VIDEO: Legg Mason's Robert Hagstrom on WealthTrack

Legg Mason fund manager, Robert Hagstrom was one of the interviewees on last Monday's edition of WealthTrack.

In my opinion, Hagstrom's greater contribution to the world is not as an asset allocator, but rather as a best-selling author. His books The Warren Buffett Way, The Warren Buffett Portfolio, and Latticework all raised the level of understanding and awareness with regards to Value Investing. In my opinion, all three are invaluable resources for becoming a more successful long-term investor.

In the last 5 minutes of the WealthTrack interview, the host provides a tight summary of Hagstrom's first book - which is about Warren Buffett's Value Investing Philosophy.

Below I provide some excerpts from Hagstrom's comments in the interview. As you will see from my thoughts (tagged IV in blue), I wasn't as impressed as I was from his books.

"It's true, the economy is weak, and it's true, there's a lot of negativity in the market, but these times are also the seeds of future excess returns. I think it's time to be cautious, a time to stay with quality, but I think if you look back at periods like this - these are the opportunistic periods that allow you to build a portfolio that's going to generate very high returns, much better than the market rate of returns".

IV: Why do some investors see what's happening in the market now as a terrible thing, while others are actually glad? The difference between these 2 camps is their 'investment horizons'. Short term oriented investors are having trouble dealing with the recent market weakness. Those investors that adopt a longer investment horizon view these periods as an opportunity to invest in great companies at bargain prices. Hagstrom's fund has an average holding perid of 3 to 4 years - so it is little wonder that he is concerned.

IV: In the interview Hagstrom indicated that his fund is now 100% fully invested in the market (i.e. it's cash holdings are minimal). I found this strange considering the fact that his previous comment suggested that this is the opportune time to look for great prices. If he thinks this is the case, why doesn't he keep some cash in reserve - like Fairholme's Berkowitz or First Eagle's Eveillard? Perhaps Legg Mason's team believe that the worst is already behind us? I don't know.

"We've taken the Warren Buffett Way, the Warren Buffett Process, and tried to apply it to the new economy".

IV: Hagstrom's top 5 holdings are Nokia, Yahoo, Amazon, Qualcomm and E-Bay. They make up a little over 30% of the fund. So he's definitely 'new economy'. I can see how he applies Buffett's principles of businesses with economic moats (you could argue that each is the dominant brand in its space), but what about predictability of future cashflows? You know there's going to be growth - but isn't that already factored into the high valuation multiple? How does one seek a 'Margin of Safety', the centerpiece to the 'Warren Buffett Process', when it is not easy to forecast future cashflows? This is why I wrote in my last analysis of SanDisk that Warren Buffett would not touch it.

When WealthTrack's host, Consuelo Mack, asked Hagstrom whether those stocks offer protection in a weak economy he replied:

"If we go into a recession, there's not much of anything that you can own that will do exceptionally well."

IV:Now I'm not sure about you, but I find this reply a little strange. How about company's that hold large positions of cash? Like Buffett's Berkshire Hathaway (BRK). That's what Sequoia, Fairholme and Eveillard have done - invested heavily in a business with strong cashflows and a strong cash position. When the market really craps out - you can count on Buffett to be pick out the treasure from the trash. How about Charlie Munger's favorite Costco (COST)? Costco will benefit in a recessionary environment as people seek ways to save money - and Costco is certainly one of the obvious places to do so. Another is GEICO - with a reputation as a cheap Insurance provider. Oh - that's right - it's owned by Berkshire.

If you can think of any other investment ideas whose business might benefit from a recessionary period - I'd love to hear them.

Signing off for today: "May you always possess the Wisdom to see what the market does not, and the Courage to act on it".

VIDEO: Warren Buffett Interview on Fox Business (Oct. 18,2007)

The Fox Business Network which commenced operations last week, hit it off to a great start with this great one-hour interview with Warren Buffett. The interview was conducted by Liz Clayman, formerly of CNBC, who recently joined the network. This was not her first interview with Buffett, and as always, Buffett's humility, candor and wisdom does not disappoint.

Below are some of the video excerpts from the interview, along with the gems that I extracted and some personal thoughts (in blue and tagged with 'IV').

