Novel Investor

Compounding investing wisdom...

Seth Klarman: When Enron Looked Like A Steal

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Twenty years ago this month, the Enron scandal came to light. It was one of the biggest falls from grace for a Wall Street darling in recent history. It was the largest bankruptcy at the time (2001). That is, until a year later when Worldcom filed and more recently with the financial crisis.

The fraud at Enron destroyed the accounting firm Arthur Andersen. It led to new regulations with Sarbanes-Oxley Act. A book, The Smartest Guys in the Room, was written about it (then made into a movie with the same name). But worst of all, the shareholders were wiped out.

If there is one lesson to take away from Enron’s collapse, it is the risk of having a huge chunk of your net worth tied to the existence of one company. A lot of decent shareholders, including employees, were completely oblivious to the fraud going on at the top. They were all wiped out!

Unfortunately, while bankruptcy often has a nasty ending for stockholders, it’s not the end of the story. Another world of investing exists around failing companies.

A bankrupt company still has assets, which are sold off to pay its creditors. Secured creditors, like bondholders, are paid first. Unsecured creditors, like banks, employees, and suppliers are next, if there’s any money left. The stockholders are always last and typically get nothing. Continue Reading…

The Squeal that Set Off the Panic of 1907

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And one cloudy day somebody asked for a dollar, and not getting it promptly enough, very promptly squealed. That squeal was the signal to the chorus of the entire world, which also wanted Money! Money! Money! It is sad to want money and not get it. But to ask for your own money and not get it is the civilized man’s hell.

Thus the 1907 bank run began.

The Panic of 1907 is a story of the stupidity of a few greedy rich men attempting to corner United Copper, the failure of the Knickerbocker Trust Company, and one J.P. Morgan.

Augustus Heinze, his brother Otto, and Charles Morse cooked up a scheme to corner the market in United Copper stock. The corner began on October 14, 1907. Their plan was a short squeeze, that failed spectacularly two days later as it took Otto’s brokerage house down with it.

A dip in confidence is all it takes to set off a bank run and the Heinze brother’s failure was enough catalyst to trigger distrust. Continue Reading…

Wise Words from Warren Buffett

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Most people will point to Warren Buffett’s spectacular track record as a thing that sets him apart. And it’s certainly impressive. His results show what great returns and a long runway can accomplish. Of course, only one of those things is easily copied.

Everyone is drawn to Buffett’s returns but the biggest lesson is the advantage of investing early in life. Buffett made his first investment at the age of 11. That started a 78 year (and counting) long experiment for compounding to work its magic.

No special skills or knowledge are required with compounding. It’s the one thing everyone can take advantage of with a little bit of money and time and patience. Patience is key. It also, likely, causes the most trouble.

Buffett seemed almost destined to build an empire. He had a business mindset at an early age. He hustled gum and Coca-Cola bottles door to door, bought a 40-acre farm, and built a pinball machine business before he went off to college.

Buffett’s investment track record officially began in 1956 with the Buffett Partnership. He ran it until 1968, producing a 32% annual return (25% for his limited partners). But before he closed up shop, he bought shares in a declining textile company known as Berkshire Hathaway. It was trading below its net current asset value. Continue Reading…

Howard Marks and Seth Klarman on Being Prepared

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There are a lot of ways to invest. Value investing is the most counterintuitive, in that value investors are often better prepared to seize opportunities during market drawdowns. It’s also why it’s so hard to follow.

2008 was an extreme example of this. It was, potentially, the worst-case scenario. The crisis had multiple possible outcomes and on October 2nd of 2008, every outcome was on the table.

Only a week before, Wachovia and Washington Mutual were “saved” through forced acquisitions and the first attempt at a financial bailout plan failed in a House vote. A week before that, Lehman collapsed. Then the next day, October 3rd, Congress came to its senses, passing the Emergency Economic Stabilization Act — the bailout — which President Bush signed later that day.

That was just in the U.S. It was global and only the beginning. The timeline of events is extraordinary. Continue Reading…

Lessons from Seth Klarman’s Margin of Safety

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Seth Klarman’s Margin of Safety is a rare and elusive book that sells for a huge premium over its IPO original price. It’s a book about managing risk and its title is the key to it all.

Klarman follows a value investing philosophy influenced by Ben Graham — buying something for less its worth.

What’s unique about Klarman’s book is the updated views relating to his own experiences prior to publishing in 1991. There are chapters dedicated to junk bonds, institutional investing and the short-term performance race, thrift conversions, looking for catalysts, and distressed/bankrupt securities. He also covers the basic value philosophy.

I pulled eight of the bigger lessons (there are more) from the book to share. If you can get your hands on a copy, it’s worth the read. Continue Reading…

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