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Geoff Gannon September 24, 2010

Opportunity Costs: Prices Exist; Interest Rates Don’t – More on Columella

I have a confession to make. I don’t look at bond yields. I invert bond yields to look at bond prices. Always have.

(Price = 1/Yield)

In one article: I multiplied a stock’s free cash flow by the inverse of the 30-year AAA bond yield to get the stock’s intrinsic value. That confused a reader:

“I am still a little confused why the price-to-coupon ratio is used as a multiplier.”

Investors choose between assets like stocks, bonds, and land. If bonds and land are expensive, people buy stocks and vice versa.

Think about Columella and his vineyard. It will cost Columella 32,480 sesterces to plant the vineyard and wait for it to give grapes. In two years: the vineyard will start giving him grapes. Columella will then sell those grapes for at least 2,100 sesterces a year.

His other option is lending the 32,480 sesterces at 6% a year. That would give Columella 1,950 sesterces a year (actually 1,948.8 sesterces; Romans had trouble with fractions).

There are two ways of looking at this choice. You can compare the two options – making a loan and planting a vineyard – in terms of yield: 2,100 sesterces a year is more than 1,950 sesterces.

Or you can compare the two options in terms of value:

2,100 * (1/0.06) = 35,000 > 32,480

I like the value way of looking at things better. It makes more sense to value bonds than discount everything else.

Here is the best thing I’ve read on this topic.


Columella: Ancient Romans Thought About Opportunity Costs – Planting a Vineyard

A Roman named Columella wrote a farming manual 2,000 years ago. In it he mentions opportunity costs.

You need to know 3 things to understand what you’re about to read:

1) Sesterces are Roman money

2) A iugerum is two-thirds of an acre, and

3) Vinedressers are slaves.

I…consider a high-priced vinedresser of first importance. And supposing his purchase price to be 6,000 or, better, 8,000 sesterces, when I estimate the seven iugera of ground as acquired for just as many thousands of sesterces, and that the vineyards…with stakes and withes…set out for 2,000 sesterces per iugerum, still the total cost…amounts to 29,000 sesterces. Added to this is interest at six percent per annum, amounting to 3,480 sesterces for the two-year period when the vineyards, in their infancy…are delayed in bearing. The sum total of principal and interest comes to 32,480 sesterces. And if the (farmer) would enter this amount as a debt against his vineyards just as a moneylender does with a debtor, so that the owner may realize the aforementioned six percent interest on that total as a perpetual annuity, he should take in 1,950 sesterces every year. By this reckoning the return from seven iugera…exceeds the interest on 32,480 sesterces…For, assuming that the vineyards are of the very worst sort, still, if taken care of, they will yield…a total of 2,100 sesterces 

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Geoff Gannon September 23, 2010

Greenbackd: One of My Favorite Blogs – 1 Hour 15 Minute Interview With Toby Carlisle

Toby Carlisle writes about stocks Benjamin Graham would buy. He focuses on catalysts more than Benjamin Graham did. Toby’s approach shares some things with Warren Buffett’s and Michael Burry’s partnership days. One of those things is an appetite for illiquid stocks.

Another thing Toby shares with Warren Buffett is an interest in activism. Buffett’s partnership did a lot of coat tail riding. Warren Buffett didn’t just stick to buying a huge basket of Benjamin Graham bargains. Instead Buffett sometimes followed activists into Benjamin Graham bargains. Other times: Buffett went activist himself.

You’ll read a lot of that early Buffett thinking at Greenbackd. One thing you won’t read about is focus. Benjamin Graham spread his bets around. Warren Buffett didn’t. Toby definitely prefers the Benjamin Graham approach. Toby doesn’t just minimize risk when he picks each stock. He also minimizes risk by picking lots of stocks. Every stock Toby buys is super cheap.

A good recent example – one I don’t own but am terribly interested in – is Seahawk Drilling (HAWK). Seahawk owns rigs worth more than its market cap. The company did a presentation where they said an outside appraisal valued the fleet at 75% of book. The stock trades for less than 25% of book. Seahawk first appeared on Greenbackd as a guest post. Toby gets phenomenal guest posts. Since then Toby’s been writing about the stock himself.

HAWK is just one example of the great Benjamin Graham bargains you’ll find at Greenbackd.

Listen to the Interview

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Geoff Gannon September 22, 2010

E-Readers: 19 Million Americans Read E-Books on Devices Like Kindle, Nook, and iPad

How many Americans read e-books?

19.6 million.