On the Economy (6 Minutes)

"We don't really worry that much about Fed policy, and actually we don't really worry that much about a recession - I hope I live to see a couple recessions."

IV: Value Investors do not pay too much attention to macroeconomic figures such as interest rates, inflation, unemployment figures or the trade balance. They only focus on the fundamentals of the business they are analyzing. As they are long term investors, they know that the businesses they invest in will one day go through a recessionary period. It is inevitable. It is for this reason that when analyzing a company, Value Investors look at the 10-year financial history, and assess how well the business fared during the tougher years.

IV: "I hope I live to see a couple recessions." - This is typical of the Value Investing philosophy - Value Investors love market weakness - as these are the times when the best buying opportunities are available. Incidentally, I recently met with the Managing Director of one of Israel's largest mutual funds businesses, and he was telling me how tough this environment was for him, and how these were dark times for the business. His fund managers are not seeking bargains now, but rather taking the market's lead, and exiting their positions.

"When the tide goes out, you see who's been swimming naked".

IV: This is one of my favorite Buffett quotes - one he has used many times. What he means by this is that it is easy to do well as an investor when the market has been rising and you are buoyed by it. The real test however is when the market suffers significant weakness, and investors flee to 'quality' and defensive companies. One such company is Buffett's Berkshire Hathaway (Ticker:BRK)- which has increased 20% since last July.

On Selling Petrochina (5 Minutes)

"Unfortunately I sold it a little too soon..... we made about $3.5 billion on a $500m investment... I still sold it way too soon.... Charlie would say 'you've done it again!".

IV: This type of comment is vintage Buffett, and which has endeared him to fans and investors around the world. He doesn't speak with bravado declaring 'look I turned $500m into $3.5b but rather - 'I screwed up' - I sold it too soon. It's this type of candid talk which Value Investors look for in the management of businesses they are analyzing.

"It was a 100% decision based on valuation."

"We think about 'how much is it selling for?... 'how much do we think it's worth?"

IV: Value Investors do not try to time the market. They do not seek 'bottoms' or 'tops'. Their investments are based on their estimate of what the entire business is worth.

When asked 'How did [Petrochina] come to your attention? How do you find a stock like that'?

"I sat there in my office, and read an annual report, which fortunately was in English - and it described a very good company..... I sat there and said to myself this company's worth about $100 billion (and at the time it was trading for $35 billion). Now I didn't look at the price first. I looked at the business first, and tried to figure out what its worth - because if I look at the price first I'll get influenced by that. I look at the business first, I try to value it and then I look at the price. If the price is way less than what I just valued it at, I'm going to buy it."

"Other guys read Playboy. I read annual reports....I just read every report I can and figure out whether something is cheap."

IV: Buffett's message is clear. You've got to do the work yourself. No shortcuts. Don't listen to analyst reports or rumors. Do your own independent research. Read the annual reports. Look for what the rest of the market is not seeing.

On Buffett's Best Investment Ever (30 seconds)

IV: Those who know Buffett's history will know already that this investment is GEICO. The story goes that whilst studying at Columbia under his mentor Benjamin Graham, the 21-year old Buffett discovered that Graham was on the Board of GEICO. One Saturday morning, he boarded a train and headed to GEICO's headquarters, which were closed. He found a janitor and pleaded with him to take him to someone who worked for the company. The janitor took him up to the only person in the building at the time - Lorimar Davidson, GEICO's Chief Investment Officer. The young Buffett made enough of an impression on the senior executive that Davidson ended up chatting with him for 5 hours. By the end of that Saturday Buffett recognized GEICO business potential, and why Graham had invested in the business. Soon after Buffett invested 75% of his net worth - $9,000 and sold a couple of years later for a 50% profit. In the late '70's Buffett returned to GEICO, and invested more than $47 million into the company. Today that investment is worth more than $9 billion.

You can read a 1951 analysis of GEICO written by a young Buffett here - "The Security I Like Best" - (thanks to Oded for the link).

Buffett on Bear Stearns (50 seconds)

Buffett on the Yankees (2 mins)

Buffett on Succession (1 min. 41 secs)

"All Three [CEO's] of them are far better than I am".

