Revisit Whe Buffett Partnership In 1957, 1960, 1962 And 1966 - Part III

The year of 1962 marked another spectacular outperformance of the Buffett Partnership. The Dow was down 7.6% and the partnership was up 11.9%, resulting in a 19.5% out-performance.

If we recall from the prior articles, before the 1957 market decline, Buffett stated that the market was expensive:

"My view of the general market level is that it is priced above intrinsic value. This view relates to blue-chip securities. This view, if accurate, carries with it the possibility of a substantial decline in all stock prices, both undervalued and other wise. In any event I think the probability is very slight that current market level will be thought of as cheap five years from now. Even a full-scale bear market, however, should not hurt the market value of our work-out substantially.”

Before the 1960 decline, he observed the divergence in the stock market:

“The Dow-Jones Industrial Average, undoubtedly the most widely used index of stock market behavior, presented a somewhat faulty picture in 1959. This index recorded an advance from 583 to 679, or 16.4% for the year. When the dividends which would have been received through ownership of the average are added, an overall gain of 19.9% indicated for 1959.

Despite this indication of a robust market, more stocks declined than advanced on the New York Stock Exchange during the year by a margin of 710 to 628. Both the Dow-Jones Railroad Average and Utility Average registered declines.”

However, in his 1961 letter, the Oracle did not make similar statements about the general market as he did in 1956 and 1959. Instead, he laid out his expectation in terms of annual returns of the Dow for the long term:

“I think you can be quite sure that over the next ten years there are going to be a few years when the general market is plus 20% or 25%, a few when it is minus on the same order, and a majority when it is in between. I haven't any notion as to the sequence in which these will occur. Nor do I think it is of any great importance for the long-term investor.

Over any long period of years, I think it likely that the Dow will probably produce something like 5% to 7% per year compounded from a combination of dividends and market value gain. Despite the experience of recent years, anyone expecting substantially better than that from the general market probably faces disappointment.”

If we use a 3% dividend rate for the Dow and strip that out from the 5% to 7% Buffett expected, his price return for the Dow in the long run was 2% to 4% per year, which was conservatively pessimistic. If we repeat the Shiller P/E exercise we did for 1957, we can see that the market was mildly expensive at the end of 1961 based on the Shiller P/E. Below is the table of the Shiller P/E of the S&P for 1960 and 1961:

1-Dec-61	22.04
1-Nov-61	21.86
1-Oct-61	20.92
1-Sep-61	20.71
1-Aug-61	20.94
1-Jul-61	20.15
1-Jun-61	20.33
1-May-61	20.6
1-Apr-61	20.38
1-Mar-61	19.84
1-Feb-61	19.23
1-Jan-61	18.47
1-Dec-60	17.56
1-Nov-60	17.15
1-Oct-60	16.61
1-Sep-60	17.05
1-Aug-60	17.58
1-Jul-60	17.38
1-Jun-60	17.82
1-May-60	17.26
1-Apr-60	17.43
1-Mar-60	17.29
1-Feb-60	17.55
1-Jan-60	18.34

The decline in 1960 brought the Shiller P/E down to as low as 16.61. As the market advanced significantly in 1961, the Shiller P/E rose to 22 at the end of 1961, much higher than the historical average of 14.5 up to 1961.

Another indication that Buffett thinks that the market was not cheap comes from this video:

In this video, Buffett said although the stock market had been rising at a rather rapid rate for some time, corporate earnings and dividends had not been increasing. Therefore, a correction was expected.

Buffett’s portfolio, incidentally, included a position that was usually large just as it did in 1956 and 1959. This time, it was Dempster Mill, a windmills and water irrigation systems maker in Beatrice, Neb. To be clear, Buffett started purchasing the stocks of Dempster Mill back in 1958. It was a classic Graham-style cheap the stock had book value of $72 per share and price of $18 per share. Over the next few years, Buffett continued to accumulate shares at prices significantly below book value and eventually he owned 70% of the stock with another 10% held by a few associates by August 1961. At the end of 1961, Dempster Mill represented more than 20% of the Buffett Partnership’s portfolio. In his letter dated November 1962, Buffett mentioned that the outperformance up until Oct. 31 was about 40% due to Dempster Mill if valued at $50 per share. Although we can’t tell how much Dempster Mill contributed to 1962 full year’s outperformance, an educated guess would suggest a 40% to 50% range.

