Seth Klarman Investment Wisdom

Below are the updated links to Seth Klarman’s investment wisdom. You can find the full archive at the Investment Resources.

You can also buy one of the most famous book ever on investing, Margin of Safety by Seth Klarman, for $7.58 on the Kindle. Hard copies are going for $500 to $1000 each. Of course you don’t get the joy of holding a hard copy of this rare book in your hands, but you get access to its treasured wisdom.

Seth Klarman (Baupost Group)

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A Primer On Brookfield Asset Management

My latest article on Seeking Alpha. This article can be seen as a companion for The Intelligent Podcasting with Eric Schleien. It took a while to get it published and it’s worth the wait. The topic is Brookfield Asset Management. The summary of the article is below. The full version is available here.


A Primer On Brookfield Asset Management

Summary

  • Brookfield (BAM), an under-the-radar company, is one of the largest alternative asset managers in the world.
  • Its CEO, Bruce Flatt, also low profile, is a value investor who has delivered tremendous value to investors over the past 16 years.
  • Brookfield finds opportunities that everyone else deems as uneconomic. If there’s a dearth of capital, expect Brookfield to be sniffing around. A crisis is a good time to find value.
  • Management is a key part in investing in Brookfield. They hold 20% of the company.
  • It is reasonable to assume that BAM will continue to increase the amount of assets with harvestable cash flow. Assets Under Management is also expected to significantly increase.

*Brookfield Asset Management’s Class A Limited Voting Shares are co-listed on the NYSE under the symbol (BAM) the Toronto Stock Exchange under the symbol (BAM.A)and Euronext under the symbol (BAMA.) I will be referring to the American symbol for the article. Dollar amounts are in USD$ unless mentioned otherwise. BAM currently trades for ~$40 with a market cap of $40 billion. It’s currently trading down from its all-time high of ~$44.

I had the privilege to be a guest on The Intelligent Investing Podcast with Eric Schleien. We mainly talked about Brookfield Asset Management but we barely scratched the surface. Since I wanted to elaborate on some points, I wrote this primer on Brookfield as a companion guide to the podcast. I have no affiliation with The Intelligent Investing podcast whatsoever, but I am a fan of his work.

Brookfield Asset Management (BAMBAM.A) is one of the most under-rated, under the radar, low profile company in the world. Brookfield doesn’t make headlines. For those of you that are in the investment business, you are most likely familiar with the global value investor Brookfield, its CEO Bruce Flatt, and the tremendous success the company had under his leadership. For the folks that are not in the investment industry, you wouldn’t know that Brookfield owns a large chunk of the arteries and pipelines essential to how global economy functions. BAM owns some of most prized real estate in the world, such as Manhattan’s prestigious World Financial Center. In Berlin, it owns Potsdamer Platz and, in London, Canary Wharf. And that’s just the real estate. In Ireland it supplies Facebook with electricity. A good part of Chicago is powered by Brookfield. It owns 36 ports in the UK, North America, Australia and Europe, and in India and South America it manages 3,600 kilometres of toll roads.

Brookfield Place “World Financial Center. Source: therealdeal.com

Brookfield is a global alternative asset manager with $285 billion in assets. They employ a value investing style, where they shop around the world for bargains, with a penchant for distressed assets. BAM has the distinction of being an owner-operator of their assets. BAM’s modus operandi is to buy the asset on the cheap, fix it, improve the cash flow and value of the assets, sell it at maturity, and efficiently redeploy capital back into new development opportunities. A quick Google search of Brookfield Asset Management would freak out most investors. Among the results, you will links to Jared Kushner’s infamous 666 Fifth Ave. deal, mall operator General Growth Properties (GGP),Brazil, and Canada’s controversial Trans Mountain pipeline; basically deals that contribute to lack of sleep. But isn’t it odd that Brookfield finds opportunities that everyone else deems as uneconomic? All these moves have an anti-herd contrarian mentality. If there’s a dearth of capital, expect Brookfield to be sniffing around. A crisis is a good time to find value. It seems to have worked out well for the company. Brookfield’s formula for making contrarian investments by going where capital is most needed and in the shortest supply has worked well for Flatt in his 16 years as CEO.

Chart: Yahoo! Finance.

