Seven Follow-Up Questions for Clyde Milton of Cheap Stocks

On April 1st, 2007 Clyde Milton of Cheap Stocks answered 20 questions. Today, he answers seven more.

Read 20 Questions for Clyde Milton of Cheap Stocks

Clyde Milton became enamored with deep value, off the beaten path investment ideas through years of fundamental research, and ultimately, as a writer/editor for a now defunct personal finance magazine.

He strives to research stocks that few others will, using valuation techniques based on Ben Graham’s ideas (such as stocks trading below their net current asset value) as well as some ideas he has developed himself.

Milton freely admits that his site is written under a pseudonym; Clyde and Milton being the first names of his beloved grandfathers, to whom the site is dedicated. While Cheap Stocks was originally launched primarily to keep Milton’s research and writing skills sharp (and not as a public site) it has developed a following.

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Which do you tend to invest in – high quality businesses or cheap stocks? Why?

Well, in a perfect world you’d want a hybrid: high quality businesses at cheap prices. In practice though, I tend to invest in stocks that are cheap, and honestly, they are not always high quality businesses. There is huge risk, however, if you don’t do your homework. You’ve heard it before: Stocks are often cheap for good reasons, and the art is to not fall into the value trap that you can easily become prone to.

What have your experiences with each been? What have you learned?

I’ve learned not to jump in too quickly, not to fall in love with an idea, to limit initial position sizes, to stagger purchases, and that it’s prudent to throw in the towel on a bad idea before it fails. As investors, we are all prone to behavioral biases. Some are hard to shake, others you can learn to deal with through experience…usually a bad experience.

How focused a portfolio do you tend to keep?

My current portfolio is about 20 names, and there’s definitely an asset focus toward water, land or other assets that I believe are not properly valued.

What are your views on diversification and concentration?

Diversification is a great word: it tends to disappear from investor’s vocabularies during a great bull run, then re-appears when the market tanks. But the truth is, it is imperative to be well diversified. While my stock portfolio is somewhat concentrated, and not well diversified, it is just one piece of the puzzle: My portfolio’s beta exposure comes from other sources.

Diversification is the word you did not hear in the late 90’s, and it’s made a huge comeback! I say that in jest, but it’s amazing what a bear market will do to investors. I am a huge believer in diversification, especially in the context of building a portfolio designed to meet an investor’s goals. It’s not a one size fits all proposition.

How do you deal with general market risk and specific business risks?

I’m not all that …

And the Winner is…Me!

Value Investing News completed its first full calendar year in 2007 – and my post entitled “Gannon to Barron’s: Berkshire Fairly Valued…As a Buffettless Empire!” won the title of best value investing article and link submission for 2007.

It’s no surprise that a Berkshire (BRK.B) article received the most votes (the folks over at Value Investing News aren’t exactly Buffett haters).

However, it is surprising that the article managed to rise to the top of the 2007 heap in just two weeks of voting (it was submitted on December 16th). As George points out, this was made possible by the tremendous growth over at Value Investing News. The number of users skyrocketed over the past year.

Also, as articles were submitted at a more feverish pace, they were either voted up or lost in the shuffle a lot quicker. So, the difference between a top story and a neglected story is now determined pretty fast on Value Investing News, because the community there is so much larger and more vibrant than ever.

Apparently, I’ll be getting a trophy badge to display on my site – once George designs it. I’ll also be getting a copy of Vitaliy Katsenelson’s Active Value Investing – a book I reviewed favorably back in October.

This contest reminds me that I still have duplicate copies of some excellent value investing books and I ought to be holding some contests of my own to share the wealth. Expect them some time in early 2008.

I’d like to say the obligatory “I never expected this”, etc., etc. – but, really I can’t. I didn’t expect a free book. But, as I was writing the post, I knew it was perfect for Value Investing News. My post got circulated much more widely as a result of its exposure at Value Investing News; evidence of this fact can be seen by entering the title of the post into Google. The actual blog post on my site is far from the top result. Normally, my posts don’t get much mention in sites with higher page ranks.

So, thanks to Value Investing News for the award – and more importantly, for spreading the word. For those who frequent either Value Investing News or my blog, this post was definitely one of the highlights of 2007.

By the way, I actually enjoyed the Barron’s article – I’m glad they ran it. Barron’s is an excellent publication and my favorite weekly by far. They haven’t always been bearish on Berkshire. However, their valuation process in the article was fundamentally flawed as Berkshire has partially transformed itself from an asset based entity to an earnings based entity.

Berkshire still holds a lot of marketable securities; but, it’s as much a conglomerate as a closed-end fund these days. If you apply either a price-to-book ratio to the whole company or a price-to-earnings ratio to the whole company you’re going to end up with a very whacky intrinsic value estimate.

You have to …

Nautilus Concedes Defeat; Sherborne Controls Board

Nautilus (NLS) issued the following press release yesterday:

Nautilus…and Sherborne Investors LP said today that the voting results from the December 18, 2007 special meeting of shareholders confirmed that all four Sherborne Investors nominees have been elected to the Company’s Board of Directors. The final voting results, which were certified by IVS Associates, also showed that all of Sherborne Investors’ other proposals were passed.

