"Cigar Butt" Investing

Just to expound on an email I rattled off this morning to a couple friends - although I think the stock market was cheap (before the 10% run up), I think there is the case for "worser". When is "worser" coming? I think the next few quarters earnings will give us a good idea of how things will pan out during this recession and I'm hopeful that stocks will trade at single-digit multiples. Just to remind you - we're coming off a period of above average earnings with above average multiples and it has been reported that the DOW event at 8,000 is trading at 10x next year's worst-case scenario earnings (according to first call 2009 estimates, which I know, is always slow).

In any case, what's a person to do? Recently, during the muni crunch, I moved my money into a Vanguard Muni Money Market fund. Liquid, relatively risk free (not as good as treasuries, but conceivably supported by the ability for municipalities to increase taxes) at 5% tax free. That equates to around a pre-tax 8% yield. Buffett's recent preferred deals have gone for a 10% yield warrants as a kicker. I'll use Buffett's 10% yield as a hurdle; deals above that are worth looking at.

That leads me to CEG (Constallation Energy Group). Buffett has agreed to puchase the stock at $26.50 cash, currently you're in the $24 range. Anything below, say $23.50, particularily before December 5th (there's a divvy for shareholders on record December 10th) yields 12% and looks worthy. The deal is supposed to close 2Q09 so a >12% return for that period is pretty good.

So where's the risk? The risk is that CEG shareholders vote down the deal. In the event that the deal is voted down, CEG is going to have to go to the market it's liquidity needs. That means CEG shareholders think they can pay Uncle Warren the breakup fee, go to the market to satisfy debt needs, and still end out ahead. It could be said that credit markets are a little looser than they were during the crunch, so taking into account the various class-action suits against the company, the scenario seems possible.

Another risk is that Uncle Warren renegotiates the deal - that can happen, although I think Buffett is okay paying 30 cents on the dollar and won't risk mucking the deal to get 25 cents on the dollar. As he's said before, he'd rather be approximately right than precisely wrong. Besides, this is a slam-dunk deal for him, as he's getting the company on the cheap.

All in all, at a >12% return for a 6-9 month investment seems pretty decent to me. In the event that it falls out, there may be the case for an even greater return. If you look at where the company was before the credit crunch, you're in the 60-80 dollar range. My guess is that the deal will close with Buffett and he will have gotten a company on the cheap (although you can buy the company cheaper).

Lastly, I should say that I've never purchased in a take-out scenario, so this is a first for me. But I think the reason the deal isn't closer to the closing price (besides the reasons above) is because a lot of the arb-guys are finding financing to be expensive, hard to come by, and frankly - take-out arbitrage has been very risky this past year (i.e. lots of deals have fallen through or gotten renegotiated). Essentially, those with cash get to be greedy while others are scared.

The Legacy of a 'Classic' Broker

I thought, given the financial turmoil right now, that it'd be good to post an article I read and kept from the Washington Post many years ago. The DOW, incidentally, was around 8500 when this was published.

The Legacy of a 'Classic' Broker
By Allan Sloan
Tuesday, December 10, 2002; Page E03

My broker, Douglas Bridges, died suddenly last week. He was 59, and we'd known each other almost half our lives. We met in the mid-'70s, when I was a business writer at the Detroit Free Press and he was a broker in a nearby office of First of Michigan Corp., now Fahnestock & Co. We bonded. When I moved to New York in 1979, I never considered switching brokers.

I trusted Doug completely. He wasn't always right on his stock picks, but he was always honest and decent and fair, and he was my friend and mentor. With Wall Street under attack for sleaziness, it's important to remember that our system also produces wonderful brokers like Doug. "He was the classic of what brokers used to be, and were supposed to be," said Bob Teeter, the prominent political pollster, who grew up a few houses from Doug in Coldwater, Mich. "Doug took care of his clients," said Teeter, one of the dozen eulogists at Doug's standing-room-only funeral in Ann Arbor. "He removed worry from them; he put their needs ahead of his own."