Under Flatt’s leadership, from February 1, 2002, to May 1 2018, BAM returned 1110%, or 11x your money, compared to 1.4x for the S&P 500. This doesn’t include dividends.

BAM, known for its low profile, is not afraid to display their great performance in their latest annual report (pdf). BAM mentions that they target returns of 12% to 15%. These numbers under estimate their real returns. The figures below include dividends:

Source: BAM 2017 Annual Report. Page 8.

BAM is a global alternative asset manager. What are alternatives assets? Well traditional assets are stocks and bonds (equity and debt). Alternative assets can be real estate, infrastructure (ports, pipelines, toll roads etc…), renewable energy and private equity among other things. Alternative assets are a little bit of a misnomer because all assets are composed of equity and debt.

Brookfield loves “real” assets. The emphasis is on “real” because we currently live in a world where investors highly value intangible assets. Some of the top companies by market capitalization barely have any tangible assets. For example, Facebook (FB) and Alphabet (GOOGL) are highly valued for their intangibles/intellectual properties, and sometimes that can be hard to value (e.g. network effects). Brookfield is the exact opposite; they love these tangible hard assets with a nice cash stable cash flow that can grow in value over time.

Brookfield likes to focus on long-life, high quality real assets. “Long-life” because BAM invests in assets like a hydroelectric dam that can last over a hundred years. “High-quality” because these assets are considered critical to the economy, scarce, and have a high barrier to entry. They also come with a 15 to 20 years contract with clauses for yearly price escalation and inflation. For example, one of BAM’s publicly listed partnerships, Brookfield Renewable Partners (BEP), sells the majority of its power under long-term, inflation-linked contracts that allow them to capture increases in power prices over time. This provides stable cash flows for a very long period.

Who also likes the investment profile of “alternative assets”? Pension funds, institutions, insurance companies, university endowment funds, sovereign wealth funds among others. Over the last twenty years, there has been an increase to their portfolio allocation to alternatives, and the shift seems to gather pace. Why is that? Pension funds have long-term obligations and in a world of low interest rates, they seek return outside the stock market with less volatility.

Institutions’ thirst for alternative assets provides Brookfield with the type of capital they need, which is a lot and patient. BAM is typically one of the largest investors in their funds. This provides an alignment of interest with their investors. Below is a list of BAM’s publicly listed partnerships (L.Ps) and their equity ownership interest. BAM also manages over 40 private funds.

Brookfield Property Partners (BPY) – 64% – Operations include the ownership, operation and development of core office, core retail, opportunistic and other properties. BPY consists of 147 properties totaling 100 million square feet of office space. BPY also has a portfolio of regional and urban malls (mostly GGP). Brookfield Renewable Partners (BEP) – 60% (*Wrote about here). – Operations include the ownership, operation and development of hydroelectric, wind, solar, storage and other power generating facilities. BEP consists of 217hydroelectric stations, 76 wind facilities, 537 solar facilities and storage.Brookfield Infrastructure Partners (BIP) – 30% – Operations include the ownership, operation and development of utilities, transport, energy, communications and sustainable resource assets. BIP’s main assets are ~2,000 km of natural gas pipelines, ~12,000 km of transmission lines, and ~3,500 km of greenfield electricity transmission developments, ~10,300 km of railroad tracks, 4,000 km of toll roads, 37 port terminals, and BIP also owns ~15,000 km of natural gas transmission pipelines, primarily in the U.S., and 600 billion cubic feet of natural gas storage in the U.S. and Canada. Brookfield Business Partners (BBU) – 68% – Operations include a broad range of industries, and are mostly focused on construction, other business services, energy, and industrial operations.

Long before Brookfield was an asset manager, BAM invested its own capital to develop, own, and operate assets. It’s in the early 2000s that BAM began other private investors to partner with them. As an owner-operator, BAM works to increase the value of the assets within their operating businesses and the cash flows they produce. They do this through their operating expertise, development capabilities and effective financing. This is significant because if it’s done properly, this is how Brookfield achieves superior returns. BAM has over delivered on their target of 12% to 15%. Once the asset has achieved targeted returns and cash flow has “matured”, BAM sells the asset to a buyer looking to achieve a yield of 5% to 7%. Most institutions are fine with that kind of return since the asset has been “fixed” and “de-risked”. Below in the article I provide a real example on how BAM operates.

 

Full article here.