What happened next to Dempster Mill was very interesting. First of all, in the 1962 annual report, the Dempster Mill position was not valued using quoted prices. Instead, it was valued using Buffett’s own intrinsic value estimate, which is based on liquidation value. In today’s accounting lingo, this investment would be classified as a Level III asset, which means the value of the assets are estimated using unobservable inputs. Although $35 per share does look like a very conservative estimate of liquidation value, for a declining business, I doubt that Dempster Mill could be traded at $50 per share if it were listed on NYSE in today’s market environment.

The second interesting point about the Dempster Mill investment was that Buffett was in serious trouble with this investment at one point in 1962. This was skillfully depicted by Alice Schroeder in "Snowball":

“Since Dempster was just another cigar butt, Warren applied his cigar-butt technique, which was to keep buying a stock as long as it continued to sell below book value. If the price rose for any reason, he could sell out at a profit. If it didn’t, and he ended up buying until he owned so much stock that he controlled the company, he could sell off—that is, liquidate—its assets at a profit.

…

Buffett was looking at only a few months before it all caved in and he would have to report to the partners that a business into which he had sunk a million dollars of their money was broke. He tried to recruit his old Columbia friend Bob Dunn to leave his job at U.S. Steel, move to Beatrice, and run Dempster. Dunn actually made a trip out to Beatrice but in the end wasn’t interested. Buffett rarely asked advice, but finally that April he took the situation up with his friend Munger while he and Susie were visiting Los Angeles.

‘We were going to dinner with the Grahams and the Mungers, Susie and I. We met them at the Captain’s Table on El Segundo in L.A. During the dinner, I’m telling Charlie, ‘I’m in this mess with this company; I’ve got this jerk running Dempster, and the inventories keep going up and up.’”

So the situation at Dempster Mill was awful and if the current manager kept messing up the company, it was likely that Dempster Mill would go bankruptcy eventually. Buffett had to talk to Munger and then hired a best turnaround expert to get out this mess at a very nice profit. The investment made a lot of money for his investors but it also got ugly in the end when everyone in Beatrice hated him

I don’t think small investors can replicate what Buffett did at Dempster Mill. Today we may call situations like this value traps and unless an investor can unlock the value by taking a controlled position, he is very unlikely to get the return Buffett got for Dempster Mill. But if there is one lesson we can learn from the Dempster Mill case, I think it is this:

By buying assets at a bargain price, we don't need to pull any rabbits out of a hat to get extremely good percentage gains. This is the cornerstone of our investment philosophy: “Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results. The better sales will be the frosting on the cake.”

The last point I noted in the 1962 letter was a short position. It may not be material to Buffett’s outstanding relative performance against the Dow, but he had a short position about 4% to 5% of the beginning assets under management. Most of this occurred in conjunction with a work-out situation. In his words, “The short sales eliminated the general market risk related to that situation.”

To be continued…

Revisit The Buffett Partnership In 1957, 1960, 1962 And 1966 - Part II

In my previous article, I analyzed how Warren Buffett managed to outperform the Dow by 17.7% in 1957 when the Dow was down 8.4%. In this article, I will move on to the year of 1960. Here is the table of outperformance for reference purposes:

In 1960, the Dow declined 6.2% whereas the Buffett Partnership advanced 18.6%. The outperformance was a whopping 24.8%. Having been skeptical of the market’s advance in 1959, the Oracle wrote the following to his investors in the 1959 letter.

“The Dow-Jones Industrial Average, undoubtedly the most widely used index of stock market behavior, presented a somewhat faulty picture in 1959. This index recorded an advance from 583 to 679, or 16.4% for the year. When the dividends which would have been received through ownership of the average are added, an overall gain of 19.9% indicated for 1959.

Despite this indication of a robust market, more stocks declined than advanced on the New York Stock Exchange during the year by a margin of 710 to 628. Both the Dow-Jones Railroad Average and Utility Average registered declines.

Most investment trusts had a difficult time in comparison with the Industrial Average. Tri-Continental Corp. the nation's largest closed-end investment company (total asset $400 million) had an overall gain of about 5.7% for the year.

……

Massachusetts Investors Trust, the country's largest mutual fund with assets of $1.5 billion showed an overall gain of about 9% for the year.

Most of you know I have been very apprehensive about general stock market levels for several years. To date, this caution has been unnecessary. By previous standards, the present level of ‘blue chip’ security prices contains a substantial speculative component with a corresponding risk of loss. Perhaps other standards of valuation are evolving which will permanently replace the old standard. I don't think so. I may very well be wrong; however, I would rather sustain the penalties resulting from over-conservatism than face the consequences of error, perhaps with permanent capital loss, resulting from the adoption of a "New Era" philosophy where trees really do grow to the sky.

