Eddie Lampert Issues Letter to Sears Associates

Yesterday, Sears Holdings announced our results for the third quarter of 2007. While we were not pleased with these results, much of the commentary in the media and on Wall Street following the results ignores the strength of our company and the progress that we have made. In fact, over the past several years, we are one of the few retail companies that have actually reduced our overall debt levels, while at the same time investing over $1 billion on capital expenditures, making investments in inventory for our customers, contributing significantly to our pension plans for our past and future retirees and repurchasing over $3 billion of our shares.

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Retail is a fickle business. Nevertheless, like any other business, by focusing on the long term, making decisions based on facts and logic, and appreciating that all decisions are based on many possible future scenarios, companies can navigate the ups and downs of the economy and the stock market to create long term value for their shareholders. That is our focus, and our goal, at Sears Holdings. We will take the actions we believe are necessary to drive value over the long term and manage the business closely and opportunistically in the short term.

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We thank you for your hard work and are committed to working to deliver better results in the future. Remember, not everybody likes rooting for the underdog. It is up to us to earn their respect by our performance on the retail playing field.

Arne Alsin: No pretty bow, but still a gift

Here is a new stock idea: recently I said “bargains don’t arrive at the market in pretty packages wrapped with a bow”. While my gift to you, Tecumseh Products, is an amazing bargain, it is far from being wrapped in a pretty package. It is not only a messy package, it is also complicated – there are a lot of moving parts. Here is the story, in brief.

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A few months ago, Tecumseh had compressor, engine and electrical businesses. It was struggling with a potential liquidity crisis because of a significant debt burden. The company has just finished selling off its engine and electrical businesses for $260m, using the proceeds to pay off all of its domestic debt. Now the company can concentrate on maximising the potential of its global $1.1bn (annual sales) compressor business.

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Today, the market values Tecumseh at about $400m. By my calculations, the company will not only be debt-free, but also will accumulate $150m-$200m in cash over the next few quarters from non-operating items such miscellaneous asset sales, a tax refund, monies from an over-funded pension and assorted other items. My calculations also indicate that if the dollar is stable, the company can generate $90m in annual free cash flow beginning in 2009.

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Based on these numbers alone, you can recognise a bargain. This gift does not need to be wrapped in a pretty package tied with a bow.

Arne Alsin: The rational investor looks beyond price

How do you value a stock? This is the single most important question that an investor has to answer. If you cannot generate an informed estimate of value, you should not be making buy-and-sell decisions.

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All rational buyers of assets go through the same exercise. They ask two simple questions: "What does it cost?" and "What is it worth?" If you can look up a stock quote, you can answer the first question. But the answer, by itself, is meaningless.

The Entrepreneurial Investor

A logical investor must take irrational market behavior into account when choosing stocks to buy, sell, and hold. Fear and euphoria cannot dominate the actions of someone who really knows the companies and industries in which he or she invests, but other people’s fear and euphoria should influence one’s choices. Do not blindly follow the herd, but pay close attention to its movements. Opportunity exists in the gap between a company’s value and the herd’s perception of its value. Of course, it can take a long time for the herd to catch up, but that is how an entrepreneurial investor’s patience is rewarded.
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Book: The Entrepreneurial Investor: The Art, Science, and Business of Value Investing

Tweedy, Browne's Semi-Annual Report

In a fascinating new book, A Demon of Our Own Design, author Richard Bookstaber, a “Wall Streeter” with over 20 years of quantitative trading experience, contends that financial innovation, complexity and globalization have combined to make our markets more crisis prone. He uses biology as a frame of reference for economic behavior, and contrasts the cockroach and the furu, a small perch-like fish, in a case study of risk management. He finds the survival of the cockroach over millions of years quite remarkable, especially in light of what he describes as their “coarse and sub-optimal behavior” when it comes to risk management. In essence, the cockroach has a rather simple defense mechanism: moving away from slight puffs of air. It completely ignores a wide range of other information and risks “…that one would think an optimal risk management system would take into account.”