Conan & Andy’s Stock Market Cliché-Off

If blocked in your country try this link: http://teamcoco.com/node/102675

The Intelligent Investing Podcast – Stocks & Poutine

Print
The Intelligent Investing Podcast – Copyright 2017 Eric Schleien

I had the privilege of being a guest on The Intelligent Investing Podcast with Eric Schleien. Eric is an excellent host and I had a blast doing this. We mainly talked about Brookfield Asset Management (BAM) and we also touched on Shopify (SHOP), investor behavior that led to inferior returns, and poutine. Eric also found some crazy filings on Reddit. What was originally supposed to be a 30 minute podcast turned into over an hour. Time flies when you are having fun. I’ve listened to a few episodes and Eric’s podcast is a great way to learn more about investing and to get exposed to investing ideas.

If you like listening to podcasts like I do, Google has a new podcast app, called Google Podcast.  If you are on Android, I find it better than their default Play Music app which I’m not fond of.  If you are with iOS (iPhone), you can also use Google Podcast. The app has a minimalist design which I like.

You can listen to The Intelligent Investing Podcast by Eric Schleien here:

Even though we talked about Brookfield Asset Management (BAM), we barely scratched the surface. I am currently writing a post on Brookfield Asset Management that I hope to linked to the podcast soon. BAM is a huge organization with a rich history that’s over 100 years old that goes all the way back to Brazil. I wanted to elaborate on some points. Once completed it can be seen as a companion to the podcast.

What Is Bank Capital, Anyway?

Below is a good primer on bank capital from the NYT. The article dates from 2013 but is still relevant. American banks are about to find out if the Feds approve their plan to return capital to shareholders. It’s good to review what is bank capital and why it is important.


What Is Bank Capital, Anyway?
By William Alden

New-York Times

Regulators are butting heads with banks this week over capital, with new rules on the table that could force banks to hold more of it. But what exactly is capital, and why is it so important?

The question gets at the heart of finance today. In the crisis, a lack of capital brought some banks to the brink. Now, by requiring banks to bolster their capital, the government is trying to eliminate the need for taxpayer bailouts in the future.

Though capital is a centerpiece of Wall Street regulation, it resists a simple definition.

Capital is often described as a cushion that banks hold against losses. That’s true, but the implications are not always clear. One unfortunate misconception that can arise is that capital is a “rainy day fund.”

Related Links
Regulators Seek Stiffer Bank Rules on Capital (June 9, 2013)
To understand capital, think about how a financial firm does business. In a typical transaction, a firm pays for an investment with a combination of debt and equity. The more debt, or leverage, that finances the transaction, the more money the firm can make (or lose).

Say a firm pays for its investments with nine parts borrowing and one part equity. By using debt, the firm can magnify the return it makes on its equity. This is a principle banks use when determining how to finance their operations.

A bank’s capital is analogous to equity in the above example. More capital (so, less debt) means banks are more able to withstand losses. But it also means they can’t make as much money. This dynamic – more capital leading to lower returns – helps explain why banks tend to argue that holding more capital is “expensive.”

But even banks won’t deny that capital is essential. Without it, the tiniest loss would put a bank out of business.

Think about capital this way: It designates the percentage of assets that a bank can stand to lose without becoming insolvent.

If a bank’s assets decline in value, it has to account for that by adjusting the source of financing that it used. Liabilities like debt and deposits can’t be reduced, as they represent money that the bank has promised to pay to bondholders or depositors.

But what’s useful about capital is that it can be reduced, or written down. That’s the whole point. Shareholders, who contribute to capital, agree to absorb losses if the bank falls on hard times. So, rather than a “rainy day fund,” capital is a measure of a bank’s potential to absorb losses.

How does a bank increase its capital? There are few ways to do this, none of which banks particularly love. One is for banks to retain more of their profit, and not pay it out as dividends or spend it on share buybacks.

Another is to sell more shares in the market. That’s generally unappealing to banks because the shares would very likely be sold at a discount, and the slug of new shares could dilute the stakes of other shareholders.

A third method is reducing assets. This doesn’t actually increase the nominal level of capital. But it does increase ratio of capital to assets, which is one way that regulators measure the adequacy of a bank’s capital. If banks sell some of the things they own, that can have the effect of bolstering capital ratios.