Here’s the math:

Americans 15 and Older * Percent of Americans Who Use E-Readers = U.S. E-Book Market

Harris found 8% of Americans use e-readers. There are 307 million Americans. Only 245 million Americans are 15 or older. The Harris poll surveyed people 18 and older. But using 15 and older better measures market size.

245,267,292 * 0.08 = 19,621,383

The U.S. e-book market is 19.6 million people. What is the market in dollars?

U.S. book spending is $77.80 per capita. People who use e-readers spend more. So we’re talking about an installed base that buys more than $1.5 billion in books each year.  That’s today’s addressable market for content. A lot of that is still print. It doesn’t have to be. The most profitable e-book growth will come from selling more e-books to people who already have devices.

People born between 1946 and 1976 read less than everybody else. They are income rich and time poor. There’s a danger they will buy devices without buying enough e-books. I’d ignore them.

Amazon (AMZN) and Barnes & Noble (BKS) should focus on selling e-books to readers who grew up in the ‘80s and ‘90s. They need to maximize the number of e-books sold per device. Whoever sells the most e-books per device will eventually turn cash profits at gross margins that will bankrupt competitors.

The way to sell more e-books per device is to sell devices by subscription.

Think Xbox Live and Costco (COST).

Benjamin Graham: The Memoirs of the Dean of Wall Street – Investment Revolutions

Benjamin Graham died in 1976. In 1996: His memoirs were published. They sold for $28. Today, they’re out of print. Used copies sell for $75. They’re worth every penny.

…intrinsic value and investment merit were destined to assume increasing importance in common-stock analysis after 1914. As a newcomer uninfluenced by the distorting traditions of the old regime – I could respond readily to the new forces that were beginning to enter the financial scene. I learned to distinguish between what was important and unimportant, dependable and undependable, even what was honest and dishonest, with a clearer eye and better judgment than many of my seniors, whose intelligence had been corrupted by their experience. To a large degree, therefore, I found Wall Street virgin territory for examination by a genuine, penetrating analysis of security values.

(Benjamin Graham: The Memoirs of the Dean of Wall Street)

When I read Graham I think of Kuhn. Graham was a revolutionary. When he wrote Security Analysis in 1934, Graham redefined words like “intrinsic value”, “margin of safety”, and “investment” to fit his value paradigm. He tore down the pre-1914 system. Graham could say a cheap stock was a sound investment. That was gibberish to the generation before him. Their definition of investment was: “not a stock”. Graham flipped the investment universe so it spun round the analyst instead of the market.

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Geoff Gannon September 21, 2010

Barnes & Noble: Riggio Writes Letter to Shareholders – Transformation

Len Riggio, Chairman of Barnes & Noble (BKS), sent a letter to shareholders as part of his campaign for the September 28th board election against Ron Burkle.

Riggio starts personally:”For myself and the good people of Barnes & Noble it is a fight we did not ask for, and do not deserve. Self-pity is a bad message. Maybe Riggio wrote that line for employees. They feel it. And they can vote. More likely, he wrote it for himself.  It’s an honest emotion. But it doesn’t belong in the letter.

Most of Riggio’s letter slings stale mud. The only paragraph shareholders care about is this 138 word pitch:

As you well know, the book industry – as well as all industries that deal with printed matter – is undergoing a rapid transformation. Rather than trying to stem the inevitable march of technology, we view this development as an enormous opportunity for Barnes & Noble; first to continue to gain our share as the world’s largest retail booksellers, second to use our storefronts to sell digital devices, and finally to profit greatly from our growing digital business. In fact, in the eleven months since we launched our e-Reading platform, we have already attained a 20% share of the digital marketplace for books. This compared to our 18% share of the physical book space. And we’re just getting started. Speaking for myself, I’ve never been more excited about our prospects since the first day we opened our doors in 1965.

Read Riggio’s Letter

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Geoff Gannon September 21, 2010

Plain English: How to Rewrite an SEC Disclosure – Geoff Translates

SEC reports are wordy. Here’s an example. The before paragraph is part of Birner’s 10-K. The after paragraph is my translation.


The Company may see increased costs or lower revenue arising from health care reform. 

In March 2010, Congress passed, and the President signed, the Patient Protection and Affordable Care Act. This act may have a significant impact on health care providers, insurers and others associated with the health care industry, including the Company. The Company is currently evaluating the impact of this comprehensive act on its business. Federal and state governments may propose other health care initiatives and revisions to the health care and health insurance systems. It is uncertain what legislative programs, if any will be adopted in the future, or what action Congress or state legislatures may take regarding other health care reform proposals or legislation. In addition, changes in the health care industry, such as the growth of managed care organizations and provider networks, may result in lower payments for the services of the Company’s managed practices.