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He contrasts the sub-optimal behaving cockroach to the finely tuned and optimizing behavior of the furu, a once dominant, small, perch-like fish that survived in Africa’s Lake Victoria for thousands of years. The furu, over the centuries, became highly adapted to its environment, evolving into some 300 species and developing a myriad of skills, which allowed it to thrive and flourish in its habitat, rivaling “the finches that Darwin studied in the Galapagos.” It unfortunately fell victim to extinction when the Nile Perch was introduced by a Kenyan game fisheries officer into the lakes of Central Africa. Bookstaber points out that their “extinction was not the result of natural selection based on fitness in the usual sense; they were diverse and suited for almost every conceivable element of the Lake Victoria ecology.…Its path toward extinction was just a result of dumb luck that someone had introduced an alien species into its waters.”

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Bookstaber concludes that “the cockroach and the furu are just two of many examples I can cite in biology to illustrate the benefits of coarse behavior and the perils of finely-tuned behavior in reacting to a broad range of natural uncertainty.”

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To carry Bookstaber’s biological case study into the capital markets, Benjamin Graham and Warren Buffett are perhaps the “cockroaches” of the investment world, eschewing leverage and demanding a substantial margin of safety in each investment they made. Their simple and elegant defense mechanism against the vast uncertainty of financial markets was a cheap entry price supported by collateral value. By avoiding leverage, they were not likely to ever be untethered from their ownership of real and growing assets.

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The furu, on the other hand, is akin to today’s highly leveraged investor seeking to eradicate risk by fine tuning portfolios using probability theory in an attempt to ferret out and nullify any and all conceivable risks. Portfolios of high alpha generating, non-correlated assets are put together in a mosaic that is supposed to enhance return and lower volatility. With risk so theoretically constrained, investors are free to use leverage to exploit small market inefficiencies, allowing them to proverbially and safely “pick up dimes in front of steamrollers.” With massive amounts of individual and institutional capital having moved into these finely-tuned and highly leveraged strategies, Bookstaber contends that our capital markets will from time to time be confronted with liquidity shocks that could accelerate into full blown crises. Such was the case with the credit crunch in August.

Annaly - Note on Freddie Mac Following Release of its 3rd Quarter Results

Another (see post below on Pzena) opinion on Freddie Mac:

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Richard Syron, Chairman and CEO of Freddie Mac, articulated the company’s dilemma in very blunt terms. He said that he could either turn his company into “Fortress Freddie”, in which the company shrinks its business, or he can continue down the path they have laid out today. Either outcome is unpleasant. “Fortress Freddie” would mean that the firm would likely be a seller into the market at a time when the market is looking to the GSEs to provide liquidity, which would not benefit the mortgage market or the economy as a whole. The path they have laid out, on the other hand, will depress returns to shareholders, at least in the short run, but keep Freddie as a more active participant in the mortgage finance process.

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Headlines and press releases will continue to affect the trading of the securities of the Agencies. We already see what has happened to their share prices. Agency MBS, as usual, underperform Treasuries, a fact that has not been helped by the challenges of the current credit crunch. But Freddie Mac has chosen wisely to focus on fulfilling its mandate and to shore up its balance sheet. This bodes well for holders of Agency MBS. Freddie Mac stockholders, however, will have to wait.

Long-Term Value in Freddie Mac

[Rich] Pzena, whose firm, Pzena Investment Management, recently went public, says the mortgage purchaser is still severely undervalued.

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Speaking at the annual Value Investing Congress in New York City, Pzena labeled Freddie "the single cheapest stock that I've come across in my career." This isn't because Pzena is bullish on the U.S. housing market (he's not), but because he says Freddie has been unfairly tarnished by the subprime brush that is has afflicted so many mortgage lenders.

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Freddie's shares (symbol FRE) traded at $65 as recently as August 22 and plunged to as low as $22.90 on November 26 before rebounding.

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Pzena says he considers three questions when analyzing businesses selling at low prices. Is it a good business? Are its problems temporary, rather than permanent? Is it rational to think that earnings will return to historical levels? With Freddie, he says the answer to each is yes.

