Arohan’s investing life

Inherently value investing ignores macro issues. Warren Buffet does not believe in letting market decide what to do (top down macro approach), nor did Ben Graham have any use for macro considerations

The Efficient market theory attempts to neatly segregate risk into two parts: 1) company specific risk (micro), and 2) market risk (macro)

What Buffet and Graham tell us is to ignore the market risk (well not really ignore it, use the concept of “margin of safety” to cushion any curve balls that the market may throw at you) and focus solely on the company fundamentals. Is the company inherently strong? Does it have a growing franchise? And above all, is it attractively valued?

However, it is not always this simple? What if the company you are looking at investing in is a solid company with large marketshare, good management, provides services that are needed now and are going to be needed in the future, is very attractively priced, has good strong fundamentals, etc but the market conditions are such that the company has a potential to be forced into bankruptcy due to a ‘market collapse or breakdown’? A market collapse or breakdown that has the potential to push the country in recession, create major upheavals in the business environment, to the extent that there is a real fear that by the time US re-emerges from this, it may not be the most powerful economy in the world anymore

And what if a detached pragmatic line of thinking suggests that the regulators and the government will do everything in their power to ensure that such a collapse or market breakdown does not occur

You know, Chrysler at one time was a company knocking at the doors of bankruptcy. Very few had guts to invest in Chrysler stock at that time. Peter Lynch did, and he did it because he recognized that this is a company that is too important for the American economy to be allowed to fail

There are companies like that in the market today. I am of course talking about Financials. For starters, here is a list compiled by Jim Cramer of 10 companies that cannot be allowed to go under.

For starters, allowing a company like CFC or WM to fail does not do anything to fix the problem of bad loans in the system. These loans do not magically disappear. They will just migrate to someone else’s books. The problem is the bad loans and the breakdown it has caused in the market pricing mechanism. A solid response to this issue is to ensure that these companies survive and put in a process to slowly work out these bad debts over time. Just what Paulson is attempting to do now. If these lenders fail, the impact on the market and the confidence destruction will be enough to push US in deep recession ( and the problem will still not have been solved)

I realize that investing in these stocks at present time has an appearance of taking on too much risk. To me, this is an acceptable risk with low probability of permanent capital loss but with high potential rewards

Disclosure: I own stock in CFC, WM and BAC.

Note: Please do not invest in these or any other stock unless you have done your own due diligence. Standard disclaimers about this not being an investment recommendation, invest at your own peril, etc, etc, apply

Just a quick update for the readers …

Today CFC was too good to pass up and I bought. This is truly a contrarian/value judgment and goes with my conviction that the stock is severely undervalued

Here is another opinion that lays out a case for investing in Countrywide from good friends at The Tycoon Report

I also bought WaMU (WM) in the last week and I added to my position at BAC

With my holdings in LPX I am now well positioned for the eventual housing turn around

Whenever that happens

I am patient

Appears that the Soros fund has bought into Countrywide

Soros Fund Management reported in a filing with the U.S. Securities and Exchange Commission its holdings as of Sept. 30, which included a $33.9 million investment in Countrywide

On Sep 28th CFC stock closed at around 19. The subprime meltdown was in full swing.

Bank of America thought CFC stock at $18 is a good value. CFC is now trading at $13-$14

Does Countrywide now present us with enough discount on the stock to compensate for the risk that the business may not survive in the long term?

The stock is cheap enough, according to Yahoo trading at about 0.55 Price to Book. The liquidity in the credit markets have also eased a bit

Any investment in CFC today has to be based on a judgement of how much bankruptcy risk remains in the name. Countrywide has restructured its organization as well as the loan portfolio to safer loans and does expect to be profitable going forward. The profits however, may be minimal and will do wonders to inflate the PE ratio, still it will allow it to survive long enough to see the upturn in the housing market. The weak would have died, leaving the market to the survivors. The pot of gold here surely lies at the other end of the housing cycle. How long is this going to be?

And BAC has always coveted CFC, now more so than ever!

Decisions, decisions, decisions …

Looks like Mr Market has presented us with a great opportunity to scoop up some financial names. With subprime issues and CEO resignations at Merrill Lynch and Citigroup even some of the strongest names have taken a battering. If you, like I did, felt that Bank of America (BAC) was cheap before, now it is almost a no-brainer.

Hmmm, where in the market will you find a strong franchise like BAC, with reasonable growth prospects, recent one-time writedowns notwithstanding, with a mouth-watering-CD-busting 5.75% dividend yield, and a long long history of dividend growth

The problem as I see it, and why the investors are not rushing in, is the uncertainty in general surrounding the financial names. This is a valid reason. However, the investors need to take into account BAC’s low exposure to sub-primes as well as its appetite to make opportunistic investments a la Countrywide and a management team that is generally well regarded. This together with its continued focus on growth (acquiring LaSalle, for example) in underrepresented markets does show that the company is sticking to its way of doing business

It also has a vote of confidence from Mr Buffet