"Dead Duck" Soars Like An Eagle

(Continuing on the wonderful compilation of Warren Buffett's sayings done by Bud Labitan called "The Warren Buffett Business Factors" but unfortunately the link I had recorded is broken.)

The true investor welcomes volatility. Ben Graham explained why in Chapter 8 of "The Intelligent Investor"

There he introduced "Mr.Market," an obliging fellow who shows up every day to either buy from you or sell to you, whichever you wish.

The more manic-depressive this chap is, the greater the opportunities available to the investor. That's true because a wildly fluctuating market means that irrationally low prices will periodically be attached to solid businesses. It is impossible to see how the availability of such prices can be thought of as increasing the hazards for an investor who is totally free to either ignore the market or exploit its folly.

In assessing risk, a beta purist will disdain examining what a company produces, what its competitors are doing, or how much borrowed money the business employs. What he treasures is the price history of its stock. In contrast, we'll happily forgo knowing the price history and instead will seek whatever information will further our understanding of the company's business. After we buy a stock we would not be disturbed if markets closed for a year or two. We don't need a daily quote on our 100% position in See's or H. H. Brown to validate our well-being. Why, then, should we need a quote on our 7% interest in Coke?

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

There's this great example told by Andrew Kilpatrick, Of Permanent Value ( pg 631) on how Warren exploited the folly of the Mr.Market.

Here's a summary from me based on what Mr.Kilpatrick wrote.

Wells Fargo - "A Dead Duck" Soars Like An Eagle

In 1990, Buffett's original investment into Wells fargo came when there was a stigma surrounding the purchase, because it was a terrible time for banks. His purchase was deemed outrageous for at that time 'bank' meant layoffs, real estate write-offs, slashed dividends. Some had even suggested that the rapidly declining real estate prices could bring down the banking system.

On the day Buffett bought, the price earnings ratio of Wells Fargo was a minuscule 3.7! Mr.Market was really in a crummy mood. The stock had traded as high of $86 a share and a low os $41.25 in 1990. Buffett's initial average cost was about $58 a share.

And all this was admist negative nay-sayers and some big time short sellers, who betted that the stock would drop.

Some called it a dead duck. Whilst admitting that it would not be a bankruptcy candidate, they predicted the stock to fall to the low teens.

At first, the short sellers seemed right. For very soon, the dividends were slashed and reserves for real estate loans increased dramaticallyy.

George Salem, an analyst with Prudential Securities, was quoted : "He picked the management that underwrites real estate the best. But one thing he didn't realise that even Mark Spitx (the former Olympic Star then) can't swim in a hurricane in the middle of the ocean".

So how was Wells Fargo's earnings per share at that time? Doing quite nicely. The bank would wind up earnings of $712 million or $13.39 per share.

But then commercial real estates continued to decline.

And so Wells Fargo set aside for potential loan losses a little over $1.3 billion, or approximately $25 a share of the $55 a share in net worth. When a bank sets aside funds for potential losses, it is merely designating part of its net worth as a reserve for potential future losses. It doesn't mean those losses have happen, nor does it mean they will happen. It just means, if it does happen, the bank is prepared. (how did Wells Fargo actually do? The losses evetually did happen but it wasn't as bad as what Wells Fargo prepared for. Its loan loss figure in 1990 was a stunning $700 million but it still reported a profit of $21 million or $0.04 a share)

And of course the Mr. Market did not liked it. And the stock fell again. In which, it presented Buffett with his scond purchase in Aug 1992. He bought at prices ranging from $66 to $68 a share. And in late 1992, Buffett invested another $37 million - at prices ranging from $66 to $69.