FPA Capital Fund's Semi-Annual Report

In light of the above comments, we believe the odds of a 2008 recession have increased to at least 50%, or more. Given the growing credit contraction, oil prices approaching $90 per barrel and the dollar setting new alltime lows versus a basket of currencies; future Fed policy actions may prove rather ineffectual in dealing with these challenges. We are of the opinion that the Fed will lower the Fed Funds rate into the 3.75% to 4% range next year, or lower, as housing, capital markets and consumer issues negatively affect economic and corporate earnings growth. We view consensus earnings growth expectations as being too high and believe that they will have to be lowered. Only recently have various types of financial services companies begun to recognize their problem loans and investments, with charges and provisions for future losses. Some of these stocks have responded favorably, with the belief that these companies are getting their problems behind them. Again, we believe the consensus is being too optimistic. Generally, managements are always initially optimistic, until they have to face the grim reality of the situation, and this process should extend well into 2008. The stock market appears to be ignoring these various risks since there appears to be a general belief that lower interest rates will ride to the rescue to solve these credit problems and support stock prices. We do not agree with this optimistic view and, therefore, we will continue to deploy a highly defensive portfolio strategy since we do not believe we are being appropriately compensated for these risks.

LeBron Inc. - The building of a billion-dollar athlete

And here lies the difference between James and nearly every other professional athlete. Together with Maverick Carter, a childhood chum and the de facto CEO of LeBron Inc., James is trying to create a new financial model for the 21st-century athlete.

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Instead of just lining up endorsements and cashing checks, James is seeking equity in the companies he works with; and he is using his on-court prowess to build a corporation that deals with entities as disparate as Bubblicious and Warren Buffett.

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"What I do on the court will drive revenue," says James. He's also picky about his partners, always asking himself, "Is it authentic? I know I can go out and sign a lot of endorsements and get checks. Money is not the issue."

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Wouldn't it be interesting if LeBron used LRMR (see article) the way Mr. Buffett has used the insurance business to build a diversified holding company? For LeBron, the return on capital for that business is ridiculously high while he is in his prime and if he lets all that cash build up, gets someone with capital allocating expertise to partner with, and then either invests in and/or buys businesses when they are cheap, he could have pretty sizable conglomerate by the time he retires.

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And in full disclosure, I grew up in the Cleveland area and am a big Cavs fan. That fact also makes me hope that Mr. Buffett's decision to stay in his home town of Omaha also rubs off on LeBron and he spends his entire career in Cleveland!

Another “Friendly” Deal? - by Phillip Ristau

Why would anyone invest in SNS? There may be a catalyst. There is a proxy fight to gain two board seats by tenacious value investor Sardar Biglari. A sale of Friendly Ice Cream was announced about 9 months after he disclosed his initial 13D filing in 2006 for about twice his average cost.

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Putting it all together, SNS’s earnings are worth $78 million in three years, discounted at 10% equals $59 million or $2.06 present value per share for the pure-franchise model. In addition, a sale/leaseback plan for the real estate would generate $5.97 a share for the 155 properties it owns. Finally, refranchising 435 units might generate $435 million, or $15 per share. Since this operation would take time, I use a 10% discount rate and a three year time frame. I derive a present value of refranchising of $327 million, or $11.47 per share.

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Thus, intrinsic value is $2.06 future earnings + $5.97 sale/leaseback proceeds + $11.47 refranchising cash for a total intrinsic value of $19.50 per share. SNS is currently trading around $11.

What Makes Warren Buffett Successful?

Mr. Buffett has explained it by acknowledging that he is “wired” in such a way that makes him very adept at capital allocation. This might be a disconcerting notion to some as it implies that you either have it or you don’t.

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But what is “it” anyway? To me, it is a combination of an array of characteristics, some very learnable, some less so. The learnable ones are characteristics every CFA charterholder probably has. These are things like strong analytical skills as well as simply a good knowledge of the financial markets. That is not especially hard to replicate. Moreover, with tens of thousands of CFAs in the world you would expect a few more Buffetts were this all it takes.

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It is the less-learnable characteristics that set Buffett apart and this is where watching Warren Buffett the person may help the most. People who have spent time with Mr. Buffett notice two things. For starters, he reads – constantly. Sometimes he can spend his entire day reading, and it’s not just for pleasure. He reads because he is hungry for information that will make him a more successful businessman. Very few people have the drive Warren Buffett has.

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Easy enough right? You are probably thinking, “Well if all I have to do to become a billionaire is read all the time then sign me up for the value investor’s book club.” Not so fast. A lot of people read a lot. The difference is Buffett’s memory. Not only does he read but he remembers everything he reads. Folks familiar with the man know how tremendous his memory is. Very few people have the memory Warren Buffett has.

