Be greedy when other are fearful and be fearful when others are greedy

This has been a tough peice of advice to follow due to everyone running for the same exit and the mass media covering the markets around the clock. When I asked my brother if he is willing to put some money to work he respectfully declined due to all the “bad” news he has been hearing. Warren Buffett seems to have the same belief as me ( or is it vice versa?) as companies will experience a slowdown in earnings but will be fine years from now.

These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.

Link: http://www.charlierose.com/shows/2008/10/01/1/an-exclusive-conversation-with-warren-buffett

Seth Klarman is known as an investor who keeps a low profile while heading the Boston based  Baupost Group. When the Baupost Group establishes a sizeable position, one has to take notice. It is no coincidence the firm has averaged 20% annual returns since 1983. According to this 13G filing, Baupost Group bought 2,255,318 shares of Centerplate (CVP). I haven’t looked at Centerplate’s latest SEC Filings but I am assuming the position has to do with Centerplate looking for a buyer. I wouldn’t bet on Centerplate (CVP) without further due dilligence as Seth Klarman’s picks are tough to figure out without spending significant time on them, then again that’s why they have impressive returns.

Without a doubt Warren Buffett and Charlie Munger have provided some of the most memorable quotes in the investing arena. Not too far behind the dynamic duo are the late John Templeton and the contrarian maestro himself David Dreman. Below are four memorable quotes David Dreman has enlightened the world with.

1. “Psychology is probably the most important factor in the market – and one that is least understood.”
2. “I paraphrase Lord Rothschild: ‘The time to buy is when there’s blood on the streets.’”
3. “One of the big problems with growth investing is that we can’t estimate earnings very well. I really want to buy growth at value prices. I always look at trailing earnings when I judge stocks.”
4. “If you have good stocks and you really know them, you’ll make money if you’re patient over three years or more.”

It’s pretty hard to argue with any of the above quotes. All four quotes are only part of the solution in outperforming the market. Number four in particular is something most investors (including myself) lack, patience.  In a world where everything moves at a fast pace, its tough waiting for value stocks to rebound. Ultimately, its the patient investor who is able to wait out the storm who benefits the most when contrarian stocks rebound.

A particular Warren Buffett quote reminds me that doing nothing is good:

“”I call investing the greatest business in the world because you never have to swing. You stand at the plate, the pitcher throws you General Motors at 47! U.S. Steel at 39! and nobody calls a strike on you. There’s no penalty except opportunity lost. All day you wait for the pitch you like; then when the fielders are asleep, you step up and hit it.”-Warren Buffett

With 14% cash on hand, its tempting to get into some positions. Especially Microsoft which has been climbing the magic formula list this past week as it hits new lows. I continue to tell everyone I know that the magic formula has to be among the most undervalued books/sites/investing system around. Where else can I find a screen that looks for great businesses at a discount. Its only a matter of being patient and sticking with the system. For many years studies have proven that low P/E’s outperform the market, but investors/speculators continue to invest in companies that are trading at sometimes catastrophic P/E’s. Companies with high P/E’s are usually dangerous in this type of market as analysts expect companies to deliver outstanding numbers. What happens next? The company delivers great numbers (usually double digit growth ) but the stock gets pummeled (i.e. AAPL, GOOG,MSFT). How do low P/E’s fare during earnings season? Good. David Dreman highlights this in the book. Expectations for these companies are so low, no matter what kind of numbers the company reports, chances are a) a positive earnings surprise will make the stock soar (WFC)  or b) the news has been priced in already.

To keep from falling under the same frame of mind, I have decided to reinforce the idea that right now is the time to be patient, look for opportunities and not panic. To keep busy, I am re-reading the contrarian investing bible. The book might have collected a little dust, but the information is in a league of its own.

A common question among value investors is whether The Intelligent Investor and Security Analysis are worth reading? This question stems from the idea that both books have the perception of being “dated” and thus the information is irrelevant. Many of the companies mentioned in both books might not exist today, but the content on investments and investor behavior are relevant today as when they were first written. In fact, its scary to see how not much has changed in terms of Mr.Market and his wild mood swings. Since I do not have time to re-read The Intelligent Investor, I have spent my time reading  the two most important chapters in value investing, Chapters 8 and 20 of The Intelligent Investor.