To the extent possible, I continue to attempt to invest in situations at least partially insulated from the behavior of the general market.”

In this letter, Buffett shrewdly pointed out the divergence he observed: The Dow advanced 16.4% while more stocks declined than advanced on the NYSE during 1959. This divergence suggested that the advance was probably led by a small group of stocks, or in this case, very likely the “blue chip” securities. This divergence suggests another way that Buffett looks at the general market. It is widely known that one of his favorite metrics to use to value the general market is total cap as a percentage of GNP. However, by looking at the components that make up the exchange, we can also get a good sense of the market condition. In the case of 1959, the divergence observed by Buffett should serve as a cautious sign for investors.

I don’t know whether the portfolio allocation decision Buffett made leading up to 1960 was due to anticipation of a decline in the general market or not but at the end of 1959, there was a particularly large position that made up 35% of the portfolio. This is a workout that should be uncorrelated to the market movement.

“Last year, I mentioned a new commitment which involved about 25% of assets of the various partnerships. Presently this investment is about 35% of assets. This is an unusually large percentage, but has been made for strong reasons. In effect, this company is partially an investment trust owing some thirty or forty other securities of high quality. Our investment was made and is carried at a substantial discount from asset value based on market value of their securities and a conservative appraisal of the operating business.”

As some of the readers know, this investment was Sanborn Map. The readers can get the details in the 1960 letter. Essentially, Sanborn Map is a stock that was trading around $45 per share and had an investment portfolio worth about $65 per share. Sanborn Map also had a declining, yet still profitable map business that was earning less than $100,000 or less than $1 per share (Sanborn had 105,000 shares outstanding).

To unlock the value of Sanborn Map, Buffett practiced what nowadays called activism, joined by his friends Walter Schloss, Fred Stanback and Henry Brandt. In the end, he purchased enough shares to effective take control of the company and Sanborn Map exchanged a portion of the investment portfolio for company shares. As part of the deal, the Buffett partnership tendered all their shares.

It is worth noting that the Sanborn Map investment is different from National American in that Sanborn Map’s business quality and earnings power were much worse than those of National American. However, Sanborn’s asset value provides better protection as the investment portfolio could be readily liquidated.

Although in both cases, Buffett made a lot of money for his investors, often overlooked was the amount of effort he put into both Sanborn Map and National American. In the case of National American, he and his partner Dan had to go to the countryside to first find out who may own the shares and then to ask every possible shareholder to sell them their shares. In the case of Sanborn Map, he almost went on a proxy fight in order to unlock the value.

Neither investment would turn out as good as they were if not for the tremendous amount of hard work Buffett put in. Many Buffett followers know that his early career involved buying cigar-butt type of companies, but I wonder how many of us think about the fact that he went extra miles by doing whatever he needed to do in order to take control of the companies he invested in so he could unlock the value. The classic Ben Graham approach, combined with his determination and persistence, contributed to his early successes.

To be continued.

A Good Summary of Snowball

http://valueprax.wordpress.com/2012/06/24/notes-the-snowball-by-alice-schroeder-part-iii-chap-20-33/

Revisit Buffett Partnership in 1957,1960,1962 and 1966 - Part I

"Rule No.1: Never lose money. Rule No.2 : Never forget rule No.1."
                                                                                                                Warren E. Buffett

Every serious value investor is aware of the above famous rules from the Oracle of Omaha. These two seemingly simple rules require considerably more than mere memorization. In practice, never lose money is almost impractical, especially in a full-blown bear market. No one does a better job than the rule setter himself in achieving the above goals. So when reading through Warren Buffett's letters to partners from 1957 to 1969 again, I set up the goal to analyze how did Mr. Buffett generate gains during the down years in 1957,1960,1962 and 1966.

First of all, let's take a look at the performances of the Buffett Partnership during the down years against the Dow. Below is the performance of the Dow Jones and the Buffett Partnership during the aforementioned periods:

           Dow        BP     Out-performance
1957: -8.4%     9.3%        17.7%
1960: -6.2%    18.6%       24.8%
1962:-7.6%     11.9%       19.5%
1966:-15.6%   16.8%       32.4%

In all 4 years, the Dow suffered from mild to severe declines while the Buffett Partnership generated gains. The out-performance is nothing short of spectacular. In order to analyze how Mr. Buffett achieved the above results, I read the annual letters of these 4 years, the preceding years if available(1956, 1959,1961 and 1965) as well as the succeeding years (1958, 1961, 1963 and 1967). I also read Snowball by Alice Schroeder for supplemental information if needed.

