Seeking Alpha
Deep value, special situations, long-term horizon, hedge fund manager
Profile| Send Message|
( followers)  

one_dollarThe following is a copy of email correspondence with a friend and in the same spirit as our post "Correspondence with a friend on Investing".

Help was offered after learning of tremendous losses he had suffered in a bad investment. The decision was made to publish the correspondence because it reflects the usual questions and fears often heard from investors as well as the answers provided - and because it's more efficient to provide representative correspondence once than continue to provide the same answers on an ongoing basis.

Persons names, the origin of the prime minister and various and sundry details referenced have been either changed or omitted in order to protect their privacy - despite this, we still could not publish all of the related correspondence without revealing identities.

Now some six months later, and with the major indexes all higher since the original February 1st, 2012 publication date, it seems like a good time to look back.

The following is an update on the performance of American Greetings Corp. since the time our friend received the Amvona article referenced below on January 5th, 2012 and at the time of the original publication:

S & P 50001/04/20121253.282/1/20121329.284.1%0.9053.0%

**Update (shares purchased for investors accounts referenced in the article):

  • American Greetings Corp. (AM-OLD) initially purchased on December 22nd, 2011 at $12.91 and referenced below were later sold on April 26th, 2012 at $15.44 per share for an annualized return of ~57%.
  • Skechers (SKX) purchased on November 28th, 2011 at $12.77 and referenced below were later sold on June 12th, 2012 at $20.36 per share for an annualized return of ~110%.
  • Corning Inc. (GLW) purchased on December 19th, 2011 at $12.77 and referenced below were later sold on April 25th, 2012 at $14.30 per share for an annualized return of ~38%.

On Fri, Jan 6, 2012 at 2:31 PM, Emmanuel Gregory Lemelson wrote:

Not convinced CA and Securities lawyers are "all over" the RMBS trusts just yet… (there is tremendous denial b/c of the scope of the problem).

On another note the shares in the article below are now up ~31% (owned for investor accounts about 6 weeks)

You may want to look at (article sent yesterday - revised this morning - hopefully you received it).

Have 100% hit rate on all ideas (w/ exception of SKX, which will prove correct in time) - the returns you could say have been at least "better than average" ;o) with very little risk.

There is a myth in the investment world that one must take greater risk to produce greater returns - this may be promulgated by mediocre managers who wish to pawn off their unremarkable performance on their client's natural desire for a higher return...

Have produced very high rate of return for friends and family in last 1.5-2 yrs. of focusing on common stocks… think could be of service to you as well, if you are interested (would not expect anything for this - and have not received so much as a penny from anyone else either).

Partial documented history here (and countless other places online): haven't always been able to publish all ideas (but always execute for friends and family) - for e.g. haven't had time to write an article on it yet, but have also been buying GLW (mostly below 13).

Hope you have been well - look forward to when we speak again someday by phone.

From: John Doe [mailto:JohnDoe]

Sent: Saturday, January 07, 2012 12:26 PM

To: Emmanuel Gregory Lemelson

Subject: Re: on another note

Will have my son take a look at your email--as I have too many other interests and too little time to become expert investor. My concerns are that macroeconomics will trump microeconomics in the next year, that is, likelihood of European problems worsening and negatively impacting US and others is much higher than probability that all will go well.

On our recent around the world trip, the prime minister of [country name omitted], a phD in economics with close contacts to his counterparts in Europe, said he has $1 bets with several US CEOs that Dow will be 5000 by Jan 1, 2013. While that is extreme prediction, I think Europe will have serious problems this year that will adversely impact US and leave US markets lower than they are now.

In any event, I have lots of cash, big bet that Europe unravels (up 10% since Sept), many long term VC and other investments and [bank name omitted] judgment accruing interest at 8%. For now, I am following my first rule of investing: don't lose what you already have, since I don't have the time or disposition to earn it all over again. Making another 50% will not change my life style, but dropping 50% would not make me happy.

On Sat, Jan 7, 2012 at 6:56 PM, Emmanuel Gregory Lemelson wrote:

Dear John,

Thank you for the email.

Happy to speak with your son if he is interested - but believe you would be amazed at how much can be learned in a short period of time and just how simple it is...

