Newsletter July 14, 2007

InvestorsFriend Inc. Newsletter July 14, 2007

GETTING RICH IN STOCKS IS SIMPLE BUT NOT EASY

Warren Buffett became one of richest people in the world from a standing start (started out delivering newspapers – inherited little or no money).

He claims that it is basically simple (although not easy) to become very rich in stocks. The extremely simple formula is to buy shares in excellent highly profitable companies, in businesses that you understand and ran by trustworthy managers,  but only at bargain or at fair prices. Then you must simply hold those companies for many years. This will allow most of the gains to compound without ever paying capital gains tax. These companies should not be sold when there is a fear that that they might temporarily drop in price. They should only be sold if they become very over-valued or if their competitive position in the market is permanently damaged.

This strategy requires a long-term outlook and it requires tremendous discipline. For example the discipline to avoid extremely over-priced internet stocks in the last 1990’s. The discipline to go against the crowd. The discipline to accept (but not realize) losses “on paper” when you are confident that the market is under-pricing a stock.

Last Week I read an article by James P. O’ Shaughnessy that provided his latest evidence that a strategy of buying low P/E or low P/B or low Price to Sales stocks (ideally combined with earnings and share price momentum) consistently beats the market by a wide margin on average. See my earlier article that reviewed his 1997 book. It’s really a simple strategy. Applied with discipline this simple strategy works.

In my own case checking for reasonable value is always a key part of our analysis. We apply methods that we understand to be consistent with those of Warren Buffett.

I have done very well in the market. I suspect I would have done even better if I had not sometimes allowed the fear of short-term loss scare me into selling shares in excellent companies.

I am absolutely convinced that getting rich in Stocks is inevitable in the long run if one has the discipline to follow the simple logical strategy espoused by Warren Buffett and as practiced by InvestorsFriend.com. Such a strategy will rarely result in very large losses even on any one individual stock. With few or no large losers, the overall portfolio will do well. Our performance speaks for itself.

Meanwhile I read yet another article that argued that in essence you can’t beat the market except by luck. As Warren Buffett says, it is wonderful to play a game where most of the opponents have been taught that there is no use in even trying!

CONRAD BLACK

(Lord) Conrad Black has been found guilty of three charges of mail fraud and one charge of obstruction of justice and faces perhaps 10 or more years in prison in the U.S.

Call me crazy, but I have some sympathy for him.

I do think he took money that should have gone to shareholders but I am not entirely convinced it was illegal. Keep in mind too that the he was convicted on the word of an admitted liar (David Radler). Also the case was somewhat weak given that he was found not guilty on fully 9 of 13 charges. Also last week it looked like the jury might not be able to reach a verdict.

His lawyer indicates he was found guilty on amounts that total $2.9 million whereas the total charges amounted to about $90 million.

I am sympathetic too because this is happening in the U.S. where sentences are harsher. He may get a longer sentence “to send a warning” to others. How fair is that? And if the sentence were served in Canada he might be on parole after serving less than 20% of a sentence as opposed to some 90% in the U.S.

Keep in mind that there is generally nothing illegal about CEOs taking multi-million salaries. Ironically, Black and company could likely have legally taken the money as pay and bonus. They wanted it structured as non-compete payments because for inexplicable reasons, those are non-taxable.

I am against obese executive pay. Had they taken these amounts as excessive bonuses I would view that as morally wrong but not illegal.  I believe too the large management fees flowed through to Black’s private company Ravelston were likely obese and immoral but not illegal.

The line between the immoral the illegal can sometimes be a blurry line, not a bright line. But if Black had taken the highroad and stayed away from excessive compensation, then there would have been no charges.

As a large percentage owner of these companies I believe Black should have insured that the companies paid a reasonable dividend. If an owner/CEO receives large dividends then he has a lot less reason to seek obese pay and bonus money. Black should ideally have taken a modest salary as CEO and then earned dividends like any other shareholder. I always get nervous of large established profitable companies that do not pay a dividend. It can provide extra incentive for obese executive pay and other “looting” by controlling owners.

Due to his actions I am not entirely sympathetic, perhaps indeed he does deserve some jail time.

Keep in mind too, that while Black has been found guilty of diverting $2.9 million and charged with diverting some $90 million, it has been reported that Hollinger International and Hollinger Inc. have spent an unbelievable $600 million “going after him”. (The $600 million is from memory of news reports I can’t find a source for this figure at the moment). That is not illegal but it is surely immoral. The prosecution brought forward no victims. The shareholder victims have lost much more in the zeal to “get” Conrad than they they ever lost due to his improper actions.

Even if he gets little jail time, Black has certainly lost a huge fortune, perhaps ultimately lost everything. It appears he will be dragged through various courts for many years to come (even while he is is jail).

I believe Canada should act quickly to restore Black’s citizenship so he can be allowed to serve his time in Canada and be eligible for early parole like any other Canadian.

He renounced his citizenship only after then Prime Minister Chrétien refused to give permission for the United Kingdom to allow him to be honored as a Lord. If the U.K. which after all is in effect the historical “parent” of Canada  wanted to give him this honor, what justification was there for Chrétien to stand in the way of that honor?

The man was born in this Country and lived most of his life here. Now he is in a time of need. It behooves Canadians to show some charity and assist him by supporting restoring his citizenship on his request.

AN AMAZING EXAMPLE OF TRUE INDEPENDENCE

Most everyone claims to be independent. No one likes to admit that they have been “bought” in any manner.

Most of us like to think that if we were ever offered a large “kick-back” we would turn it down. But we are also glad not to be put into the position of having to make a choice like that. There is a reason that the Christian Lord’s Prayer includes the line  “And lead us not into temptation”. Humans are often weak and it’s best that we not be led into temptation.

Recently I came across a College that had been led into a sort of temptation. And this College decided to hold firm and resist that temptation. And it was a huge temptation involving a LOT of money. I found their story to be inspirational.

Prior to the late 1950’s the U.S. Federal Government did not subsidize colleges and universities. When the Federal Government began to do so, virtually all colleges accepted the money with open arms. That was their choice and it is fine. But Hillsdale College felt it was a threat to its independence and REFUSED to accept the money. Basically they wanted the freedom to teach without being beholden to the powerful Federal Government.

There is a saying “When you drink from the King’s wine, you must sing the King’s song”. There is some truth to that. It is difficult to be completely independent from your supply of money.

By the 1970’s the federal government tried to impose certain regulations on Hillsdale College on the grounds that even though Hillsdale was not accepting Federal Money, its students were accepting Federal student loans. Once again Hillsdale refused to back down. They found other ways to help their students with loans and grants and they forbade their students from accepting any Federal Money.

Now that is true independence. I stand in awe of such resolve.

Perhaps if more corporate managers were as careful as Hillsdale College to avoid any perception f being “bought”, corporate performance would be the better for it.

END

Shawn Allen, President
InvestorsFriend Inc.

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