When banks threaten to reduce lending or sell assets if they are forced to raise capital, this is the dynamic they are referring to.

The issue is complicated enough as it is, without the political posturing that is taking place. As regulators tinker with the rules, an understanding of capital will help reveal what’s at stake.

Where, Oh Where Are the .400 Hitters of Yesteryear? by Peter L. Bernstein

Peter L. Bernstein, the editor of Journal of Portfolio Management and the famous writer of two popular finance books — Capital Ideas: The Improbable Origins of Modern Wall Street and Against the Gods: The Remarkable Story of Risks. In this article, Bernstein has taken on  has taken Stephen Gould’s theses in Full House: The Spread of Excellence from Plato to Darwin about the 0.400 hits in baseball , and correlates it to the business and portfolio management. In his book, Gould talks about the the disappearance of the .400 hitter. What happened? Do batters have less skill than they used to have? Gould rejects that possibility as highly improbable, especially in a society that cultivates talent with as much zeal as U.S. society does. Bernstein said that “Portfolio managers performance data reveal patterns that are very similar to what actually happens in the baseball world”.

This article demonstrates that potential .400 hitters in the stock market are falling short of their goal because growing numbers of today’s investors are sufficiently educated, sophisticated, and informed to block their way, just as batters capable of achieving a .400 average have fallen short of that goal since the old days because defending teams have developed sufficient skill to block their way.

Where, Oh Where Are the .400 Hitters of Yesteryear? by Peter L. Bernstein

Arnold Schwarzenegger Recalls His Best and Worst Financial Bets

Great article in the WSJ on Arnold Schwarzenegger. In the article he talks about his various some of his best and worst investments. It’s worth sharing.

Schwarzenegger was a big influence on my life growing up. His story is unbelievable. He came from nothing. Really nothing. He had dreams, vision, and a plan.  For those not too familiar with his body of work and accomplishments, I highly suggest you read his book, Total Recall. I wrote a review here.

Below is the article from the WSJ.


Arnold Schwarzenegger Recalls His Best and Worst Financial Bets
By Chris Kornelis from the WSJ