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The most important less-learnable characteristic Buffett possesses, though, is very uncommon. It is emotional discipline. By this I mean the ability to resist the natural human instincts of fear, greed, pride, regret and all the other irrational biases to which people are inherently inclined to succumb. I have been trying myself to master these biases for years and, let me tell you, it is tough. Even once an investor is cognizant of these biases he may find it extremely difficult to control them. I can’t let myself buy because stocks are going up (greed) or sell because they are going down (fear). I have to base my decisions entirely on an unbiased assessment of the underlying business. This is far easier said than done.

Incentive-caused Bias in the Medical Profession

An excellent post from the blog of Sanjay Bakshi:

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Mr. Charlie Munger would surely have enjoyed reading this superb article in New York Times Magazine published on 25 November.

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The piece titled, "Dr. Drug Rep", is a moral story of Dr. Daniel Carlat, a medical man, who learnt how to deal with one of Mr. Munger's favorite mental models: Incentive-Caused Bias which Mr. Munger likes to describe as "whose bread I eat, his song I sing."

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Every professional should read Dr. Carlat's story. It has powerful lessons for professions outside of medicine...

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Mr. Munger likes to talk about incentive-caused bias as a very powerful psychological tendency, which makes, "a decent man, driven both consciously and subconsciously, by incentives, drift into immoral behavior in order to get what he wants."

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Its fascinating to me to see what happens once incentive-cause bias sets in.

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After his immoral behavior has started, the victim would come under the influence of several more psychological tendencies. For example, Operant Conditioning (It feels good, so I want more), Social Proof (everyone is doing it, so it must be OK), bias from Commitment and Consistency principle (I have to be consistent with my earlier, taken stand), and Low contrast effect (If I said yes to x, then saying yes to 1.01 x is no big deal) would combine together to produce rationalized immoral behavior. ("Man is not a rational animal, but a rationalizing one.")

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It takes a lot of courage for a professional to speak out against the incentive caused bias spreading like cancer in his profession, which is exactly why such stories deserve to be recommended for reading...

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For example, the accounting profession could do with more Dr. Carlats...

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Article: Dr. Drug Rep

On Seeking Professional Help - By Dan Ferris

There’s much documentation to show that most investors – individual and professional alike – fail to adequately appreciate how difficult, and therefore rare, is the production of outsized investment returns. I don’t want to suggest that you’re crazy to pursue such a goal, but I think most of us – again, individual and professional alike – ought to have no qualms about seeking, as it were, “professional help.”

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Seeking professional help means that, when the public equity markets offer you easy access to a great capital allocator, you should exploit the opportunity. The names I’m talking about include the folks in Omaha, Loews, Sears Holdings, Leucadia National, Markel, Fairfax Financial Holdings and the one I own, for which I shall advocate forthwith, Alleghany Corporation (NYSE: Y).

The Davis Research Methodology

A short history of Davis Advisors and our unique approach to building long-term wealth through investing in equities, including: what we look for in a company, how we arrive at an appropriate purchase price and the factors that may prompt us to sell a position.

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There is also an audio overview of the Davis Research Methodology HERE.

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Book: The Davis Dynasty: 50 Years of Successful Investing on Wall Street

Newsweek: The Future of Reading

Amazon's Jeff Bezos already built a better bookstore. Now he believes he can improve upon one of humankind's most divine creations: the book itself.

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There's a video demonstration of the Kindle on Amazon HERE.

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Although currently sold out, you can order one from Amazon for $399.

Charlie Munger's Lollapalooza Effect and This Credit Fiasco

Charlie Munger, Warren Buffett's brilliant sidekick, has expounded many times on innate human biases and incentive effects. For anyone interested in this topic, I highly recommend you read the transcript of an amazing speech he delivered in 1995, called The Psychology of Human Misjudgement. I have read this speech at least a dozen times and each time I glean something new and valuable. At first it may seem somewhat rambling and confusing, but I think anyone who can get a grip on this material will have a leg up in life on the average Joe who has no idea about these important concepts.