IV: In my opinion, this is one of the secrets to Buffett's success. Buffett's investment company owns 49 private businesses, that employ more than 217,000 employees. The CEO's that run these businesses are all independently wealthy and do not really need to work. Yet they continue to work under and remain extremely devoted and loyal to Buffett. The reason for this is simple: Buffett refuses to take credit for Berkshire's success. Rather he gives all the credit to his managers, often making statements like "All three are far better than me". This is how you earn long-term loyalty. In contrast, a CEO who takes all the credit for himself will inevitably chase away great executives and managers.

VIDEO: Fairholme's Bruce Berkowitz Interviewed on CNBC

Maria Bartiromo interviewed Fairholme's Bruce Berkowitz yesterday on CNBC's Money Masters Series. The $6 billion Fairholme Fund (FAIRX) which has adopted Warren Buffett's Value Investing playbook has outperformed the market in 7 of the last 8 years (including this year) since its inception. If you had invested $10,000 with Berkowitz when he set up the fund in 1999, that investment would be worth today nearly $36,000. That's an average annual return of 17.8%. A similar investment in the S&P 500 would have earned you just under $12,000. In the last year alone, the fund achieved 17% returns.

Street Smarts: Value Plays

A Gem from the Interview

When Bartiromo asked him how he screens the market, and what he looks for in an investment, Berkowitz's reply could have been scripted by Buffett himself:

1. Great Owner / Managers that do well in all economic environments.
2. Businesses that generate significant free cash flow.

The relevance of both these points to Value Investing cannot be emphasized enough. Firstly, Value Investors focus on free cashflow, not net profit. Net profit can be manipulated or distorted by one-time items or non-cash expenses (such as depreciation). Cashflow is the only thing that matters. Secondly, cashflow must be assessed across an entire business cycle - preferably 10 years and at least 7. And you need to be looking at what's happening to cashflow during the recessionary years. That's what Berkowitz meant when he said "in all economic environments".

What is Fairholme's Long-Term Performance?

1 Year: 23.33% (S&P 500 - 15.54%)

3 Year: 19.94% (S&P 500 - 13.90%)

5 Year: 19.79% (S&P 500 - 13.99%)

I think these returns speak for themselves.

How was this Performance Achieved?

Fairholme's Value Investing style is best viewed by looking at some of the Fund's metrics. In particular:

(1) Fairholme does not diversify - it has 24 holdings only. In fact, 2 of it's holdings - Berkshire Hathaway (BRK-A) and Canadian National Resources (CNQ) make up just over 35% of the entire portoflio's value.

(2) Fairholme is a Long-Term Investor - the fund's asset tunover is 20%, which means it holds its investments on average for 5 years. You couldn't ask for clearer proof of patience or analysis conviction.

(3) Fairholme is 'Cash-heavy' - Like most Value Investors, Berkowitz views cash as a strategic asset - to be stored and hoarded, and to only be used when great opportunities arise. The Fund does not feel compelled to be fully invested in the market, but rather waits for doom and gloom periods where better value can be found. It currently has 22.5% of its assets in cash.

Fairholme and Berkowitz's team have clearly demonstrated that stellar returns are achievable by a combination of good old fashioned patience, fundamental and research and rational analysis. Value Investing is not rocket science; It just demands that you think critically and independently.

Friday Video: SNL on Stock Brokers

Every Friday, in anticipation of the weekend (and Shabbat) I hope to post a video that has some relevance to Value Investing and / Israel.

This first one, a Saturday Night Live classic, is on the stock broking profession. Like most satirical lampooning, there lies much truth within the comedy.

Despite beginning his career as a stock broker, Warren Buffett has often been critical of the stock broking and funds management professions and analysts' research in general. Specifically he has questioned the value of stock recommendations that are short-term oriented and which are based on fickle 'flavor-of-the-month' consensus. Instead he prefers his own independent thinking and ideas, which were mostly generated without a supporting team of research analysts, computers, or research databases.

Three of Buffett's most memorable quotes on the subject that come to mind are:

"Wall Street is the only place that people ride into in a Rolls Royce to get advice from those who take the subway".

"The only role of stock forecasters is to make fortune-tellers look good'.

"I don't read economic forecasts. I don't read the funny papers".

Shabbat Shalom and Have a Great Weekend!