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Smead Capital Management is a registered investment advisor headquartered in Seattle, WA; founded in 2007. The company was formed to allow investors to benefit from long-term ownership of common stocks meeting the firm’s eight proprietary investment criteria. The firm manages a US Large Cap... More
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  • The Smell Test

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    Dear Fellow Investors:

    In my family we have a busy household with many friends and relatives floating in and out. We stockpile non-refrigerated foods in a large pantry and many times we don't get these items opened before the date listed as safe to eat expires. At that point we open the package and do what we call the smell test. If it smells fresh, we taste test and if it passes both tests, we eat it. We at Smead Capital Management would like to consider a certain current stock market circumstance to see if it passes the smell test.

    I started my career at Drexel Burnham Lambert. It was in the news because it was the target of an SEC investigation and US Attorney's office criminal probe in the late 1980's. I was a young stockbroker and assistant office manager without the life experiences to understand the full implications of the situation. The company had no fans in politics and was hated in the marketplace for hogging almost all of the revenue and profit in the market for trading and underwriting what came to be known as "junk bonds". These were bonds rated less than investment grade and prior to Drexel's trading desk, did not have much of a market. The company fought the government and ultimately was liquidated when their primary market, junk bonds, collapsed in 1989 during the Bank and Savings and Loan crisis of that era. They didn't pass the smell test.

    Goldman Sachs is the target of an SEC civil suit and the US Attorney's office is doing a preliminary investigation into possible criminal charges. They made markets in synthetic CDO's (Collateralized Debt Obligations) and are being accused of creating a CDO so that it would fail for the benefit of a client, who was betting against these kinds of instruments. Let's open the package and do the smell test.

    Every investment transaction has a buyer and a seller. Both parties believe they are right and someone is charging a commission for brokering the trade. John Paulson was the Goldman client who wanted to take the short side bet on the CDO in question and he was a relative unknown outside of his segment of the hedge fund world. He wanted to bet against the US mortgage market. The municipal insurance company, ACA, which put the deal together, did so to insure these bonds for a premium. They did not want to absorb the full risk, so they laid some of that risk off on ABN Amro, a large European financial institution which had made many investments just like this one in that time frame. In early 2007, we all knew that there was trouble brewing in US residential real estate, but we didn't know the magnitude or velocity at which this problem would unfold. The media and populist politicians appear to be rewriting history because they were asleep at the wheel in early 2007 and the animals are now "out of the barn". Politicians tapping into populist political anger at banks is much easier than trying to get their constituents to admit their own greed in residential real estate. Telling the American public that they had as much to do with the mortgage meltdown and the deep recession of 2008-09 as the greedy financial institutions seems totally unacceptable when congressional elections are coming up in November.

    Warren Buffett got to watch Drexel Burnham up close and when he got into a similar situation with a company called Salomon Brothers in 1992, he reacted swiftly. He took over Chairmanship of the company and immediately went to the government and told them that that the company (Salomon Brothers) would do whatever was required by the US government to make amends. He also pledged to the government that a culture would be put in place going forward so that it wouldn't happen again and allowed ongoing verification by the feds. He was a large shareholder in Salomon through 9% convertible preferred shares he owned and is a large stakeholder in Goldman by virtue of a $5 billion investment he made in the fall of 2008 in a 10% preferred, which has warrants attached to buy Goldman common shares at $115 per share. When he opened the bag over the weekend at his annual meeting and on T.V. this morning (May 3rd, 2010), it didn't smell bad. He is making no effort to takeover any control or leadership of the company and gave CEO Lloyd Blankfein as resounding an endorsement as I have just about ever heard him give! When asked who he'd get to run Goldman if Lloyd was forced out, Buffett said, "If Lloyd had a twin brother, I'd vote for him."

    We are going to taste our shares of Goldman Sachs. We believe they have many political friends and many satisfied customers. As fragile as the financial system was in 2008 and early 2009, we don't think the populist politicians are interested in cutting off their nose to spite their face. Crippling Goldman in any permanent way could torpedo confidence in our economic recovery, but damaging them some in the short run might help get a stronger bank regulation bill passed in Congress. And while the government is at it, let's pursue those who lied about their incomes to get loans, real estate agents who encouraged them and mortgage companies which passed those fraudulent loans into large bond pools. Somehow, skipping them to get to the end of the food chain doesn't pass the smell test.

    Best Wishes,

    William Smead

    The information contained in this missive represents SCM's opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. Some of the securities identified and described in this missive are a sample of issuers being currently recommended for suitable clients as of the date stated in this missive and do not represent all of the securities purchased or recommended for our clients. It should not be assumed that investing in these securities was or will be profitable. A list of all recommendations made by Smead Capital Management with in the past twelve month period is available upon request.




    Disclosure:

    Disclosure: No positions

    Disclosure: No positIons
    May 05 12:04 PM | Link | Comment!
  • Running Your Offense

    Printable Version

    Dear Fellow Investors:

    I've seen West Virginia's Men's Basketball team play four times in the last two weeks. The first time was live at the Big East Tournament and the last three in the NCAA Tourney on TV. Close observance of them has helped us at Smead Capital Management to be even more excited about our investment discipline.