This article series will start with the year of 1957. Here is an excerpt from the 1956 letter that explains his view of the general market of 1957:

"My view of the general market level is that it is priced above intrinsic value. This view relates to blue-chip securities. This view, if accurate, carries with it the possibility of a substantial decline in all stock prices, both undervalued and other wise. In any event I think the probability is very slight that current market level will be thought of as cheap five years from now. Even a full-scale bear market, however, should not hurt the market value of our work-out substantially."

With this view that the market is priced above intrinsic value, Buffett's adjusted the ratio of general issues and work-outs to 70-30, meaning that 30% of his portfolio should not be impacted by market moves. Naturally one may ponder how did Buffett come to the view that the market is priced above intrinsic value. In order to answer that question, ideally one should find the market cap as a percentage of GNP for the year 1956 because that is Buffett's favorite metric to use when valuing the overall market. However, I was not able to find such data for 1956. As an alternative,  I gathered the Shiller P/E information for the S&P index until 1956. Assuming the data I gathered is correct, the pre-1956 average Shiller P/E for the S&P is just over 14 times. Here is the monthly Shiller P/E ratio for 1956:

1-Dec-56	17.2
1-Nov-56	17.1
1-Oct-56	17.4
1-Sep-56	17.8
1-Aug-56	18.7
1-Jul-56	18.9
1-Jun-56	18.2
1-May-56	18.5
1-Apr-56	19.4
1-Mar-56	19.4
1-Feb-56	18.3
1-Jan-56	18.3

On average, S&P had a Shiller P/E of 18.3 during 1956. Although based on the ratio itself, the market was not terribly expensive,  the ratio was still much higher than the pre-1956 historical average of a little over 14 times.

Now that we know the market was expensive, what stocks did Mr.Buffett buy during 1956 and 1957? I could not find the answer I wanted in the 1957 letter to partners. However, a careful read of Chapter 22 of the Snowball by Alice Schroeder reveals that at least one of the stocks he bought was National American.
According to Ms. Schroeder, this is the story between the Oracle and National American.

"Monen had joined Warren on a personal side project that he had been pursuing for some time: buying the stock of an Omaha-based insurer, National American Fire Insurance. This company’s worthless stock had been sold to farmers all over Nebraska in 1919 by unscrupulous promoters in exchange for the Liberty Bonds issued during World War I. Since then, its certificates had lain crumbling in drawers, while their owners gradually lost hope of ever seeing their money again.

Warren had discovered National American while working at Buffett-Falk, flipping through the Moody’s Manual.

The company was headquartered only a block away from his father’s office. William Ahmanson, a prominent Omaha insurance agent, had originally been sucked into it unawares, set up as a local front man for what had started out as a fraud. But the Ahmanson family had gradually turned it into a legitimate company. Now, Howard Ahmanson, William’s son, was feeding top-drawer insurance business into National American through Home Savings of America, a company he had founded in California, which was becoming one of the largest and most successful savings-and-loan companies in the United States?

The defrauded farmers had no idea that their moldering paper was now worth something. Howard had been quietly buying the stock back from them on the cheap for years through his younger brother Hayden, who ran National American. By now the Ahmansons owned seventy percent of the company.

Warren admired Howard Ahmanson.'Nobody else was quite as audacious at managing capital as Howard Ahmanson. He was very shrewd in a lot of ways. Formerly, a lot of people came in to Home Savings and paid their mortgages in person. Howard put the mortgage at the farthest branch away from where you lived so that you paid by mail and didn’t spend half an hour of one of his guys’ time telling them about your kids. Everybody else had been to see It’s a Wonderful Life and felt that you should do this Jimmy Stewart stuff, but Howard didn’t want to see his customers. His operating costs were way under anybody else’s.'

National American was earning $29 per share, and Howard’s brother Hayden was buying its stock for around $30 per share. Thus, as with the rarest and most attractive of the cheap stocks that Warren stalked, the Ahmansons could pay virtually the entire cost of buying a share of stock out of one year’s profits from that single share. National American was the cheapest stock Warren had ever seen—except for Western Insurance. And it was a nice little company, too, not a soggy cigar butt.