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Mr. Munger's treatise is clearly directed towards understanding how biases and incentive effects drive much of human behavior, and are not directed specifically at investing. However, the field of behavioral finance has grown to study many of these same concepts as they apply to financial decisions.

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A major point here is that you can never underestimate the power of incentives. One should always ask themselves in any human interaction what the incentives (or reinforcement effects) of the counter party are, especially when money is involved. Munger quips, "I think I've been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I've underestimated it. And never a year passes but I get some surprise that pushes my limit a little farther."

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Book with Charlie Munger's speeches and other wisdom: Poor Charlie's Almanack

HOW TO GET RICH - A Talk by Jared Diamond

.....we can extract from human history a couple of principles. First, the principle that really isolated groups are at a disadvantage, because most groups get most of their ideas and innovations from the outside. Second, I also derive the principle of intermediate fragmentation: you don't want excessive unity and you don't want excessive fragmentation; instead, you want your human society or business to be broken up into a number of groups which compete with each other but which also maintain relatively free communication with each other. And those I see as the overall principles of how to organize a business and get rich.

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A printable version of Diamond's talk begins about halfway down the page HERE.

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Book: Guns, Germs, and Steel: The Fates of Human Societies

Mind Over Money

In Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich (Simon & Schuster), author Jason Zweig, a senior writer at Money magazine, offers new explanations about what makes the investing brain a battleground between emotion and reason.

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His book is not only an enlightening account of what goes on in the brain when you think about money but a practical guide on how investors can make wiser decisions.

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We spoke with Zweig, now collaborating on a book with Nobel Prize-winning psychologist Daniel Kahneman , to learn the ways in which financial advisors can apply neuroeconomics in their practices.

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Book: Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich

Combing Through the Bargain Bin

AFTER SELLING OFF FOR WEEKS AMID CONCERNS about the health of the U.S. consumer, retail shares finally look like a bargain. Companies such as Macy's (ticker: M), Kohl's (KSS) and Home Depot (HD) have seen their stocks fall more than 30% from highs reached earlier this year, and now trade at levels last seen in 2005.

"Retailers are one of the few sectors that appear to be pricing in the fear of a recession," says Bill Nygren, manager of the Oakmark Fund (OAKMX). As a result, he believes that the shares are more attractive than other stocks, including many in the materials and technology sectors, whose still-lofty prices reflect little risk that the economy will stop growing. Retail stocks would outperform in a recession, he maintains, and could rally strongly if the economy keeps growing.

Digging for Value in the Real Estate Rubble by Zeke Ashton

It has been a long time since we’ve had extreme fear in the U.S. equity markets, an observation supported by the historically low volatility in recent years and the low prices one could pay for disaster protection in various forms (U.S. equity index puts, credit default swap spreads, etc) prior to this summer’s credit crunch driven sell-off.

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Clearly, we’ve got fear now, and at the epicenter of that fear is the U.S. real estate market. This fear is reflected in extraordinary volatility and stock price declines for those companies seen most vulnerable to the real estate bust – most notably homebuilders, mortgage lenders, and mortgage guarantors – coupled with all-time high prices for disaster protection on these names.

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But as all value investors know, fear brings opportunity. One of the axioms of fear-based selling is that everything viewed as being in proximity to the danger gets sold. Panic selling does not lend itself to careful consideration of relative risk. The market often does not begin to discriminate between those securities with truly high risk and those with low risk until after the crisis has abated. Once time has allowed for a more appropriate discernment of value and risk, the value of those securities that were unjustly marked down inevitably recover the full measure of their value. There is opportunity in virtually any crisis for those investors willing to carefully pick through the rubble. It is never easy, and getting the timing perfect is virtually impossible, but we believe that the recent fear in the real estate sector has provided us with actionable bargains.

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We have identified two investments in particular that we believe offer us a unique combination of compelling value and reasonable safety: Fidelity National Financial (FNF) and LandAmerica Financial (LFG). Both are engaged in the somewhat esoteric business of title insurance.

How the Crunch Is Playing Out

In recent weeks, every major bond insurer has reached out to Berkshire -- owner of a range of companies including reinsurer General Re Corp. and auto insurer Geico -- as a source of capital relief while their financial strength comes under scrutiny by ratings firms and investors, according to these people. In the process of pleading their cases with Berkshire, these companies provide Mr. Buffett with opportunities to size up their businesses.