It is not so much about being an "expert investor" so much as having a clear rational framework from which to make decisions.

Consider the following:

- Are all investment philosophies equal?

- Are all investment managers equal?

- Are all opinions equal?

Truly great investment managers are no different than truly great Lawyers; there is the top .0001% and everybody else. Curiously the other .999% of money managers just like lawyers, hide in tall shiny buildings, behind "fees".

Successful investing, like success in big cases is not complex; it is simple (albeit a lot of work).

On Macroeconomics and Microeconomics

The single biggest source of err for investors is confusing the value of studying macro-economic dynamics (a future they cannot know or predict with any form of accuracy), with studying individual securities (a future they can roughly know and predict). In legal terms this is like confusing the beauty and high-minded ideals of moral ethics and the truth of the law with what is actually necessary to win in court or the strategy and preparedness (they are related, one depends on the other, but only the study of the later has practical utility). I have a funny feeling you never went in to court quoting Thomas Jefferson or the Mosaic Law.

A false dichotomy

Here is the argument laid out in the email:

1. Premise I: European problems will worsen

2. Premise II: These problems will create a negative impact on the US

3. Conclusion: All will not go well

The argument restated:

1. Premise I: If there are problems in the world it is not safe to invest

2. Premise II: There are problems in the world

3. Conclusion: It is not safe to invest

However, if analyzed more thoughtfully the following questions might be important:

1. Are the current problems an anomaly? (consider Cuban missile crisis, cold war, etc.)

2. When in history did "All go well"? (starting with earliest recorded history)

3. If I wait for "all to go well" will I ever invest?

The underlying driver of the argument is "fear"

Fear is not typically associated with success - why would investing be any different? Success in investing is no different than building a successful [type omitted] law practice. You settle on a strategy, you asses what you have to work with, and when you're sure of what you're doing, you go.

Consider the following argument:

1. Premise I: Fear is an emotion

2. Premise II: All emotions are irrational

3. Conclusion: Fear is irrational

Then consider if the following two statements are the same?

1. I do not invest because I have fear about the future of world events

2. I do not invest because I am irrational about the future of world events

On the PM of [country name omitted]

Have a funny feeling he will not go down in history as a great investment thinker. While it is not necessary for you to be an "expert investor" some simple categories will help tremendously.

If the PM of [country name omitted] argument is no more sophisticated than what is indicated in the email and utilizes nothing more than vague statements, radical predictions, petty bets, and above all fear, unsubstantiated by a single rational statement, is his opinion on this topic worth contemplating?

If you watch or read mainstream financial news, it is shocking how often terms such as "experts predict" or "analysts say" or simply "they" is used all the time - as in "they say". Who are the experts, analysts, and the ubiquitous "they"? What are the merits of their opinion exactly? Try reading mainstream financial news critically sometime - you'll get a laugh out of just how true this statement is when you look for the all-powerful "they".

Next time the PM of [country name omitted] (or anyone else) suggests special knowledge from "counterparts" [read: 'they'] ask a few critical questions - here are some suggestions:

- Which counterparts? Are we talking about Angela Merkel or the PM of Albania? Surely their opinions don't carry equal weight do they?

- Did suddenly all of his "counterparts" reach "consensus", although they have never been able to in the past on a single issue, let alone one with such gravity as the possibility of a collapse in the US equities markets.

- What are their backgrounds, on what merits do their opinions rest? What is their track record of accurately forecasting the future of the Dow? Or do they have any practical experience with markets at all?

- If "they" [pun intended] are good at this impossible activity, why in the world are they in politics? They should be investors; they will become not billionaires, but trillionaires.

In the 1930's "they" used to say that the Dow would go to zero - that is ZERO, "0", "ZILCH" - it was widely held, and widely believed - imagine that - shares in the top US companies of the time (which included the likes of (IBM) and (GM) ) having no more value than toilet paper - regardless of their true assets.

In 1999 there was seminal work published by a very smart man named David Elias - the title was simply "Dow 40,000" - many faithful "believed".

Speculation is speculation. It will never be investment. There are extremes in both directions and many shades of "gray" in-between - Dow 5,000 is just another shade.

Here are some definitions of "speculation:

"guess: a message expressing an opinion based on incomplete evidence."

