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Geoff Gannon March 4, 2007

20 Questions for Robert Freedland of Stock Picks Bob’s Advice

Robert Freedland has been a stock market enthusiast longer than he has been a practicing physician. Starting at the age of 13 with a single investment he has developed his own investing and trading strategy drawing from value and earnings momentum writers. Sharing both his passion for investing as well as politics, he started writing online in 1998 on the Delphi Boards. His current blog, Stock Picks Bob’s Advice, has been active since 2003.

Visit Stock Picks Bob’s Advice

1. Are you a value investor?

Quite frankly, value is an important part of my evaluation of stocks, but not the entire driving force behind deciding on a stock pick. I view myself as an eclectic investor, who is part momentum, part value, and part technician. If I can find a stock that fits my other criteria, I am reassured if I can find everything that I am seeking at a reasonable valuation. Even though I look at price/earnings, price/sales, return on equity, balance sheets, and free cash flow, probably I would be best described as a GARP investor, Growth at a Reasonable Price.

2. What is value investing?

In general, I would suggest that a value investor is someone who is interested in the intrinsic value of assets, minus the liabilities, and what a ‘break-up’ valuation might be for a company. They might be interested in buying stock in companies, as they would say, ‘under book’. I also believe that growth investors need to take into consideration valuation when making purchases which simply suggests that instead of a static, or break-up valuation, they also consider future earnings and cash flow in determining an appropriate valuation of a stock.

3. What is your approach to investing?

There really are three parts to my investment approach. First of all, I have chosen to profile the ‘perfect stock’ that meets my criteria of consistency in financial results. I like to find companies that first of all have good momentum on the day I decide to purchase them; that is, they are on the list of top percentage gainers that particular day. After that, I review the most recent quarter expecting them to have increasing revenue and earnings. If they can exceed expectations that is an added plus. Also, if they raise guidance, I give them extra “points” in my evaluation.

Next, utilizing Morningstar’s “5-Yr Restated” financial page, I check to see that revenue growth is persistent, that is it is more than a one quarter event. I also wish to see persistence in earnings growth, an increasing dividend is a plus, a stable number of shares outstanding, positive and if possible growing free cash flow, and a reasonable balance sheet with a current ratio of 1.25 or greater.

I take a look at valuation, looking for a moderate P/E if possible and a PEG between 1.0 and 1.5 if possible. In addition, I check the price/sales ratio relative to other companies in the same industry. I also review the return on equity. …

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Geoff Gannon March 3, 2007

On High Normalized P/E Years

While reading a post at The Confused Capitalist discussing Ken Fisher’s book, The Only Three Questions That Count, I started thinking about how best to discuss the risks present in high normalized P/E years.

The following quote from The Confused Capitalist lead me to write this post:

Mr. Fisher’s big opening statement in his book challenges a long-held market axiom that high PE’s denote reduced returns for some period of time into the future. He states that the year immediately following a high PE year has virtually no statistical inverse correlation. While this might be true, it ignores the fact that there is heightened risk of a reduced return into the relatively near term future. Whether that lower return is realized in the immediate year following, Mr. Fisher’s data suggests, no.

However, an investor (rather than a “speculator” or “trader”) would be foolish to ignore the reduced odds of outperformance that this period provides.

After reading this, I decided I had to write a post directly discussing the risk present in extraordinarily high normalized P/E years – because such years are riskier than most years.

I don’t mean to say that an intelligent investor (or more likely trader) can never have a good reason for buying during an obviously expensive year. I do, however, mean to say that anyone who blindly assumes the risks present in an expensive year are comparable to the risks that were present during a typical year in the 20th century is operating under a dangerous delusion.

Furthermore, while I prefer to focus on the long-term, I can not allow others to unthinkingly entertain the pleasing notion that the ill effects of high normalized P/E years are only felt in the long-run. The evidence directly contradicts this particular delusion. A one-year bet on the Dow during a high normalized P/E year is a risky bet quite unlike a one-year bet on the Dow in any other year.

For those who haven’t read my series on normalized P/E ratios, let me explain how I worked with the data. I measured compound annual point growth in the Dow based on yearly averages for that index. For the sake of simplicity, dividends were ignored entirely – obviously, this omission benefits high normalized P/E years and serves to downplay the normalized P/E effect, because low normalized P/E years tend to have high dividend yields while high normalized P/E years tend to have low dividend yields. For a description of how I calculated normalized P/E ratios read “On Calculating Normalized P/E Ratios“.

With that explanation out of the way I can turn to the issue raised by The Confused Capitalist. Remember, I’m using 15-year normalized P/E ratios which differ somewhat from the P/E ratios you read about on a daily basis. Occasionally, the difference is quite large.

The poster child for such differences between P/E ratios and normalized P/E ratios is 1982, a year with a fairly ordinary looking P/E ratio of 14.26 but an absurdly …

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Geoff Gannon March 3, 2007

The Normalized P/E Ratio Series

There are more posts forthcoming in my series on normalized P/E ratios, but I thought new readers might want to have a list of all the posts thus far:

On 15-Year Normalized P/E Ratios for the Dow

On Normalized P/E Ratios and the Election Cycle

On Normalized P/E Ratios and the Election Cycle (Again)

On Normalized P/E Effects Over Time

On Calculating Normalized P/E Ratios

On the Difference Between Actual Earnings and Normalized Earnings

On the Dow’s Normalized Earnings Yields for 1935-2006

In Defense of Extraordinary Claims

On Normalized P/E Ratios Over Six Decades

On High Normalized P/E Years

I’ll have many more posts on this project in the days ahead. If you have any questions (or suggestions) about this project, please feel free to comment to this post – or, simply send me an email.