    West Virginia has quality players. These players are molded into a team by a hard driving coach, Bob Huggins. But what got them to the final four is that they run their offense. They not only run it, but they actually set the screens that are required. I have been a rabid basketball fan for over forty years and can't remember better picks being set. They are wearing out the other teams physically and getting much easier shots in the process.

    To us at SCM, this speaks to the fundamentals of successful investing. Buy quality common stocks and do it inside your circle of competency. Let the businesses operate for years, executing the kind of business plans which can be built on for decades. Do it in businesses which sell products and services again and again and again.

    Setting a good screen is 90 per cent effort and 10 per cent talent. Finding a coach and players willing to do it is unusual, but could be done by anyone truly committed.

    Think of companies we own like Starbucks, Disney, McDonalds and Walgreens. They provide products and services in the same clean and consistent way all over the US and around the world. They wear out the competition through branding, balance sheet strength and scale in the same way the Mountaineers have done through well-placed screens and consistent defense in this tournament. We at SCM like those kind of fundamentals on our side.

    Best Wishes,

    William Smead

    The information contained in this missive represents SCM's opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. Some of the securities identified and described in this missive are a sample of issuers being currently recommended for suitable clients as of the date stated in this missive and do not represent all of the securities purchased or recommended for our clients. It should not be assumed that investing in these securities was or will be profitable. A list of all recommendations made by Smead Capital Management with in the past twelve month period is available upon request.



    Disclosure: SBUX,DIS,MCD,WAG
    Mar 30 10:52 AM | Link | Comment!
  • Hoarders

    Printable Version

    Dear Fellow Investors:

    "Hoarders" is a popular TV show currently. It tells the story of people who buy and collect things and virtually never throw anything away. As we look out to the rest of 2010, some of the lessons from the show could help us as investors over the coming years.

    Like most addictions or idolatrous behaviors in a person's life, hoarding starts out with the best of intentioned purchases. None of the original items, be they knick knacks, clothing or even collectibles are in and of themselves harmful. Unfortunately, hoarders don't stop there. They continue to buy new things and never throw anything out.

    In the US investment markets there has been some major hoarding going on the last five years. First, between 2004 and 2008, US investors hoarded Oil, Basic Materials and Heavy Industrial company’s common stock and international mutual fund shares to participate in the popularity of the emerging stock markets like Brazil, Russia, India and China (the BRIC trade).

    Second, US households and corporations hoarded Treasury Bills and Money Market Funds during the market meltdown between October of 2007 and March of 2009. In a recent Barron’s' article, money manager William Priest points out that the ratio of cash to total assets surged to 35-year highs for both non-financial corporations and households. Since March of 2009, they have been hoarding bond Mutual Funds, despite the stock market marching upward. Various reports from Lipper and Morningstar have reported net inflows into bond funds at $350-400 billion, while US stock funds and ETFs saw net liquidations.

    On the TV show, extreme problem hoarders end up with a great deal of useless trash in their house. The piles of junk collect dust and have no value to future buyers. It would be one thing to hoard works of art from Picasso or Chihuly, but the folks on the show buy and keep things that nobody else ends up wanting.

    At Smead Capital Management, we watch what the crowd is hoarding and try to avoid those popular areas. Bond funds and most investments tied to the BRIC trade appear as over-crowded as the dust covered rooms in the TV show. Simultaneously, the lousy results of the last ten years have caused investors to avoid the kind of Hall of Fame companies we like. In our opinion, these works of art can make us wealthy by buying and hoarding their shares for ten years or longer until the building gets overcrowded. We have formed museums (portfolios) to collect what we believe are "works of art". We do this under the assumption that the companies that meet our Eight Criteria will successfully execute their business purpose and plans. In so doing, they grow their earnings and free cash flow. Ultimately, the hoarders of cyclical businesses, commodities, emerging markets, money market funds, T-bills and bond funds may someday have to look at what they hoarded and reevaluate what creates long-term wealth. This could cause a transition away from formerly useful investments into the kinds of “Hall of Fame” companies we like.

    If interest rates in the US rise for many years and/or China’s economic growth slows down, we believe you should watch for a giant yard sale in bond mutual funds and the BRIC trade. Hoard quality when it is out-of-favor and avoid holding Hall of Fame companies only when maniacal pricing threatens to turn future returns into junk.

    Best Wishes,

    William Smead

    The information contained in this missive represents SCM's opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. Some of the securities identified and described in this missive are a sample of issuers being currently recommended for suitable clients as of the date stated in this missive and do not represent all of the securities purchased or recommended for our clients. It should not be assumed that investing in these securities was or will be profitable. A list of all recommendations made by Smead Capital Management with in the past twelve month period is available upon request.



    Disclosure:

    Disclosure: No positions
    Mar 23 4:41 PM | Link | Comment!
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