And again:

"Reasoning based on inconclusive evidence; conjecture or supposition"

In these definitions it is nothing more than a guess, because the "evidence" required to elevate the statement to something more can never be complete because of the very nature of the activity.

Having said that, crystal ball gazing is really more for fun and should be left out of the realm of serious investing decisions.

If successful investing came down to having a PhD in economics and "close contacts with high ranking officials in Europe" ('they') - many economists would also be billionaires.

Understanding the engine that grows existing wealth (compounding), and just how powerful it is and can be when done right, is very liberating (if for no other reason than intellectual ones).

The industry is comprised mainly of "smoke and mirrors" by design. A good many brokers eat because the investing public is often confused, and in their confusion unable to act on good or even great investment ideas, though they are in plain sight and require little more than basic arithmetic and a bit of work. Incidentally the financial media and the "economists" seem to conspire to help this parasitic industry along - and otherwise brilliant businessmen surrender their wealth through something no more sophisticate than a "shell game" - "surrender" is used, because there are no loses, there are only "transfers".

parable_of_the_talentsOnce this truth is apprehended, the machinations of the world which always take place in time (what we call history) cease to matter, for they can never be changed. The foundations of sound investing are discovered to be immovable from Aesop's fables and the Gospel of Jesus Christ to Benjamin Graham and Warren Buffet (all discuss the same concepts of sound investment policy) - no event in world history has or can change these principles, because they are transcendent.

It is important to focus on what can be "known" both a-priori and a posteriori (ability to act) and not be distracted by what "cannot be known" (paralysis).

The PM's statements involve three fallacies:

a) He has no way of knowing the future of the Dow or what decisions governments will make (just 'speculating' he and Merkel don't 'hang-out').

b) He has no way of knowing the impact of any hypothetical future geo-political or macro-economic events on the Dow, much less particular securities (for e.g. can he explain how this forecast will affect sales of Skechers shoes in Japan or Cisco routers in China as a result? Will the value of American Greetings real estate suddenly be different if Greece leaves the Eurozone?)

c) He has offered no hedge or alternative against his prediction - affirming the driver is nothing more than simple fear vs. rational thought (sitting on a mountain of paper in an inflationary world is not a valid alternative).

For example if the Dow returned to 5000 as is the case in his example, what would the number represents in relation to:

a) Real inflation (

b) Money supply (

c) US debt (

In other words, what is the "real inflation-money supply-us debt adjusted figure"? it is certainly not 5000 in today's dollars.

Is there an example in modern economic history where money supply increased as a derivative of government debt, and the result was deflation? After all Dow 5000 is a deflationary event.

Is there a single example taken from history of a government which carried significant debt, had the ability to devalue its own currency, and did not?

If items A, B and C above are correctly understood, than Dow 5000 effectively means that 30 blue chip companies in 2013 would be sold for basically Free (and many orders below not only tangible assets, but indeed likely just cash on hand) - let's call it the 1930's dream come true -only 80+ years late. How likely is that?

What would be the catalyst of this radical depreciation in the value of the Dow components in light of the increases in money supply? The Dow consists of only 30 companies which are all multi-nationals - arguably the best run large companies in the world.

Will their assets be worth less than cash on hand at that point? If so, then it means the US dollar itself would have no value whatsoever (given the democratization of information in our age) - so sitting on cash would be irrelevant.

Ownership in a company in such a scenario would be safe, because new monetary instruments could be recreated - but ownership rights would presumably remain irrespective of a fiscal crisis affecting the central bank. The only thing that would eliminate ownership rights would be a complete removal of the "rule of law", a scenario even more remote than a collapse of the currency.

How long is it supposed that this Dow 5000 prediction would last? Is it one week, one month, one year? If correct and prolonged (US dollar worthless), we only need to leave enough money aside for food rations and weapons, because it essentially means WWIII has broken out, in which case we all will have different priorities. If WWIII does not break out, it seems like betting on simple inflation is a safer bet.

How can the engine of growth that these companies represent in terms of return on assets, and return on liabilities defy the immutable nature of math? Money is understood in particular units of measure - the security is the engine that magnifies those units - the question is how do we find good engines, before the unit of measure changes (shrinks) against our best interest? If not common stocks, what is the alternative?