I could go on about how Doug, who never forgot that he grew up poor, treated janitors more politely than college presidents and kicked out million-dollar clients who annoyed him but spent endless hours helping people who would never make him a dime. But this isn't about Doug. It's about what we can learn from him. He never wanted to benefit from my high profile, so I never wrote about him. Now I get the last word -- but not the way I ever wanted to. Some lessons:

• Country mice can outsmart city mice. Although Wall Street is the financial capital of the world, plenty of wisdom exists west of the Hudson River. Doug, at a small regional brokerage, was as astute as anyone. Well before Warren Buffett and his partner Charles Munger became famous, Doug put his clients into the stocks of the companies they ran and bought some of the same securities they were buying. I first met Buffett and Munger through Doug in the 1970s because he showed me that their companies had stakes in companies I covered. "I referred customers to Doug despite my aversion to brokers," Munger told me last week. "He was independent, idiosyncratic and very smart, and wonderfully cranky. He was completely trustworthy. . . . We've lost a good one."

• Honesty pays. Like other brokers, Doug depended on commissions for his livelihood. He didn't work cheap, but he tried to sell small investors like me stocks we could hold forever. Many people I sent to Doug for financial advice came back surprised, because he'd tell them to buy a house or build up savings rather than invest in stocks. Doug's honesty and smarts attracted several clients who gave him huge amounts of money to manage. He was a big, big producer. Knowing that he could easily generate enough commissions to feed his family, Doug could indulge his passions like reading, helping kids become literate and helping people he liked.

• Do your own research. Doug, a brilliant math student who put himself through the University of Michigan by working various jobs, was a ferocious researcher. He used to mock the products the firm asked its brokers to peddle. Instead, he hunted for what he called "truffles lying on the forest floor": investment companies whose assets were worth far more than their stock price, small but financially sound banks, obscure industrial firms laden with cash. He was the polar opposite of the pretty types who peddle whatever the firm is selling. Doug wasn't trim. He was disheveled. He was even cruder than I am. He was into coarse humor: He disliked the orientation of the Michigan economics department, and he joked about naming a scholarship for the arsonist who'd gutted the department's building. I used to climb over the piles of paper in Doug's office to get to his guest chair, where I'd watch him flip the bird to passersby, including the firm's chairman, who'd just smile. Moral: You can get away with it if you're a big producer.

I don't have data to calculate how Doug's investments did for me over the years. But my individual stocks, most of which he picked, are down less than 10 percent for the past two years. The S&P 500 is down 30 percent.

I may be able to find an investment adviser to replace Doug. But I don't think I'll ever get lucky enough to find a friend and guide like him.

Pac-Man Paulson

My good friend at Weiss got me in a Photoshop throwdown...it all started with a forwarded JPEG and a comment "I know you can do much better". I had to show him that GSA is worth the cost of every nickel per share they pay us. The trick is, be smart and keep it in the gutter.

Here's the play by play.
First round - opening salvo:










My response (same theme because they asked for it):






His reply - much gayer (and quite good, I should add):








My KO - total dominatrix.








Apparently, I ended up making the notorious trader wall at Weiss. GSA - worth every nickel.

I am so smrt...reloaded

I look back on some of these posts with disgust. Not because I find what I'm writing to be trite and meaningless, but because these posts document decisions that have cost me hard money. My being "smart", then being "smrt" trade cost me - big. Being "smart" would've ultimately paid off, the verdict is still out on being "smrt".

As retarded as I feel (and yes, I feel retarded a lot when I look at my Vanguard statements) ... I look back on these decisions, ignore the "would've, should've, and could'ves", and remind myself what the maestro (Buffett) says, "Whatever the outcome, we will heed a prime rule of investing: You don't have to make it back the way that you lost it."

As much as I like to say that "hope is not an investment philosophy", but good God, I sure hope I'm right...