'I tried to buy the stock for a long time. But none of it was getting to me, because there was a security dealer in town and Hayden had given this guy the shareholders list. This stockbroker—he regarded me as a punk kid. But he had the list. And I didn't have the list. So he was buying the stock at thirty for Hayden’s account.'

Cash on the barrel from Hayden Ahmanson sounded good to some of the farmers compared to their worthless certificates. Though they had paid around $100 per share many years before and were only receiving $30, many of them had gradually convinced themselves that they were better off without the stock.

Warren was determined. 'I looked it up in some insurance book or something. If you went back to the twenties you could see who were the directors. They made some of these bigger stockholders the directors from the towns they worked the hardest for sales. There was a town called Ewing, Nebraska, which has got no population at all. But somebody sold a lot of stock out there. And that’s how they probably got the local banker on the board thirty-five years earlier.'

So Dan Monen, Warren’s partner and proxy, went off to the countryside carrying wads of Warren’s money and some of his own. He cruised around the state in a red-and-white Chevrolet, showing up in rural county courthouses and banks, casually asking who might own shares of National American.26 He sat on front porches, drinking iced tea, eating pie with farmers and their wives, and offering cash for their stock certificates.

'I didn’t want Howard to know because I was topping his price. He had been picking it off at thirty bucks, and I’d had to raise the price some. The shareholders had been listening for probably ten years at thirty bucks, so it was the first time the price moved.'

The first year Warren paid $35 each for five shares of the stock. The farmers’ ears pricked up. Now they realized that buyers were competing for the stock; they began to think maybe they weren't better off without it. The price had to keep moving up.

'Finally, toward the end, I paid a hundred. That was the magic number, because it was what they’d paid in the first place. A hundred bucks, I knew, would bring out all the stock. And sure enough, one guy came in when Dan Monen was doing this and he said, ‘We bought this like sheep, and we’re selling it like sheep.’

That they were. Many had sold at less than three times the $29 a year the company was earning. Monen eventually accumulated two thousand shares, ten percent of National American’s stock. Warren kept it in the original shareholders’ names, with a power of attorney attached that gave him control, rather than transferring it into his name. 'That would have tipped Howard off to the fact that I was out there competing with him. He didn’t know. Or, if he did, he had insufficient information. I just kept collecting shares. Then, the day I walked into Hayden’s office, I plopped them all down and said I wanted to transfer them to my name. And he said, ‘My brother’s going to kill me.’ But in the end, he transferred the stock.'

The brainstorm behind Warren’s National American coup had been more than just the price. He had learned the value of gathering as much as possible of something scarce."

Here we have a high quality insurance company whose stocks are very illiquid. The stock price has basically not moved in 10 years. We have a manager who is very shrewd at capital allocation. We also have some hidden assets value that requires more than sheer intelligence to discover. At first, Buffett tried buying around $35 a share, or a little more than 1 times earning and less than 30% of the book value. Eventually, he offered $100 a share or, 3.5 times earning per share and 75% of book value per share for a premium insurance company. I don't know the rate of return Mr. Buffett achieved for this investment but all the information above shapes up pretty well for a great investment. 

To be continued...

Case Studies Of The Peter Cundill Investment Approach

I have not heard much about Peter Cundill before reading this wonderful book titled “There’s Always Something to Do,” masterfully written by Christopher Risso-Gill. However, after reading the book, I certainly wish I had known more about Mr. Cundill a lot earlier. The book offers a fantastic summary of “The Peter Cundill Investment Approach” and plenty of great examples to illustrate this approach. Peter Cundill excelled at finding bargains using the classic Benjamin Graham approach – a business is cheap if a careful analysis of a company's balance sheet reveals that the market price of the business is meaningfully lower than its intrinsic value. To better appreciate the beauty of Cundill’s approach to investing, I have compiled the following cases. It is my hope that the readers will find these cases informative and helpful.

Case I- Credit Foncier Franco Canadien.

This is one of Cundill’s early investments that he sold for a multiple of his cost. Credit Foncier was, as he described it, “a treasure trove of wonderful assets.” 

Credit Foncier was founded by what is known today as Paribas, for the purpose of entering into the mortgage lending market in Quebec. It had become a major player in the Prairie Provinces (Alberta, Saskatchewan, Manitoba) as the area was being converted into one of the world’s greatest grain-producing expanses. Credit Foncier had been providing substantial financing to farmers and enterprises, and the profit it earned enabled it to acquire a significant commercial real estate portfolio in Eastern Canada. 