What Warren Buffett has to say about the two chapters:

“If you follow the behavioral and business principles that Graham advocates- and if you pay special attention to the invaluable advice in Chapters 8 and 20- you will not get a poor result from your investments.” -Warren Buffett

Chapter 8 - The Investor and Market Fluctuations

“Every investor who owns common stocks must expect to see them fluctuate in value over the years”- p.195

“If he is the right kind of investor he will take added satisfaction from the thought that his operations are exactly opposite from those of the crowd” p.197 (early signs of contrarian investing)

“The investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage.That man, would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other person’s mistakes of judgment.”- p. 203

“Let us close this section with something in the nature of parable. Imagine that in some private business you own a small shares that cost you $1,00. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly.” -p 205

Chapter 20- “Margin of Safety” as the Central Concept of Investment

” We say that to have a true investment there must be present a true margin of safety. And a true margin of safety is one that can be demonstrated by figures, by persuasive reasoning, and by reference to a body of actual experience”  p.520

“Investment is most intelligent when it is most businesslike“- p.523

“To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks.”- p.524

Obviously, the quotes above are only a small sample of the brilliance of Graham’s writings. I could easily pull 20 quotes from each chapter. I highly suggest re-reading the two chapters to see how relevant the information is today as they were back when Benjamin Graham wrote them.Finally, the above  page numbers are from Jason Zweig’s edition of The Intelligent Investor.

In a recent interview on the Fox Business Channel, Warren Buffett talked a bit about those fat pitches that he did not swing at (Starbucks, Fannie-Mae, Wal-Mart, Costco). Unfortunately for investors, this will occur more than once and one has to not those fat pitches get away too often.

From personal experience, those missed pitches hurt the most when one’s portfolio is lagging the benchmarks. Around September of last year, analysts were expecting steel prices to fall and many steel companies were trading at or near 52 week lows. This caught me by surprise as I knew steel prices were on the rise and not on the decline. I knew this from our steel suppliers who warned me about great demand from overseas. The same supplier also told me about consolidation in the industry (his firm was bought out by Ryerson (RYI)). So there I was with what Peter Lynch called the “amateur edge”. Nuecor (NUE) in particular caught my attention as it appeared in the magic formula screen for the top 25 ranked companies with a minimum market cap of 2000 million. I did my usual homework of reading several 10-K’s and 10-Q’s and thought the company would be a great buy, it was only a matter of swinging and waiting for the street to catch up to me. The street eventually did catch up, only problem is I never swung at that fat pitch. Nuecor recently traded as $83.

Although studies have shown that following Buffett into stocks has been a good idea, I highly do not recommend following ANY guru into a stock. For example, think about the number of people who blindly followed Mohnish Pabrai or Martin Whitman in the last year. Plus, digging into a company’s 10-K will help anyone looking into a company get a better picture about the company and where its heading. Personally, I have followed the Oracle into a couple of holdings only after checking out the companies story. Finally, when it comes to pharma’s, Warren Buffett has stated he recommends buying a basket of them.

Kraft (KFT)- This one seems to be the one he is buying the most

Wells Fargo (WFC) - High Quality Bank

US Bank (USB) - Another high quality bank with great management

WellPoint (WLP)-  Along with UNH , huge cash flow producers

UnitedHealth Group (UNH) - ^

Ingersoll-Rand (IR)- Also appears on Magic Formula screen

CarMax (KMX)- Haven’t looked into story

Glaxosmithkline (GSK)- Buy as basket

WABCO Holdings (WBC)- Have no idea

Bank of America (BAC)-

Sanofi-Aventis (SNY)- basket

US Gypsum (USG)- Moat will expand as competetors struggle with downturn

Lowes (LOW)- Will recover with economy

Also, there are several companies that Gurufocus does not list. I am guessing this is due to Warren Buffett purchasing the securities before GF was established. From the top of my head….

Moody’s (MCO)

American Express (AXP)

Coca-Cola (KO)

Proctor and Gamble (PG)

Disclaimer: I own PG and USB, I sold out of my holding in UNH a week ago.