Arnold Scharzenegger has had one of the most impressive—and oddball—careers in popular culture, from two terms as governor of California to four (going on five) turns as sci-fi icon the Terminator. The financial bets he has placed have been just as diverse. Some have been high profile, like his ownership position in Planet Hollywood. Others have flown under the radar.
In 1970, for instance, when he was a young Austrian expat with enormous biceps, he read that an airport for supersonic aircraft was being planned for the Mojave Desert. So, he spent $15,000 on 10 acres of land that had neither clean water nor electricity.
“The idea was that within a short period of time they were going to come in and bring electricity and water and roads and subdivide it, and [there] was a whole plan for the area,” says Mr. Schwarzenegger. “So, we said to ourselves, ‘We’re going to make a lot of money. We’re going to become millionaires.’ ”
But soon after he bought the land, supersonic flight was banned over the U.S., and the airport never materialized. Recently, though, those 10 acres of barren land—which he still owns—have risen in value as a nearby town has developed. The last appraisal came in close to $1 million, he says.
Still, Mr. Schwarzenegger says his best and worst bets have had less to do with writing checks and more to do with investing his time and effort in getting ahead—as well as having a clear vision of what he wanted to achieve and preparing for a job.
INVESTMENT: Relentless training as a bodybuilder
GAINS: Millions of dollars, movies, the governorship of California
By the time Mr. Schwarzenegger was 15, his mom charged him rent to live at home. After seeing videos of the U.S.—“the Golden Gate Bridge, Empire State Building, the huge highways, the big Cadillacs with the big wings in the back”—he didn’t just want to leave his parents’ house, he wanted to leave his home country, Austria.
Mr. Schwarzenegger decided that his ticket to America would be through bodybuilding. He began to train. He joined the Austrian army and continued training, his sights always set on moving to America. After he won the Mr. Universe competition in 1967—at 20, the youngest champion—he got an invitation from Joe Weider, one of the godfathers of the sport, to train in the U.S.
“Coming to America opened up all the doors that I didn’t even think about,” he says. “My movie career happened, and then my political career, and the money, the millions that I made, it goes on and on and on. Everything that I have accomplished in life is because of America. So this was really the most important and the best decision that I’ve made.”
THE TAKEAWAY: Mr. Schwarzenegger says he made it to America because he had a vision. From the time he was a teenager, he could visualize himself onstage winning Mr. Universe and using his success as an entrée to a life in America.
“The No. 1 lesson of being successful is having a vision,” he says. “Because when you have a vision of where you want to go in life and what you want to be, then it is just a matter of doing the work to get there.”
As he diversified his professional goals—whether it was being an investor or governor—Mr. Schwarzenegger says he employed the same principle. It is one the things he tries to instill in young people today.
“There’s just too many people floating around and not having a vision, especially young kids,” he says. “They don’t know what they want to do when they get out of college, they don’t know what to do when they get out of high school, what kind of work should they do. Should they go intern somewhere? There is no goal.”
Worst Bet: ‘Hercules in New York’
INVESTMENT: Time and cultural cachet
LOSSES: Future jobs and cultural cachet
As a child, Mr. Schwarzenegger looked up to men like Steve Reeves and Reg Park, bodybuilders who parlayed their muscles into film roles like “Hercules Unchained” and “Hercules and the Captive Women,” respectively. So, when Mr. Weider called him in 1969 and asked him if he wanted to go for the title role in the film “Hercules in New York,” he went for it.
Mr. Schwarzenegger hardly spoke English, so Mr. Weider instructed him not to talk during the meeting with the producer. (Mr. Weider told him Mr. Schwarzenegger was “a German Shakespearean actor.”) Mr. Schwarzenegger got the job but had to talk to make the film. It didn’t go well.
“I just said [the lines], but there was no emotion there because I didn’t even know what I was saying,” he says. “I didn’t have any acting training, and even though the director complimented me, I knew I was kind of in a bit over my head.”
The performance was so bad that his lines had to be overdubbed. His phone stopped ringing. “It really took me back with my career of becoming an actor for several years because I didn’t get an offer or anything,” Mr. Schwarzenegger says.
THE TAKEAWAY: “You have to find the sweet spot between having courage and being confident,” he says, “but also knowing that you’re deep into it and you’re not ready for something.”
Mr. Schwarzenegger says he got so caught up in his initial success as a bodybuilder that he didn’t slow down and take care of the basics before he capitalized on opportunities. But he doesn’t think of the experience as a total loss. Looking back, it taught him an important lesson.
“We learn not only just from our success, but we learn actually more from our failures,” he says. “I really learned to never do anything that you’re not really prepped, overly prepped for. Just like in bodybuilding, don’t go in the competition if you haven’t done the reps. The same is with anything else. Don’t do it if you haven’t done the reps or if you didn’t put the mileage behind it.”
Mr. Kornelis is a writer in Seattle. Email him at reports@wsj.com.
Appeared in the June 11, 2018, print edition as ‘Schwarzenegger Recalls The Good and the Bad.’

 

Disney Podcast

I recently found out that one of my article was the subject of a podcast

I wrote an article on Disney that received a lot of reaction (may or may not be behind a paywall, SA’s policy often changes).  In the article I share my thoughts and insights on the future of Disney. Interestingly, the editor of SA picked up my article for their latest podcast. I didn’t know they did this and I’m not in it. But it’s a good extension to my article.

Thoughts On Value Investing

I frequently hear some members of the value investing community complain that “value investing no longer seems to work”.  In my view, paying less than something is worth will always work. I guess what these investors may mean is that paying low multiples for mature, easy to understand businesses no longer seems to work.

Value investing has for reputation of paying a low multiple for a business and wait for the market to recognize its true value. But if you tried it, it doesn’t seem to always work that way. I have seen companies trading at 5x price-to-earnings (P/E) dropped to 2x P/E. The idea of only trading stocks on a low multiple of earnings is absurd. That would be too easy and it’s not supposed to be easy. If it was the case everybody would be rich doing that.

All businesses are worth the cash that they generate between now and eternity, discounted at the appropriate rate. The path that different companies’ cash generation takes can vary enormously. Some businesses may have outlived their useful purpose and be in liquidation. Others may have reached maturity and the current level of cash flow might be expected to continue indefinitely. Still others may have negative cash flow today as they invest to build growing cash flow in the future. At an appropriate price, each of these companies can be considered value investments. Only the size and the duration of the future cash flow relative to the price can tell you if it’s cheap. “There are no bad assets, just bad prices”.