New Health Care Laws Can Hurt Us

In March 2010: the United States passed the Patient Protection and Affordable Care Act. This big, new law affects health care companies like Birner. We are evaluating its impact. We do not know what new health care laws governments will write. And we do not know how our industry will react. When we know, we will tell the SEC. Read our SEC reports to stay up to date.

Barnes & Noble: Aletheia Sells Some Stock – Insiders vs. Outsiders

Aletheia, a big stock fund allied with Ron Burkle, sold 71,610 shares of Barnes & Noble (BKS) after August 16th. 71,610 shares is 0.12% of the company. Aletheia can still vote these shares at the September 28th board election between Len Riggio and Ron Burkle. Shares are voted by whoever owned them August 16th.

In the last 2 months, Aletheia bought and sold stock on the same day 21 times. 15 of those days (71% of the time) Aletheia bought high and sold low. 6 of those days (29% of the time) Aletheia bought low and sold high.  Is Aletheia that bad at trading?

Aletheia owns 15% of Barnes & Noble. The public owns 26%.

Outsiders want to sell Barnes & Noble. Nothing is stopping them. Insiders want to buy Barnes & Noble. The poison pill is stopping them. If Aletheia wanted to sell, who would they sell to? Burkle? Riggio?

No. The public has to want to buy Barnes & Noble. It doesn’t. It’s the insiders versus the outsiders. The insiders are bullish. The outsiders are bearish. For Aletheia, Burkle, and Riggio, selling out would be a lot like taking Barnes & Noble public. The public has almost no net long ownership of BKS. The big guys are long BKS. The little guys are short BKS.

Buying and selling on the same day is normal for big fish in small ponds.

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Geoff Gannon September 20, 2010

Michael Burry: Letters to Investors – Asperger’s

Michael Burry is the guy with Asperger’s and a glass eye in Michael Lewis’s The Big Short. In 2005: Burry got Goldman Sachs and Deutsche Bank to build credit default swaps so he could short subprime housing. He made a ton of money for his investors. Joel Greenblatt was one of them. Burry read You Can Be a Stock Market Genius. He “hated the title but liked the book.” Burry didn’t know Greenblatt. And Greenblatt only knew Burry from his posts on a stock message board. Burry’s writing made a better impression than Burry ever could. When Greenblatt met Burry he gave him $1 million to invest.

Blogs like Greenbackd and Street Capitalist dug up Burry’s past. Now you can read Burry’s message board posts and letters to investors.

I read Burry’s letters to investors. He’s a lot like early Warren Buffett. The difference is Burry had 40% cash in Q4 2001. Early Buffett never had that much. But early Buffett never saw those P/E ratios.

What’s the similarity?

Illiquidity. Benjamin Graham, Warren Buffett, and Michael Burry love illiquid stocks. In Q3 2001 Burry said he owned stocks where a 2,500 share sale could “torpedo” that stock’s market value. He also mentions a stock that “rarely trades”. Buffett says the same thing in his partnership letters.

During the subprime short: Burry took his 4-year old son to a psychologist. She diagnosed the son and his father with Asperger’s. Burry was in his 30s when he was diagnosed. I was 17.…

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Geoff Gannon September 20, 2010

Barnes & Noble: ISS Endorses Burkle – Opposes Poison Pill

Proxy advisor ISS endorsed the Burkle party and its proposal to amend the poison pill in the Barnes & Noble (BKS) board election:

 …based on BKS’ deteriorating operating performance, poor shareholder return, less-than-enthusiastic analyst recommendations, inadequate…disclosure on a very large related-party transaction…and significant concerns about unusual pay practices, we believe the dissidents have demonstrated a compelling case that change in the BKS board is warranted.

Of modern Wall Street’s sins, the one Benjamin Graham would never forgive is listening to a proxy advisor.

The institutions that are listening are hearing static. Glass Lewis endorsed Riggio. ISS endorsed Burkle. Here’s what Barnes & Noble said: “While ISS has a track record of supporting dissidents, we believe its analysis is flawed and not in the best interest of our shareholders.”

While that sentence is flawed – what’s the word “while” doing in there – we get their point. Is it true? Does ISS have a track record of supporting dissidents? No. ISS has a track record of supporting dissidents more than Glass Lewis. But both advisors usually support management. Glass Lewis supports dissidents 20% of the time. ISS supports dissidents 40% of the time.