Longleaf Partners Funds - Quarterly Report

Longleaf Partners Funds Q3 Report

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Also:
Longleaf Partners Fund November 9th letter to investors about adding additional funds to put $2 billion in new money to work.

VALUE TALK: Buying at a Discount... by Charles Mizrahi

Professor Bruce C. N. Greenwald identified three approaches to value investing: classic, mixed and contemporary. While the approaches are different, they all share the common principles laid out by Benjamin Graham in 1934 and again in 1949: view stocks as pieces of a business, ignore stock market fluctuations and buy only when a margin of safety exists.

An Investment Framework by Peter Lindmark

Investors should develop an investment framework which they make their decisions around. They should have tenets by which they abide in order to avoid permanent impairment of capital, while generating above average returns. Below are ideas from various others frameworks that are useful.

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When does an investor sell securities? Eddie Lampert was asked that question in a Washington Post article in 1995: "The reality is that when I find something I really like, I don't normally sell it. That said, there are three possible reasons to sell. One is if the facts have changed adversely -- if the economics of the business have deteriorated, if the people running the business have left or are no longer doing a good job. Second is if the price just gets to a point that the valuation is so high we think it is unsupportable and exposes us to the risk of a permanent loss of capital. Third is if there is a better alternative investment, but the burden of proof is always on the new idea."

Whitney Tilson: Nothing to fear on the wild ride

In a perfectly efficient market, stock prices and company intrinsic values would move in lockstep. Thankfully, the real market is not so efficient, and smart investors are able to take advantage when a stock price diverges markedly from its underlying value. Panic and fear create buying opportunities; euphoria and complacency deliver great opportunities to sell.

Seduced by a Super Model

On October 15th, 2007, Federal Reserve Chairman Ben Bernanke addressed the Economics Club of New York. After his prepared remarks, the Chairman took a question from Henry Kaufman, who wanted to know what kind of information he would like to receive from the risk takers who were both lenders and borrowers in the structured markets. Bernanke thought for a moment and then replied, with an air of resignation in his voice, “I’d like to know what those damn things are worth.” The thousand or so participants in the New York Hilton ballroom thundered their applause.

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Numbers can be seductive. They can speak breathlessly in low, hushed tones of certainty, make loud cries of success, or whisper of potential opportunities. Many people love numbers because they seem to have a final, conclusive nature about them. They seem so solid, so predictable. They are the basis of every relationship in the universe. Human beings have always sought to quantify, compare, analyze, study and reach definitive conclusions with numbers. Indeed, the famous adage, ‘Numbers don’t lie,” summarizes much of what motivates and ultimately satisfies us.

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We are about to explain to you why numbers are not always what they seem to be, even when they add up.

Dallas Fed Posts Previously Unreleased Conversation with Milton Friedman

The Federal Reserve Bank of Dallas today [11/8/2007] released a wide-ranging interview between Nobel Laureate economist Milton Friedman and Dallas Fed president and CEO Richard W. Fisher.

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Friedman and Fisher discuss a myriad of topics, including globalization, China, the Federal Reserve, free trade, government spending and education reform.

Investment Nuggets

Though not the most recognised public face of Berkshire Hathaway, Charlie Munger’s contributions to the philosophy of value investing cannot be overlooked. Notably, Warren Buffet credits Munger with Berkshire’s investments in high quality companies at fair price and the move away from the cigar-butt, short-term value arbitrage approach followed before. Mungerisms, as his investment philosophies are popularly known, are as forthright and simple as they can get. Here are a few samplers:

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“The number one idea is to view a stock as an ownership of the business (and) to judge the staying quality of the business in terms of its competitive advantage. Look for more value in terms of discounted future cash flow than you’re paying for. Move only when you have an advantage. It’s very basic. You have to understand the odds and have the discipline to bet only when the odds are in your favour.”

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“A single stock can make up 50 per cent of the value of the entire portfolio. Holding a concentrated number of stocks, that you know extremely well, will in the long term produce superior returns.”