I’ve own stocks with a P/E ratio that many money managers would label as high. I try to find out the free cash flow per share the company is generating, and I value the business based on that rather than GAAP P/E numbers. You need to ask yourself what are the fundamentals of the business in relation to its price? If you paid 20 times for a business that was compounding the economic value per share in the mid-teens and have some level of confidence it is likely to do that for a reasonable period of time, you should do all right. Here’s a stock tip: when Warren Buffett analyze a stock (which is a partial interest in a real business not a piece of paper) they discount the cash flows, not the P/E ratio.

Graham’s Net-Net Stocks

“Heavy ideology is one of the most extreme distorters of human cognition.” – Charlie Munger

Hardcore disciples of Graham and Dodd wouldn’t probably agree with my post. But have you tried investing in “net-net stocks”; companies trading below its net working capital. Of course I would love buying a company for less than its cash but there’s a reason why these companies are cheap. First, to do that, you really need to know what you are doing and it’s a lot of work. Maybe with a small amount of money you can make it work. However I doubt the risk and potential returns are worth the headache. True net-nets are hard to find and the one that comes off a filter are of dubious quality. Thomas Hobbes described the life of mankind as “nasty, brutish and short.” This is what you get on the list that typically pass the Ben Graham net-net working capital screen. Investors are much more efficient today than during Graham’s era.  Let’s just say there are better alternatives, like buying a high quality company.

You need to keep learning. You need to adapt. You need to evolve. You need to be mentally flexible. Nobody demonstrates this better than Buffett. Buffett evolved from the cigar-butt approach he learned under Graham to being the largest investor in Apply. He’s been at it for over fifty years and his style has evolved many times.

One might think that Buffett buying 140 million shares of Apple would dispel the notion that value investing as an analytical style is about buying “cheap stocks.” Quality is a key part of value and may not be reflected in current price creating a bargain or a margin of safety. The point is some bargains are only visible if you understand qualitative factors. I guess the holy grail of investing is buying a high quality company in high growth market with negative capital need at a discounted price.

Buy and Hold

Many also say that buy-and-hold investing no longer beat the market the way it did in the past. Buy and hold shouldn’t be your philosophy. What I want to do is own businesses that are exceptional until they are no longer exceptional. It’s a nuance on the notion of buy and hold. But it’s easy to call it buy and hold. There’s a saying in the investment world: “let your winners run, and cut your losers.” One of my greatest mistakes was selling my winners way too early. Peter Lynch said that “selling your winners and holding your losers is like cutting the flowers and watering the weeds.”

Technology

Historically value investors eschewed the tech sector because 1) its outside the circle of competence and 2) the tech sector is too fast moving. For long-term investors, basing investment decision on cash generation into the future, the sector was un-investable. Clearly, companies like Google, Apple or Amazon are far two entrenched in our modern, Internet-driven economy to be considered un-investable for the above reason. The change brought about by the Internet, mobile, and soon AI is fundamentally changing the economic basis of nearly every established business (look what Uber did to the taxi industry). A refusal to engage intellectually with these changes not only means that you miss out on the investment opportunity they throw up, but it blinds you to the fundamental changes taking place at every “easy to understand” business. It’s important to expand your circle of competence. In the past P&G or Coca-Cola were easy to understand branded consumer products. Today Apple is the modern-day incarnation of branded consumer goods company.

To conclude, what is within and what is beyond our circle of competence must continue to evolve over time. Risk comes from not knowing what you are doing, so it is wise to stay within your circle of competence. As for value investing, over time you need to keep re-calibrating the definition of value investors. The beauty of some systems is that they have the ability to evolve so as to adapt to new conditions.  Value investing evolves over time and keep an open mind on what constitutes value.

Greenblatt: Opportunity Is There If You Know How to Value Business

Greenblatt discusses active versus passive investing and some of the reasons why he still believes active investing is the better option saying:

“I was asked to give a speech at Google last year and I started it this way… I said even Warren Buffett says that most people are better off just indexing and I said I agree with him… I didn’t stop my lecture there. I said… but then again Warren Buffett doesn’t index and neither do I don’t… how come? It’s because the opportunity is there if you know how to value businesses. Which most people do not… To take advantage of the fact that the market is emotional over the short term… often!