Effective immediately, Edward Bramson, Gerard Eastman, Michael Stein and Richard Horn will join incumbent directors Robert Falcone, Ronald Badie and Marvin Siegert on the Company’s Board. Mr. Bramson was elected as Chairman at a meeting of the Board today and Mr. Falcone will remain as President and Chief Executive Officer. Mr. Siegert will remain as Audit Committee Chairman, Mr. Stein will be Chairman of the Compensation Committee and Mr. Horn will be Chairman of the Nominating and Governance Committee. Mr. Badie will remain as Lead Independent Director.

Edward Bramson said, “We appreciate the support of our fellow shareholders and look forward to working with the new Board and management to implement an effective strategy at Nautilus to return it to profitability and establish a platform for future growth.”

“I look forward to working with our newly reconstituted Board of Directors,” said Bob Falcone. “I believe very strongly in the future of this Company and am committed to implementing the necessary actions to restore it to sustainable growth.”

Shares of Nautilus closed up $0.07 (1.44%) at $4.92. At their highest point today, shares reached $5.50.…

Letter of Resignation from Heelys Board Member

Heeelys (HLYS), which was included in Cheap Stocks list of Potential Bargains in Profitable, Cash-Rich Double Net/Nets Part II on December 8th, 2007 (last trade: $6.82/share; NCAV: $4.48/share), filed this resignation letter written by a member of the board and addressed to the company’s CEO (emphasis added):

December 17, 2007

Mike Staffaroni, President and CEO
Heelys, Inc.
3200 Belmeade Drive
Suite 100
Carrollton, TX 75006

Dear Mike:

Effective immediately, I am resigning from the board of directors of Heelys, Inc.

As you know, I strongly support your vision for the company and your strategy for realizing it. Regrettably, a majority of the directors voted at the November meeting for an ultimatum expressing dissatisfaction with your performance, an action I openly opposed (that is not reflected in the minutes) and one that I feel signals an unjustified lack of confidence in you and your strategy. I am unable and unwilling to support the majority’s alternatives and directives.

You have put together a first rate management team and led Heelys to extraordinary success. I have greatly enjoyed my association with you and wish you well.

Sincerely,

Jim Kindley…

Value Blog Review Posts Stellar Year-End Results

Steven Rosales of Value Blog Review writes most of the book reviews that appear on this site. Steven is relatively new to investing. He posted his year-end results for 2007.

Envious bloggers are hoping it’s a simple case of beginner’s luck.

See Value Blog Review Year End Results

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Election Night at Nautilus

Forget about the upcoming presidential primaries; it’s already election night at Nautilus (NLS) – and the early exit polls favor the challenger.

Shareholders met Tuesday to settle a proxy fight between an activist hedge fund and the fitness equipment company’s incumbent board.

Late Tuesday, Sherborne Investors, LP (which owns 25% of the shares outstanding) declared victory in its proxy fight at Nautilus. The hedge fund claims it won four of seven board seats (which will effectively grant control of the company).

Nautilus Chairman & CEO Robert Falcone has yet to concede defeat.

Early reports provided subtle hints of a Sherborne victory with Falcone being quoted as saying, “Our proxy service says it’s close, but we just don’t know at this time” – and even more ominously, “It’s a dead heat.” Meanwhile, Sherborne’s representative was “optimistic” and claimed shareholders were “fairly supportive”.

News reports indicated the shareholders in attendance were dissatisfied with both parties’ presentations, with one shareholder saying, “Nothing was said here that hasn’t been said before.” In a series of press releases leading up to the meeting, Nautilus had been particularly expansive in its criticism of Sherborne which has been successful in several proxy fights, but hasn’t always had success in creating long-term shareholder value (in one case, that’s putting it very mildly).

Most shareholders I talked with in the lead up to the election had a low opinion of Sherborne and an even lower opinion of the board.

If the preliminary results hold, the greatest casualty of the fight will be Robert Falcone who was made interim CEO in August and (non-interim) CEO in October. His predecessor Greg Hammann stepped down in August. Falcone was then the company’s lead independent director.

Sherborne has already stated that Falcone will be removed as CEO. Technically, Falcone will retain his board seat. However, everyone’s expectation is for a quick and unceremonious resignation if the early results hold.

Falcone can’t be accused of inaction during his four month tenure, as this article makes clear:

Falcone has made several significant moves in his short tenure, including laying off 9 percent of the company’s work force and cutting expenses by more than $10 million annually. He’s also implemented an inventory reduction plan that should pump $20 million into the company’s coffers. Falcone also continues to look for a buyer for the company’s Pearl Izumi fitness apparel business.

Shares of Nautilus have traded between $18.63 and $4.31 this year. During today’s trading session (before Sherborne claimed victory), shares of NLS were up $0.97 or 17.32% to close at $6.57.