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“The mental habit of thinking backward forces objectivity. One of the ways you think a thing through backward is you take your initial assumption and say, Let’s try and disprove it. For example, if you were hired by the World Bank to help India, it would be very helpful to determine the three best ways to increase man-years of misery in India — and, then, turn around and avoid those ways. So think it backward as well as forward. It’s a trick that works in algebra and it’s a trick that works in life. If you don’t, you’ll never be a really good thinker.”

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“Rationality is not just something you do so that you can make more money, it is a binding principle. Rationality is a really good idea. You must avoid the nonsense that is conventional in one’s own time. It requires developing systems of thought that improve your batting average over time.”

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“Spend each day trying to be a little wiser than you were when you woke up. Discharge your duties faithfully and well. Step by step you get ahead, but not necessarily in fast spurts. But you build discipline by preparing for fast spurts… Slug it out one inch at a time, day by day, at the end of the day — if you live long enough — most people get what they deserve.”

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“The idea of caring that someone is making money faster (than you are) is one of the deadly sins. Envy is a really stupid sin because it’s the only one you could never possibly have any fun at. There’s a lot of pain and no fun. Why would you want to get on that trolley?”.

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“To avoid envy from other, you should deserve your success.”

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“Never wrestle with a pig, for if you do, you will both get dirty, but the pig will enjoy it.”

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“The ethos of not fooling yourself is one of the best you could possibly have. It’s powerful because it’s so rare.”

Video: John Bogle on Bill Moyers Journal

The topic of discussion is the crisis in American Capitalism. (Video)

Web-Only Video: CNBC's Becky Quick Reveals What She Learned On the Road with Warren Buffett

Video is posted here: http://www.cnbc.com/id/21598998

Bloomberg Calls for Tax on Carbon Emissions

Not really investment related, but a great speech by Michael Bloomberg:

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It’s time for America to re-establish its leadership on all issues of international importance, including climate change. Because if we are going to remain the world’s moral compass — a role that we played throughout the 20th century, not always perfectly, but pretty darn well — we need to regain our footing on the world stage. That means ending the “go-it-alone” approach to foreign affairs that has never served America well. It didn’t work in the 1920s, when we tried to isolate ourself from the world, and it hasn’t work in recent years, when we’ve tried to stand above it, pretending that vital international treaties can simply be ignored. The fight against global warming is a test of America’s leadership — and not just on the environment.

Legg Mason Value Trust Releases Letter to Shareholders

The equity sell-off on October 19 was precipitated by the market's reaction to the earnings of two stalwarts of the commodities cabal, Caterpillar and Schlumberger, both of which surprised their fans by issuing less than stellar guidance. Cat went so far as to opine that the US might be in recession already; its earnings gains were solely due to non-US growth.

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If credit is becoming harder to come by, if spreads are widening, if growth is slowing, then it seems to me the leadership is about to change. The same strategies that led when the global economy was emerging from fears of deflation and entering a period of accelerating growth and synchronized recovery are very low probability bets to lead if the global economy is peaking, the US is slowing appreciably, and credit spreads are widening, not narrowing.

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Where will the new leadership come from? The same place it usually does: the old laggards. I think the new leadership will be US, large-cap, dollar-based, and grow to encompass what no one wants to own today, especially financials and consumer. I also think so-called growth stocks will continue to do fine. When growth becomes scarcer and the discount rate becomes lower, growth becomes more valuable.

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More particularly, just as the right thing to do in 2002 was to buy what everyone was panicked about, I think the greatest gains over the next 5 years will be made in those securities people are panicked about today. For specific names, consult the 52-week new low list.

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Value Trust Comments

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One of the enduring features of the findings in behavioral psychology as it applies to finance, a subject I have discussed many times over the years, is the almost complete inability of those who are aware of them to actually apply them. You can attend Richard Zeckhauser's seminars at Harvard, read lots of articles and case studies, be reminded of how recency bias, or anchoring, or the representative fallacy, or myopic loss aversion impair clear thinking and skew decision making, and still fall prey to them and others of their ilk the moment you are confronted with real world situations.

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The recent precipitous decline in financial stocks, especially those related to housing, which sent Countrywide Financial (CFC) to $12 last week, and led to 20 to 30% drops in financial guarantors in a day or so -- after they had already dropped between 25 and 50% this year -- is a case in point. After falling 20% in a only a few days on no news, and this after being down 50% for the year, CFC rallied over 30% in one day once they reported their results and indicated they would be profitable for the 4th quarter and expect to earn a reasonable return on equity of 10-15% for all of 2008. The price action on both sides was driven by emotion -- first fear, then relief -- and was hardly the result of a careful analysis of Countrywide's long term business value. That, by the way, we think is in the $40's compared to its current price of about $14-15.