Furthermore, during the crisis from the late 1920s to early 1930s, Credit Foncier foreclosed on many of the farmers but allowed them to remain tenants on very favorable rental terms. Therefore, Credit Foncier had become the owner of swathes of farmland, including the underlying mineral rights, and whenever the land had been sold, Credit Foncier was able to keep those mineral rights. 

Cundill also noted that “the accounting policies at Credit Foncier had remained ultra conservative, with the entire real estate portfolio carried on the balance sheet at book cost with no attempt to put a realistic value on the mineral rights.” 

In Cundill’s assessment, neither the cash nor the real value of the assets was even remotely adequately reflected in the share price. Furthermore, Credit Foncier had been consistently profitable and paying dividends for many years. 

Cundill’s estimate of liquidation value appeared to be in excess of $150 value per share while Credit Foncier’s stock was trading at around $43 per share. Cundill loaded up on Credit Foncier’s shares after his analysis. Credit Foncier turned out to be a multi-bagger. 

Key takeaways: 

· Balance sheet vastly underestimated the true value of assets. 

· Market price was significantly lower than the reasonably estimated liquidation value. 

· The company had been consistently profitable and paying dividends for many years. 

Case II – J. Walter Thompson
J.Walter Thompson (JWT) is a household name in the advertising industry. During the recession of the 1970s, the advertising industry was hit hard more than most other industries with “sharply falling revenues, much publicized redundancies, and gloomy predictions that the market would never fully recover and margins would be squeezed for years to come. “

JWT went public in 1972 at more than $20 per share. As the result of both the recession and the added negativity that H.R.Haldeman, President Nixon’s ex-chief of staff, who had been previously head of JWT’s LA office, had recently been imprisoned for his part in the Watergate Conspiracy, JWT’s stock sank to around $4.00 per share. 

Cundill scrutinizes JWT’s 10-K and discovered that the company “had a hard book value of $18 per share, not including its freehold building in Paris and Tokyo, and had a long-term lease in Berkeley Square at the heart of London’s Mayfair.” Furthermore, JWT was still profitable and was paying a dividend. 

Cundill started accumulating JWT’s shares until it reached to 10% of the assets of the fund with the average cost of just over $8 per share. A year later, he sold his position at well over $20 per share.

Key takeaways: 

· Great business franchise hit hard by recession and temporary negativity.

· Hidden assets value not reflected on balance sheet. 

· Market price was significantly lower than the reasonably estimated liquidation value. 

· The company had been consistently profitable and paying dividends.

Case III - Tiffany and Co

Tiffany and Co is the iconic luxury jeweler and silversmith. In the 1970s, the perception of Tiffany turned negative for two reasons. “First, because Tiffany had lost money for several years in the 1930s, when luxury goods had been neither fashionable nor generally affordable, there was a consensus that the 1970s were likely to see a repeat of this so luxury brands were definitely out of favor. Second, Tiffany’s equity was controlled by Walter Hoving, its CEO, who, although recognized as a talented and energetic manager with real creative flair, had roundly declared in public that he would never ever sell."

Tiffany’s revenue and profits had also grown steadily through the recession period with net income crossing over the $1 million mark for the first time ever in 1974. 

“For Peter, the clincher in making an investment decision would always be the value of the net assets and in Tiffany’s case there were plenty to choose from. The most obvious and high profile one was a massive 128.5 carat canary-coloured Tiffany Diamond carried on the books for $1.00 although it was widely known that the company had recently turned down an offer of $2 million for it. Furthermore, Tiffany’s freehold of the Fifth Avenue store was sitting on the book at $1 million since 1940. On top of this, there was a factory of 120,000 square feet in Newark and a very conservative valuation placed on the inventory of the retail stock.” 

Tiffany’s shares were trading below book value of $10.5 per share and in Cundill’s judgment well below the company’s realistic liquidation value. Cundill accumulated Tiffany’s share at an average of $8.00 per share. Within a year, he sold his entire position at $19.00. 

Key takeaways:

· An iconic luxury brand with growing revenues and profits suffered from negative perceptions. 

· Value of prestigious hard assets underestimated on the balance sheet.

· Market price well below realistic liquidation value. 

Case IV – Cleveland Cliffs

Cleveland Cliffs was the largest supplier of iron ore pellets in North America. The periods following the recessions of 1981-83 were harsh ones for the iron ore industry. In response Cleveland-Cliffs shrank its operations. It had a series of joint venture investments that could not be regarded as liquid assets. Book value had declined from $30 to $22 while stock price had declined from $40 to $18. 