When ISS and Glass Lewis recommend voting for the same party, that party usually wins. What about a split decision? ISS and Glass Lewis have disagreed 21 times since 2006. Management won 33%. Dissidents won 43% outright and 14% in part. 10% were settled before the vote.

All splits were: Glass Lewis for management; ISS for dissident.…

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Geoff Gannon September 20, 2010

Birner Dental Management Services: One of my Favorite Stocks

Would Benjamin Graham buy Birner Dental Management Services (BDMS)? No. But I would.

Birner’s tangible book value is negative. Not a problem for Warren Buffett. But a huge problem for Benjamin Graham.

I like tangible assets. But I like cash earnings more. Birner’s 10-year average real free cash flow per share (adjusted for the current share count) is $1.95. Slap a Shiller P/E of 15 on $1.95 and you get an intrinsic value of $29.25.

The stock trades at $16.75. Why?

The market is pricing the wrong earnings. Over the last 3 years, Birner averaged $1.11 per share in reported earnings. Free cash flow averaged $2.25 a share.

Birner is trading at a P/E of 8. Not 15. Why?

Some states ban corporations from buying dentist offices. So instead of buying dentist offices, Birner signs 40-year management contracts. The company amortizes the contracts over 25 years. This accounting fiction subtracts $1.33 a share in earnings from Birner’s income statement. It does nothing to free cash flow.

Buying dentist offices for 8 times cash earnings is a good deal. What makes buying Birner a great deal is what Birner does with the cash. It pays dividends and buys back stock. The dividend yield is 4.78%. Birner bought back stock in each of the last 10 years.

If you buy Birner at $16.75 a share, you could get 50% of your purchase price returned in dividends and buybacks in 5 years.

That’s not a promise. It’s a guess. Just like accrual earnings.…

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Geoff Gannon September 19, 2010

Ark Restaurants: One of my Favorite Shareholder Letters

Benjamin Graham wasn’t known for his shareholder letters. Warren Buffett is. Some great CEOs don’t write great letters. And a great shareholder letter doesn’t guarantee great results. All a shareholder letter does is tell investors what the CEO is thinking, not just quarter to quarter, but year to year. Maybe it attracts investors who think in years instead of quarters. I don’t know.

I do know most shareholder letters suck. Here’s one that doesn’t.

Dear Shareholders:

This was a difficult year. Our defenses for an uncooperative economy are limited. We can and did lower our payroll expenses taking care not to impair services. We achieved a balance primarily through a reduction in hours worked by hourly employees, salary freezes and the elimination of overtime and bonuses. The dollar reduction was less than hoped for in part due to mandated increases in minimum wage for a substantial number of our employees. Some other costs, such as food, liquor and linen purchases, are variable and reduced in proportion to revenue declines. Percentage rents do reduce with decreased sales but fixed rents are just that, fixed. Other operating expenses did not decline as a category. In fact, this year utilities and insurance premiums remained stubbornly high and legal expenses became significant as we were in litigation on three matters. General and administrative costs decreased marginally.

Most companies use a dozen pages to say in legalese what Michael Weinstein says in one paragraph of plain English.

Read Ark Restaurants (ARKR) Shareholder Letter

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Geoff Gannon September 18, 2010

Amazon Kindle: Anatomy of an E-Reader – What Geoff Spends

Amazon Kindle came out November 2007. I didn’t get mine till January 2008. Since then I’ve spent $1,672.91 on 170 e-books. That means I spend $50.69 a month on e-books. I also spend $49.97 on three newspapers and $16.94 on six short story mags. My total spending on e-reading material is $117.60 a month.

The average price per e-book is $9.84. That’s deceptive. Those 170 books include stuff that has never been printed as a book and could never sell that way. I bought some short stories for $1 and $2 each. You can’t sell them in a bookstore that way. Maybe you can put 10 together and sell them for $20. Maybe. But not to me. I bought short stories by Elmore Leonard and Ross MacDonald. They wrote novels. And those novels sell for $10. I’d rather buy their novels than a short story collection. I’ll pay $3 for a good short story. I’ll never pay $30 for 10 of them.

The lowest price I paid for an e-book was $0. I got a couple that way. All of them were published in the 1800s. Most were fiction. Can you sell them in bookstores? Depends. What’s the market for Disraeli’s fiction?

The most I paid for an e-book was $74.84 for An Analysis and History of Inflation. I bought A History of Interest Rates for $53.55 and Essentials of Neuropsychological Assessment for $25.25.

I pity the Amazon engine that has to make recommendations based on that.

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