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This is not unusual. Warren Buffett has often noted how any knowledgeable analyst would have pegged the value of the Washington Post at about 5x what it traded at in the 1974 bear market, yet no one wanted it at that price. The 2002 bear market saw some similarly amazing prices. AES traded under $1. It will generate over $1 of free cash flow this year and is up 20 times from the lows of 2002. Yet fear set its price, as it did those of Nextel, Tyco, Corning, Amazon, and a host of other companies at that time.

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Today fear dominates the pricing of housing stocks, of mortgage related securities, of financials, and of many consumer stocks. Confidence and optimism underlay the pricing of energy, materials, industrials, and non-US stocks, especially those of emerging markets, and China in particular.

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I am reminded once again of the quote that sits in the front of Ben Graham's Security Analysis, from Horace's Ars Poetica: "Many shall be restored that now are fallen and many shall fall that now are in honor." (The quote does not say "all" by the way, just "many").

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In Value Trust, we have been taking advantage of the market's current turmoil to make adjustments as the market misprices some securities in relation to others. Here is what you can expect: the fund will become more of what it already is, large capitalization US, as we systematically reduce our mid-cap names in favor of those with larger market values. As I noted elsewhere, I think large-cap US is the cheapest part of the equity market and so we will have more of those names. We will also extend exposure into some sectors from which we were previously absent. Inter industry valuations are pretty homogeneous and so concentration pays less than it used to. In other words, we will own more stocks, and in new industries. We will still be quite concentrated compared to the average mutual fund, just less than we have been previously.

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We will likely reduce the weightings of many of our top 10 holdings. They will still be among our largest holdings, we will just have less of them. This is being done to reduce risk in the over-all portfolio, and to fund some of the new names we are buying.

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This is the first time since 1990 we have had two calendar years behind the S&P 500. Perhaps not surprisingly, that was also a time of panic due to a housing market recession, soaring oil prices, banks and financials collapsing. We were able to take advantage of the values then offered to begin a pretty good period of excess returns.

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While the past may not repeat itself, it does often rhyme, as Mark Twain once said. The chapters to come may be different, but the verses are likely to sound the same.

Keep It Simple, Fool

During the height of his career, Albert Einstein was in the middle of hearing his notes dictated to him by his secretary when he stopped and asked her, "Did I really write that? I could have put that so much simpler."

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Just as Einstein was able to simplify even the most complex concepts, the world's top investors have a knack for focusing on the two or three big factors that lead to a successful investment, ignoring the meaningless noise of millions of other factors.

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On the topic of Einstein, I am listening to Walter Isaacson's excellent book on him and I highly recommend it (Book, Audio Book), as did Charlie Munger at the Wesco meeting this year.

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There are also a couple of great quotes relating to Einstein that I keep in mind:

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"Everything should be made as simple as possible, but no simpler." --
Albert Einstein

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“Not everything that counts can be counted, and not everything that can be counted counts.” --sign that hung in Albert Einstein’s office at Princeton

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And the brief story mentioned by Peter Bevelin in my interview with him: When I hear them [Buffett and Munger] at the annual meeting, I am thinking about Einstein’s reply to a student. The student had challenged Einstein’s statement that the laws of physics should be simple by asking: "What if they aren’t simple?" Einstein replied, "Then I would not be interested in them."

Kicking the Tires: Why Company Visits Still Matter

Some of the world’s foremost investors have sworn off company visits, insisting there is nothing of value to be learned from highly choreographed tours and presentations. This is true to a point, but also sounds like the type of complacency that could turn someone into a former world’s foremost investor.We think a well-prepared visitor can gain useful insights by remembering that eyes believe what they see, while ears believe others.

Warren Buffett and NBC's Tom Brokaw: The Complete Interview

The Tom Brokaw piece on NBC Nightly News Monday night highlighting Warren Buffett's call for a higher tax rate on very wealthy Americans includes an excerpt from a sit-down interview with Buffett.