Upon examination, Cundill found out about a power plant in Michigan that was carried on the balance sheet at a negligible value. He was not sure how much this power plan was worth so he called two of his friends to visit the plants. Both friends reported back to Peter that the plant was worth “a lot of money.” 

What’s interesting about the Cleveland Cliffs case is that after Cundill’s initial purchase at $15 per share, Cleveland Cliffs’ shares slid relentless to $6 per share. Cundill bought the shares on the way down at an average cost of $9.75 per share. In two years, the shares hit $20. 

This is not the end of the story. During the market crash in October, Cleveland Cliffs’ shares plummeted again and Cundill bought back all the shares he had sold. The fund exited the position in 1991 with an annual compounded rate of over 30%. 

Key takeaways: 

· A neglected security selling below book value with hidden assets not reflected on balance sheet. 

· Using Cundill’s own words, “There is almost always a major blip for whatever reason and we have learnt to expect it and not to panic.” 

Case V – Angelo American

As Cundill has written a great investment analysis for Angelo American in his journal, here I will let the guru himself help us navigate through his thought process: 

“Angelo American is a South African holding and management company providing a complete range of technical and administrative services to 285 companies worldwide. In addition they hold significant equity interest in a group of international mining, industrial, and investment companies including De Beers, Engelhard, Charter Consolidated, Hudson’s Bay Mining and Smelting, Amax, and Anglo American Gold.

De Beer controls over 80% of the world’s diamond output and Anglo’s investment has a market value of over $200 million. Anglo’s mining interests last year produced 29% of the Free World’s gold production and substantial quantities of coal, uranium, copper, iron ore, platinum, nickel, and zinc. They have invested in a number of successful petroleum consortia in the UK and Dutch sectors of the North Sea, including the Forties and Argyll fields. Through Charter Consolidated they have a sizeable interest in Rio Tinto Zinc. Anglo American of Canada owns 38.5% of Hudson Bay Mining and Smelting. There are smaller, but still not insignificant, investment in timber, real estate, asbestos, potash, and citrus fruit groves. 

Anglo is holding cash and equivalents of $235 million. Their investment portfolio is carried at a cost of $600 million against a value for the quoted securities alone of $1.1 billion. The shares at $2.50 are selling at a ten year low with a capitalization of a mere $313 million, the company is profitable (will earn about 60 cents this year), and the dividend yield is 10% and more than twice covered. The numbers are solid but the share price is clearly signaling a problem or problems – precisely what we like to see. As I see it, first of all there is the gold price, which has recently sunk back from $170 and is now teetering on the brink of $100, and I take this to be a psychologically important resistance point which may or may not hold. At the same time mining costs have risen sharply, so it would be sensible to assume that Anglo’s dividend stream from its gold-producing subsidiary will be substantially reduced for the next little while. In a worst case scenario this could lop about 20% off the earnings, but still leave the dividend twice covered – a considerable margin of safety in itself and the debt/equity ratio at 0.7 is more than satisfactory. As the direction of the gold price – who can tell, but this is an unsettled and inflationary era and it is not hard to imagine a further rush of financial assets to safe heaven, one of which is gold. 

The other problem is clearly the politics, which the harbingers of doom predicting a collapse of order as black South Africans press more violently for equality, the demise of white supremacy, and a fair share of their birthright. The risks of labour unrest are undoubtedly realand might include sabotage and the spectre of expropriation if things really got out of hand. My instinct is that the worst case scenario is highly unlikely and even if it were to happen, Anglo’s internationally acknowledged expertise is in mine-management and someone would still have to manage and expropriated mines. However the true margin of safety lies in the diversified portfolio of assets outside South Africa. ”

Cundill bought Anglo America in 1977 and sold it in 1979 with over 100% realized gain. 

Case VI. Tokyo Broadcasting System.

Tokyo Broadcasting System is a classic Peter Cundill play in the Japanese market. It was the third largest television broadcaster in Japan. As a result of the stagnant Japanese economy through the 1990s, broadcasting companies in Japan suffered from severe revenue and profit decline. TBS owned valuable property, a lot of cash and a competent management team. 

TBS’s share was trading at 1,500 yen per share at the time with the value of real estate per share of 1,000 yen per share and cash and investment per share of another 500 yen. At 1,500 yen per share, you were buying the business for nothing and Peter valued the business excluding cash, real estate and investment portfolio at 2,000 yen. Adding this 2,000 yen to cash, real estate and investment portfolio, Peter arrived at a “fair value” of 3,500 yen. 

