tell You About CAPE

Saw another post today about valuation ratios and how the market is “overvalued.”  It wasn’t a bad post. It was well thought-out. (It was also basically a regurgitation of work Hussman has been doing for years.) But with all its focus on CAPE and Tobin Q, it highlights the fact that these are fundamentally technical measures that rely on the concept of reversion-to-mean, and look at the whole market.  

If you are an investor (and I assume a long-term one) who is investing in individual stocks, I question the relevance of relying on such measures, at least exclusively. That is why I have always found Hussman’s work so perpelexing. It is always about such measures, in the aggregate. Yet his fund invests in individual stocks, among other things. Are there no values in individual stocks? Is there no room for such discussion? Are these measures always relevant to the decision about whether or not to purchase one individual stock? I’m not so sure.

A few weeks ago I asked my twitter stream to give me suggestions on high quality companies that were undervalued. I got few suggestions. Since then oil has gone in the toilet, and oil companies have tanked (and then rebounded somewhat, unfortunately).

I say “unfortunately” because I am a long-term ExxonMobil investor, and I’m always looking for buying opportunities. This was one of the first stocks I bought, in 1997 or 1998 (who can remember that long ago – whenever it was, it was before the Mobil merger). I bought it in a drip account through Computershare, and from then until 2007 it crushed the market. Other than reinvesting dividends, I bought no more of it during a period of around ten years. Then came the financial crisis. XOM bottomed in July 2010 at under $60/share, right around the time that its purchase of the natural gas behemoth XTO, closed.  (This suggested the market knew at the time that Exxon’s timing was off, and that natural gas prices had not yet bottomed, though Exxon’s CEO would not admit that until 2013.)

I bought a ton of Exxon stock, starting in early 2010, and some added later in August 2011. My purchases ranged between $58/share and $65/share in 2010, and were at around $72/share for the 2011 purchase. Since then I have been reinvesting dividends, and I have maintained small monthly purchases of anywhere from $50 to $100. I have made a ton of money, though the stock has underperformed the market, especially in the last couple of years – though including the performance of the reinvested dividends the underperformance is much less severe.

Which brings us to now.  Exxon today trades at around $94/share.  It is a cyclical company, quite. If you look at Exxon’s ten-year-average yearly earnings, the number is $35,505 Billion (12/2004 – 12/2013).  Exxon’s ten-year average of yearly Earnings Per Share is $6.788 (keep in mind share count has been reduced significantly, and will continue to be reduced, but it’s not relevant for this purpose).

So at today’s price of (as of this moment) $93.66/share, Exxon is trading at a stock-specific CAPE ratio of 13.798.  That is higher than its trailing twelve-month P/E of 11.9, certainly, but it is lower than its anticipated 12-month forward anticipated P/E of 14.9.  During the past 13 years, Exxon has traded with a P/E ratio as high as 18.65. It has traded with a P/E ratio as low as 6.78. Its median P/E ratio is about 11.52 during that time period.  

Does Exxon look wildly undervalued to you? No. Does Exxon look wildly overvalued to you? No. Moreover, Exxon’s margins have remained relatively stable but DECLINING over the last ten years: (Gross: 35.04 / Operating: 13.17/ Net: 7.43 for the 12/2013 period, versus Gross: 45.12 / Operating: 23.46 / Net: 8.50 for the 12/2004 period).  Does this look like a company with profit margins currently “in the ‘wonderland’ region,” to quote the Valuewalk article I began this piece with, and which are thus subject to inevitable mean reversion? No, no, no.

So where does this leave us? I should say I value Hussman, though I have disagreed with his takes on monetary policy over the years, which I think are ideologically-blindered and wrong (particularly when he got into the “illegality” of Fed actions). And I value articles like the Valuewalk article. I think they provide a valuable and intelligent perspective, as do Grantham and Inker at GMO. But if you are an actual honest-to-God investor who buys individual stocks, listening to these people and what are, at the end of the day, technical mean-reversion analyses that relate to the entire market, is probably not a great substitute for actually analyzing individual stocks and seeking value.  Buying value is the best hedge.

Warren Buffett is often quoted as saying that his preferred way to look at the value of the market is the market cap to GNP ratio, and the Valuewalk article of course highlights his view, and also that by that measure the market is overvalued (and I agree, it IS!). But I suspect that when Warren Buffett says that, he’s thinking, “huh, that’s interesting.”  He has also repeatedly said that he focuses on individual stocks and not on macro factors, which he says he and Munger do not understand. So when Warren Buffett makes an investment decision, I strongly believe it is not because of what he thinks the value of the total market is. It is because he finds a particular company that he thinks is a compelling long term investment.

Berkshire’s businesses build cash over time via profits and resulting dividends, which compound with time and now regularly accumulate huge multi-billion-dollar cash piles for Berkshire. But Buffett is always willing to deploy them. While Hussman was treating 2009 as a prelude to a greater drop, and as a simple return to reasonable market valuations, as a result of all of his technical mean-reversion analyses, Berkshire bought Burlington Northern in what has turned out to be a darn good buy (and never mind the absurdly profitable investments in Bank of America warrants, etc).  While Hussman was hedging his tail off in 2011, Berksire bought Lubrizol for $10 billion.  He bought Orient Trading Company in 2012. He did the Heinz deal in 2013. He bought Duracell and Van Tuyl Group in 2014. And on and on and on.