It will be interesting to see how the votes were distributed, as a couple shareholder advisory services had recommended electing some (but not all) of Sherborne’s nominees.

Note: No one at Nautilus has conceded defeat and it will be a couple weeks before any actual votes have been counted and verified. However, because most shareholders vote their proxies in advance, Sherborne’s proxy solicitation firm should …

Read Barron’s Cover Story on Berkshire Hathaway

Barron’s “Sell Warren” cover story is now available to non-subscribers. Read it here.

A few other blogs have commented on the story, some recent examples include a post from the Peridot Capitalist and a post from 24/7 Wall St.

If you haven’t already, you can read my response to Barron’s cover story.

Finally, visit Value Investing News for all the latest posts on this and other Warren Buffett / Berkshire Hathaway stories.

Right now, the Barron’s article and the responses to it are among the top stories at Value Investing News.

Read Barron’s: “Sorry, Warren, Your Stock’s Too Pricey”

Visit Value Investing News…

Gannon to Barron’s: Berkshire Fairly Valued…As a Buffettless Empire!

Warren Buffett’s face graces (or disgraces) the cover of this week’s Barron’s. In big, bold print the weekly stock market mag says “Sell Buffett”. Inside, the message is equally gloomy: “Sorry, Warren, Your Stock’s Too Pricey”.

Is it?

Barron’s says:

The Street’s enthusiasm for Omaha-based Berkshire…might be excessive. Its stock now appears overpriced, reflecting a sizeable premium for the skills of the 77-year-old Buffett. What’s Berkshire worth? Our estimate, based on several valuation measures, is around $130,000 a share – about 10% below the current quote.

Valuation – In Five Minutes or Less

My estimate – admittedly based on only a single valuation measure (the one I would use to value any holding company / conglomerate / corporate hodgepodge) is around $141,000 a share. By the way, that’s an “ex-Buffett” measure – in other words, that number is my first stab at the value of any corporate hodgepodge – not a corporate hodgepodge with an investment legend at the helm.

I didn’t come up with a specialized measure just for Berkshire (BRK.B) – all I really did was “privatize” Berkshire at $141,000 a share. Of course, Berkshire’s too big to go private; Buffett’s continued leadership adds value; and Berkshire’s collection of businesses (both majority and minority owned) is far from average.

All those factors deserve special consideration.

But, before we consider those factors, it’s worth noting Barron’s is being a bit too cautious in valuing Berkshire. Even if Berkshire had a miserable 2007, the sum of the parts would still be greater than $125,000 a share which Barron’s sets as the low-end of the range ($130,000 a share is the high-end).

What’s Berkshire really worth? That’s hard to say. If you gave me five minutes, a pen, paper, and the 2006 annual report, I’d say $141,000 a share.

That figure is the result of taking Berkshire’s year-end 2006 businesses and securities, valuing Berkshire’s pre-tax earnings to yield 8% (an appropriate rate for excellent, but not necessarily fast growing businesses), valuing Berkshire’s securities at their market prices at the time of the 2006 annual report, and then correcting the combined value for the time elapsed since the 2006 annual report was published.

I did it this way so anyone could follow my logic without needing anything more than the 2006 annual report – you could look at Berkshire’s latest filings for more up to date earnings and portfolio data. But, there’s no real need to add so many complications merely to get an intrinsic value estimate that is nine months more timely.

Golden Years

Not surprisingly, Barron’s mentions Buffett’s age:

Buffett turns 78 next August, and his actuarial life expectancy is nine years. He’s likely to stay on the job for as long as possible, but in reality, few CEOs can handle the demands of the job much past 80. When Buffett departs, the stock is apt to drop as longtime Berkshire holders cash out and the investment community waits to see whether his successors can

Suggested Link: Sell Buffett?

If you enjoyed my response to Barron’s “Sell Buffett” cover story, you’ll also enjoy Jeff Matthews post.

Visit Jeff Matthews is Not Making This Up

Also, note the comment I just added to the post below. I got an email asking how I came up with a $141,000 per share intrinsic value estimate for Berkshire Hathaway (ex-Buffett). I copied the text of my email response into the comments section of my post “Gannon to Barron’s: Berkshire Fairly Valued…As a Buffettless Empire!” so those interested in the (five minute) valuation process could follow the steps themselves.…

Favorite Bloggers Add New Positions

Some of our favorite bloggers have been adding new positions.

On November 13th, Fat Pitch Financials added Western Sizzlin (WSZL) at an average price of $13.12 per share. George subsequently wrote a post valuing Western Sizzlin.

On November 23rd, Cheap Stocks added Avalon Holdings (AWX) then trading around $6.50 per share.

Finally, John Bethel of Controlled Greed just announced:

“I placed an order with my broker to purchase stock in a leading provider of office products and supplies. This will be a new position in the portfolio. Assuming the order gets filled, I’ll post my rationale for buying later today or this evening.”

During the past month some of our favorite bloggers have been finding stocks to buy.

Have you?

Visit Fat Pitch Financials

Visit Cheap Stocks

Visit Controlled Greed…