Peter began buying in 1998 and accumulated the majority of his position through 2001 and 2002 at prices below 1,500 yen. Most of the position was sold at between 2,500 yen and 3,500 yen. Incidentally, TBS’s share eventually reached Peter’s fair value of 3,500 yen. 

Key takeaways:

· A leading Japanese broadcaster suffered from stagnant macro environment. 

· At 1,500 yen per share, you can buy the cash, real estate and investment portfolio and get the rest of the business for free. 

Case VII - Sibir Energy

Sibir Energy is a Russian Oil Company and the largest company listed on London Stock Exchange’s Alternative Investment Market (AIM). It was founded in 1996 and obtained an AIM listing on the London Stock Exchange in 1997.The opportunity came after the Russian debt crisis when Sibir’s share price plummeted along with every other Russian Stock. 

“Sibir owned a UK operating that was cash flow positive and worth approximately half the company’s market capitalization. It had a rag bag of assets in Italy, whose value probably represented another quarter, which left a collection of assets in Russia, including one mature oilfield that was also cash flow positive and worth between 25% and 50% of the market cap. The rest of the assets were thrown in for free. But most important elements of the package were 50% interest in two oil fields, both in Siberia, one in partnership with Sibneft, controlled by Roman Abramovih, and the other a rather loosely constructed joint venture with Shell. ”

Peter’s friend James Morton, who was helping Peter with the Sibir Energy investment, calculated that from the sum of parts standpoint, “you were paying mere 10 cents per barrel in the ground for the Russian reserves, well below the value of any other listed Russian Oil Company.” Peter, however, “remained to be convinced as he believed that nothing in Russia was ever straightforward.” 

Peter’s cautionary notes proved to be prescient. “Everything that could go wrong did.” “Shell tried to squeeze Sibir out of the Salyn oil field by accelerating the cash requirements to bring it on stream to a level that it believed Sibir would be unable to support.” Sibir had to take a loan from its largest shareholder and sell off its UK and Italian assets to fend off Shell’s tactics. Next, Sibir had to fight the battle against LukOil and Sibneft (the other partner in Siber’s 50% interest in one of the two oilfields) to gain control of a strategic refinery. Although Sibir won the battle, Sibneft retaliated and diluted Sibir’s interest in the Siberian Joint Venture with Sibneft from 50% to 1%. 

All the turmoil made Sibir’s shares extremely volatile. In 2008, Sibir’s largest shareholder, Tchigirinski, who helped Sibir during the Shell fight-off, asked Sibir’s EO Henry Cameron to lend him $500 million because he was running out of cash. The board refused to authorize the transaction but it happened anyway. When the news broke, Sibir was suspended from AIM market and Cameron was fired.

Throughout the Sibir drama, Peter and James remained rational by “running and rerunning the ‘sum of the parts’ calculations to reassure themselves that the margin of safety is still intact.” In the end, the Sibir investment turned into a “ten bagger.” 

Key takeaways from Christopher Risso-Gill:

· “What was required was an asset-based margin of safety significantly greater than would be considered adequate in the more developed markets.” 

· It was also fairly obvious that in these less developed markets tangible fixed assets were superior to cash, which had a nasty habit of evaporating.”

Conclusion

If there is one common theme in all the cases above, it is the built-in margin of safety provided by assets value. The Peter Cundill approach will require an in-depth analysis of the balance sheet and even on-site visits to identify undervalued and hidden assets. Not surprisingly, some of Peter’s best investments involved purchasing great businesses trading below reasonably estimated liquidating value due to temporary fixable problems as demonstrated by his investments in Credit Foncier and Tiffany and Co. Also important to the Peter Cundill approach is the ability to stay patient and convinced during adverse periods as we see from the Cleveland Cliffs case and the Sibir case. Peter’s writings and experiences again remind us that combining a margin of safety mindset with the right temperament is likely to result in more than satisfactory investment returns over the long term. 

Let us end this article with three fabulous quotes: 

"There's always something to do. You just have to look harder, be creative and a little flexible." - Ivan Kahn

“We always look at the margin of safety in the balance sheet and then worry about the business.” - Peter Cundill

“Patience, patience and more patience. Graham said it, but it is true to all investment disciplines, not only value investing, although it is indispensable to that.” -Peter Cundill

Two great articles

http://www.businessinsider.com/warren-buffett-on-high-quality-stocks-2013-3
http://www.businessinsider.com/best-advice-worlds-greatest-investors-2012-7?op=1