Do you know what Buffett does not do? He does not hedge using options or anything else. He respects that the long-term trend of the market is up. He does not try to never lose money. He tries to always beat the market by the simple method of buying value and always buying value (in businesses a six year old could understand and that have good management), and by having faith that this means he will lose less at times when everyone, including Berkshire, is losing.

I realize Buffett has built for himself all kinds of advantages that others, including me, don’t have, like the wonderfully legal scam of using insurance float, and a reputation that means Goldman Sachs calls him when it’s in trouble.  But at the end of the day, this simple process of repeatedly buying good companies (including insurance companies) at good values is what he is about, and is why he has built that reputation.

I humbly suggest that as you read all of these other admittedly wonderful and intelligent commentaries about a market that is, admittedly, probably fairly significantly overvalued in the aggregate, you should ask yourself whether, no matter how smart the writer is, the writer is smarter than Uncle Warren. If not, just do as Buffett does to the best of your ability.  For an individual investor, that means dollar-cost averaging into new value-oriented investments over decades, using spare income, and then squeezing yourself to put in even more money in when the fit hits the shan occasionally.  Either do that, or just put all of your money in a 30% international and 70% domestic set of ETFs, or some such, rebalance the portfolio every year, ignore the noise, and go fishing.

Peace.

Ferguson and Garner

I’m a little late to this “party.” It’s also out of the focus of this blog. But since it’s an important issue, and one that I have been thinking about a lot, I wanted to say that we have a serious problem in this country.

I confess that the Brown/Ferguson situation never really resonated with me, at all. Even accepting the fact that, whether Brown ran or not, is disputed, Brown did, without question, reach into an officer’s car and grab his gun at some point. The Brown case in Ferguson always struck me as a very odd one, and a weak one, to form the basis of a movement. Should the officer have at least been indicted? Probably. Would he ever have been convicted, due to Brown’s own bad behavior in that situation, and the extent of the dispute in the evidence? Not a chance. On the whole though, I felt in real-time that there had been a huge overreaction to what had happened to Michael Brown.

The Garner case was much different. Here you had video corroboration of an officer putting a man in a chokehold – a middle-aged black man – lack of fighting, a totally petty crime, the man saying he could not breathe, and the man dying. The officer was not indicted. The grand jury decision, which happened later than the Brown decision, was breathtakingly horrible. That officer should have been indicted, and quite possibly could have been convicted, at the very least, of manslaughter.

With the Garner outcome firmly in my mind, I went to church last Sunday. Now I should say, I’m not a particularly religious guy. (I’m also a white male in his 30s.) My basic attitude towards God is: “God – sure, why not.” I’m sort of a culturally Episcopalian agnostic.

Anyway, one of the numerous reverends at my church is a late-middle-aged, intelligent, articulate, loving, empathetic, fact-focused woman.  (She is also black.) In her sermon, she spoke of abiding, heartrending pain she felt as a result of these cases. And she told a story of how as a little girl her town was divided by race, and how when she once crossed the train tracks to the white side, an older white girl threatened her, and when my reverend, my friend, involved the girl’s mother, the girl’s mother encouraged the threats, and my friend feared for her life. 

Something slipped inside of me, and I felt it slip, as I listened to that sermon. I saw her tears, and the tears of other African-Americans in the congregation and among the clergy.  I realized that, even though I had not even really noticed it, and should have fought it, the Brown case had hardened me. It had gotten up my reactionary hackles. Garner’s case cracked that shell, and my reverend’s sermon obliterated it.  

I think a lot of white people are hung up on the disputed facts in the Ferguson case.  They, we, are hung up on the fact that, at some point, and for some period of time, Brown violated the cardinal rule that all parents, not just black parents, teach their kids: never, ever, ever get in any way aggressive with a police officer. Ever.

But the Garner situation was totally compelling, where, as best I can tell, the officer’s conduct is not redeemable under any reasonable characterization of what happened. If the policeman who killed Garner cannot be indicted, with the whole thing caught on video, then virtually no policeman can be. They basically have a license to kill, and we all have a serious problem. Moreover, what happened to Garner’s killer made me question my assumptions about the Brown case. It led me to think more about the fact that police officers are virtually never even indicted, let alone prosecuted, no matter who they kill.

It was always in my head, in a zone of empathy, however suppressed. But one thing I know for sure after last Sunday is that the emotions of our black friends, family, acquaintances, co-workers and co-citizens are real. They have a basis. They have a history. They cannot be dismissed. They are not imagined racism. Even if they are, or were, it would not matter. It is high time for all people in this country to demand better. Officers need body cameras (at least for transparency’s sake). All officer-involved shootings should have to be reported to a national database so there is excellent, ongoing data on the racial status of those who are shot, and the officers who do the shooting. District attorneys who routinely work with police as a team should not be the same ones in charge of presenting a grand jury, or other proceeding that could lead to indictment, against those same officers. 

We have a problem in America with this issue. Recognizing it, and empathizing with our black brothers and sisters, does not make you “anti-police.” It does not mean you think the police are all bad. It does not mean you forget that police officers risk their lives every day, often in bad neighborhoods that are filled with crime. It does not make you ungrateful for their sacrifices. It does not mean you think there are no problems in the black community, or that zero fault lies there.

All it means is that you have a heart.