Rational frameworks should never involve fear, or bold predictions about the future (which cannot be known). As above, many, if not most in the 1930's believed that the depression was a new permanent condition, and that although companies at the time could be purchased for less than just their cash on hand, refused to participate in the stock market. However, the hand of time and progress does move forward, and relentlessly. The situation in Europe is probably not the end of the world - if it is, we should be talking Theology, if it is not, investing is the right topic.

Given the reality of the increase in money supply, if a prediction must be made, it ought to be that because of the ~100% increase in supply of the worlds reserve currency, the only reliable prediction regarding the future, is that there will be inflation, and significant inflation - stocks, when they are understood as companies (rather than sheets of paper) are one of the best hedges against inflation - which is the greatest, most subtle, and consistent way the government takes back the peoples wealth - including a great many wealthy. Though the wealthy often feel that they have preferential tax treatment (taxed on capital gains instead of wages), if they do not manage their money well they are taxed at a higher rate than they notice, for inflation is constant and always higher than official figures - inflation in the end is a tax itself.

It is also worth considering that many very smart, and important people have often made terrible investors.

As pointed out before:

"Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac's talents didn't extend to investing: He lost a bundle in the South Sea Bubble, explaining later, 'I can calculate the movement of the stars, but not the madness of men.' If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases." (Warren Buffet)

Thanks to widespread fear there is very little "motion" in the stock market right now.

A few more thoughts:

What is necessary for successful investing? (In order or importance):

- Genetic Predisposition - in a way "personality" - a penchant for finding "value" seems to be "hard wired" into only the minority. That is to say, some people believe it is far better to try to buy dollar bills for 50 cents, than to pay full price. While others believe they have some special knowledge on how and when that dollar bill will become worth $1.50, so they are willing to pay up to a $1.49 for the same. Of course the first does a far better job at protecting principle, and generating consistently high returns. Part of this is because of the perfection of math, once money is lost, it takes a much higher percentage return to regain what has been lost - it is the opposite of "compounding" - which effects are equally intense on capital.

Probably less than 5% of market participants fall into the "value" oriented category. As far as can tell either a person has this "gene" or they do not - it cannot be learned.

The essay "The Superinvestors of Graham-and-Doddsville" is excellent on the topic (and have not been able to disprove the theory that a 'value' orientation cannot be learned)

- Character - Patience, disciple, courage and diligence (to name a few) are traits of character that would benefit anyone in any field. They are the sum total of the decisions we have made in our life and our experience that make us the person we are. When character is added to "what is necessary" the percentage qualified candidates falls substantially from 5%.

However business schools neither teach nor promote these traits of character. In fact, graduates in finance will go immediately into the investing world to analyze "businesses" without having ever built or even run one, and probably couldn't - a serious deficiency in the "experience" category.

Hence the adage:

"Wall Street is the only place that people ride to work in a Rolls Royce to get advice from those who take the subway."

While these graduates come out of universities fluent in esoteric terms intended to create a sort of "priesthood" in the investment community, they are no better off when it comes to simple common sense.

What is not necessary for successful investing?

- High Intelligence. Although it is a "nice to have". History is replete with very intelligent people loosing huge sums of money. The same cannot be said of those who possess the qualities above, how many value oriented investors, with strong traits of character can be reported to have lost huge sums of money?

Now if an investor has the necessities above coupled with high intelligence, and perhaps exceptional analytical skills, than its pure dynamite - but it is by no means a necessity.

- Education. Because of the craziness taught in most finance departments of universities, a formal education in finances is likely to do more to confuse and disorient a money manager than assist him, no matter how many fancy words and equations they learn. The truth is little more than basic arithmetic is required to analyze a company's financial statements. Graduates of most schools of finance are really just being groomed as managers who will collect fees - actual performance (let alone bench-marked performance) will play little or no role in their compensation.

Have written more on this topic in the essay: Three Card Monte and other efficient ways of parting with your money

The goal is not to be an "expert investor", but rather to have enough sound, clear thinking to see things differently than the way the chaotic and unethical money managers want you to see it - at least that way you can choose the "right" money manager.

Continue to Part 2:

Source: The Prime Minister's 'One Dollar' Bets: Part 1