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Geoff Gannon March 3, 2007

On Misreporting Warren Buffett

I’d like to direct you to an excellent Warren Buffett related post written by Jeff Miller of A Dash of Insight. Buffett’s annual letter to shareholders is immediately read, analyzed, and reported on – though not necessarily in that order. Obviously, instant on air reports meant to give you the highlights of the letter within moments of its release should be completely ignored by anyone who has an interest in understanding what Warren wrote.

I excuse such reports, because they don’t even pretend to be serious reporting – they’re instant regurgitation and they look the part. In prior years, Buffett’s annual letter was exempted from such “breaking news” treatment; however, due to SEC regulations this year’s letter was released on Thursday instead of Saturday.

Not surprisingly, coverage of the letter suffered from the early release. But, that’s not what I’m writing about in this post – and that’s not what Jeff Miller wrote about over at A Dash of Insight.

While reading the letter on Thursday, I came across two words I knew would be misinterpreted: “soft landing”. This misinterpretation is somewhat understandable coming from someone with a background in financial reporting and no knowledge of Buffett, since the term “soft landing” is usually used to describe a possible outcome of Federal Reserve tightening.

Unfortunately, if a reporter is somewhat confused about all this, the reader is doubly damned. A quote alone would be confusing enough for someone who doesn’t know Buffett isn’t in the habit of making short-term macro economic calls in his annual letter. When a quote from Buffett’s letter is set within the body of an article authored by someone who isn’t entirely clear on what Buffett meant, the reader has little hope of leaving the article without a misconception.

To be fair, there is nothing factually incorrect about the Reuters story Miller links to.

Unfortunately, readers get more than facts from a news story. The overall impression from this Reuters story doesn’t fit well with the impression created by reading the actual letter. That’s mostly due to the decision to lead with these words:

“Warren Buffett said on Thursday the U.S. economy may not enjoy a ‘soft landing’ because Americans are taking on too much debt as the U.S. trade deficit worsens.”

Although this lead is factually correct, it misinforms the reader. Worse yet, in this electronic era, the Reuters story (rather than a careful reading of Buffett’s actual letter) may serve as the germ for another writer’s story. In this case, the reader who gets his information third hand will be an unwitting participant in a game of telephone – hopefully he has the good sense not to pass the message on.

There is one good thing to come out of such reporting – it may kindle a desire among some investors to consult the primary source. It’s quite a source.

If you haven’t read it yet, now’s your chance.

Visit A Dash of Insight

Read Warren Buffett’s Annual Letter to Berkshire Shareholders

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Geoff Gannon March 3, 2007

alue Investing News: Top Stories – Week of Monday, March 26th

1. On Buffett, Berkshire, and You
2. History of Value Investing
3. Long Term Stock Market Returns Survey: Results
4. Altria Spin: Q & A
5. Eveillard Re-Enters
6. The Complete User’s Guide to Warren Buffett’s Portfolio
7. On Billionaires, Their Buys, and Buffett
8. Sherwin-Williams Shareholders: Time To Go On Offense
9. CEO Profile: Wells Fargo’s Kovacevich
10. Highlights from Distressed Debt Analysis

Visit Value Investing News

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Geoff Gannon March 2, 2007

On Posco, Berkshire, and Buffett

Berkshire Hathaway (BRK.B) released its annual report today – by now I expect most of you have read Warren Buffett’s annual letter to shareholders. I’ll discuss the letter as a whole in another post. For now, I’d like to focus on just one line.

First, I’ll need to include the paragraph that precedes that line. Here’s what Buffett wrote before presenting his familiar table of Berkshire’s top common stock holdings:

“We show below our common stock investments. With two exceptions, those that had a market value of more than $700 million at the end of 2006 are itemized. We don’t itemize the two securities referred to, which had a market value of $1.9 billion, because we continue to buy them. I could, of course, tell you their names. But then I would have to kill you.”

I direct your attention to line nine of the table (listed alphabetically) which reads:

3,486,006 POSCO 4.0 572 1,158

Okay. Now, what does this mean? The best way to follow along with this post is to go to Berkshire’s website and open the letter for yourself. The table appears on page 15 of the letter – which is available only as a PDF.

Obviously, this line means that Berkshire owns stock in the South Korean steelmaker, POSCO (PKX). Using an appositive in the previous sentence may be grammatically incorrect, but it is rhetorically honest as POSCO is the South Korean steelmaker. No one refers to it as “a South Korean steelmaker”.

Anyway, this stake in Posco (I don’t capitalize the name, because English speaker don’t capitalize such mixed acronyms – it would actually be “PoSCo” if you used our usual practice and “PoSCo” just looks too weird to print) isn’t all that surprising. From past statements, we knew that Berkshire (had once) owned some Posco, that Buffett was comfortable enough with the name to cite it specifically when referring to South Korean stocks, and that in such statements he more or less said it wasn’t going to go out of business tomorrow.

We also knew that Posco was dirt cheap. Everyone knew that. Every analysis I read that ended with “don’t buy Posco” didn’t argue it was fairly priced, just that it was Korean, a steel company, etc. The argument most often used was that it wasn’t the right time in the cycle to buy Posco. The one argument I never read was that Posco was fairly priced when the ADRs were trading below $65 a share.

Even now, most articles I read trying to explain the improvement in Posco’s share price don’t make much mention of just how cheap this stock was – and it ain’t exactly expensive today, even after quite a run up.

However, I did read one interesting comment today. Apparently, “an official at Posco” told Reuters that Posco didn’t know when Berkshire bought shares in the company. That remark is interesting solely because it suggests (though obviously does not guarantee) that Posco’s management did not approach …

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