And Prudential's Salem kept his sell pitch in late 1992, saying what a terrible stock Wells Fargo was: "When Warren Buffett runs out of money, the stock will plummett" adding that Buffett might as well make donations to a good cause. "He's supporting the stock; otherwise it would be much lower". He said the stock would make a perfect short, that only Buffett was holding the shorts back from a real onslought. In early January 1993, Buffett bought another 66,800 shares, bringing his shares total to 6,358,418. (To Buffett, WF was one of the best-managed and most profitable money-center banks in the country, selling in the stock market for a price that was considerably less than considerable banks were selling for in a private market)

Salem continued a month later: "We reiterate our sell rating of WF.. eventual downside risks appear considerable - perhaps to $60 or below.. The price more than reflects a nearly complete recovery which we don't see'...

In which it did not happen. The stock crossed $100 a share!!!!!!!!!!!!!

In 1993, the Atlanta Journal wrote this...

Calling it the 'strangest stock I have ever covered', Prudential's Salem dropped coverage of Wells Fargo. A vociferous critic of the San Fransico based bank, Mr.Salem has been bedeviled for years by Wells Fargo.

The analysys has carried a sell recommendation on the stock since Dec 1989 when it was trading at about $60. The stock closed Thursday at $105.37 1/2.

Mr. Salem, an often quoted 25-year industry veteran, insists he isn't giving up on a bad call. "This is not a surrender of any kind,.... It was a business decision based on where i thought I could spend my time more profitably. Wells Fargo is overpriced, volatile and unpredictable and not many from investment-land care about it".

Four years later in 1997...

If Mr. Salem had wanted to purchase Wells Fargo, he would have to pay approximately $270 a share!!!!!!!!!!

As for Warren, he ended up with a pretax annual compunding rate of return of approximately 24.6% on his 1990 investment!!!

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

So, what's the point?

The point is this; if you had identified the companies that have excellent management or a great consumer monopoly or both, it is easy to predict they will most certainly survive a recession more than likely come out of it in a better position than before. Recessions are hard on the weak, but they clean the field for the strong to take an even larger share when things improve.

On the other hand, stories like this, is often very nice to read. And in this story, it depicted how Warren 'bet' against Mr.Market and won big. Warren used his advantage, his attitude , he knew he is right because his reasoning his right and that sometimes the manic Mr.Market might not agree with him.

Oh before I go looking for MY very own Wells Fargo success story, let me pour cold water all over myself and remind myself what I wrote in the other blog entry, Warren Buffett Business Factors: Using Our Advantage

And this is a great example that if one is really dead sure of one's own reasoning, then one should never be affraid if Mr.Market reacts against one's stock investment. Remember, you are right because your own reasoning is right!

But... but... but...

And again, investing is never all that easy. It does get complicated at times.
And the main issue is simply, how dead sure is one's own reasonings?
Think about it.

We are never anywhere close to be the super investor that Warren Buffett is! And also the quality and the durable competitive advantage of our listed stocks is simply not as comparable to what Warren Buffett had invested in. Put it this way, the Washington Posts, the great Coca-cola's, the Gilletes, the H&R Blocks are not listed in our stock exchange. Here, we are very much subjected to stuff like earning cycles and even changes in the fortune cycle in which so-called good companies turning bad for one reason or another.

Hence, we are quite likely to make occassional mistakes in our stock investments, in regardless if whether the fault lies in our own stock selection method or not.So forget this not. This 'right reasoning to stay invested' thingy is pretty darn complex and could be a deadly value destructor in our stock investments if we fail to accept that perhaps our own judgement could be faulty at times!!

So sometimes, if and when the market go against us, we just have to ask ourselves this question: "What if we are simply wrong?"

Err... let me remind what my Granny told me (in my local complicated lingo! (err..Chinese-English!)): "Little bugger.. you are you, you are not going to be A Warren Buffett cos if you are, you are not here sitting down and playing mahjong with Ah Poh. Sooooo little bugger,you dun simply-simply priy-priy and try to be who you cannot be! You can learn and want to be no.1 but your no.1 and other people's no.1 is like how the sky is different than the land!... so little bugger... ni ming-pei mah? :P

Oh.... and did I not mention that I got my head whacked hard by Granny as she reminded me that there's a very fine line between right and being stubbornly wrong?!!

:P