This is the final post that I will be making on Blogger. I've now completed a lot of the transfer and formatting to work on WordPress and I must say it is looking much better than what I have now.

Once I have the URL up and running, I'll post an update and let everyone know.

The URL will remain the same at www.oldschoolvalue.com

Feeds can be subscribed to via http://feeds.feedburner.com/oldschoolvalue

I'll see you soon at the new Old School Value.

I've decided to move this blog from blogger to WordPress. If you decide to blog one day, just start with WordPress. Makes life easier. Question my other ideas but trust me on this :)

Reasons for changing, in no particular order:
1. Blogger has a very very very bad comment system which led me to using a 3rd party system which I'm not fully happy with.
2. All the widgets and extras you see were the result of me hacking my own site.
3. Much more widespread use, functionality and features.
4. Better themes to play around with.
5. I get to be in control of data without worrying about Google banning me.

While this blog is still young I'll try to move it now rather than try to move a mess 1 year later or so.

More importantly, thank you to all the readers and visitors who find this place interesting. I'm no Oscar winner but it's you that make blogging fun and challenging.

I'll provide more updates as the move progresses. You may also have to resubscribe to the new address, but we'll see how it goes first.

P.S.
I've joined a new investing network focused on dividend investing, value investing and a long-term buy and hold philosophy. Check it out as it is a great collaboration and I'm excited about the great content it will contain. The Dividend Network.

As I was reading Where Are the Customers' Yachts, there was a little aptitude test which I found amusing that looks at whether you have what it takes to do well in Wall Street, Old School Style. Ready to take it yourself?

A Little Aptitude Test
Note that this book was first published in 1940 and during this time, there were no computers or internet so the Street made money by selling securities manually and in person.

"If you have to hesitate in answering them, count the answer wrong."

1) Do you perceive quite clearly what is the objection to playing roulette wheel that has two zeros on it?
2) If a man has tossed a coin "head" four times in succession, which do you think he is more likey to toss the fifth time, heads or tails?
3) When do you consider that it is a good purchase to draw one card to an inside straight?
(An inside straight draw, or gutshot draw or belly buster draw, is a hand with four of the five cards needed for a straight, but missing one in the middle. For example, 9-x-7-6-5.)
4) If you answered (3) correctly, do you find that when you are actually playing poker for money, you can always resist making that draw?
5) If a stock which is not paying any dividend is split two for one, how much good does that do the stockholder?
6) What is the primary purpose of a business enterprise?

Here are the answers.
1) If not, don't bother to be a finacier; be a roulette player.
2) If you think he is more likely to toss either heads or tails, look into the interior decorating game.
3) When you are playing for soybeans. (When you don't have anything on the line)
4) If not, stay home with your money and start practicing being a miser.
5) If you think it does him any real good, come and join the sales department, but steer clear of the trading department.
6) The primary purpose of a business is to make money.

How'd you do? Got what it takes?
Seems like I certainly don't.

Advice of the Day
There are two rules for success:
1. Never tell people everything you know.

I don't like mutual funds. Not because of the excessive fees and not because 95% (or more) underperform the market. I don't like or invest in mutual funds mainly because I don't have the temperament for them and I can't stand their sleight of hand.

No Patience
First some background. My current investment assets are ALL tied up in my 401k account and since I can't take that money out till I'm 60, it forces me to think for the long term. I also only invest in individual stocks on my 401k plan (If you have this option on your plan, you should really take advantage of it). No mutual funds for me. I have no patience for them.

It may seem contradictory that a supposedly value based investor has no patience, but I find my patience levels for stocks and mutual funds are on completely different scales. When I invest in individual companies I begin to understand the company as a business partner. When I invest in mutual funds, I see only YTD returns and charts.

Common Mistakes
Before I started to learn about investing, I did invest in mutual funds. I figured that a "guaranteed" 10% return would be great. Along with that naivety, I found myself following some common traits.

1. I looked at the percentage gains and chose funds based on the previous years returns.
2. I chased after rising funds.
3. I somehow always seemed to look at "growth" funds.
4. I switched between funds like a race driver switching lanes.
5. I figured a 2% expense ratio didn't affect my investment returns.
6. I had no idea what I or what the mutual funds were doing and I didn't do anything about it.

Now 1-5 are all common silly mistakes but the real problem was no. 6. I didn't know what was going on. Since I didn't know what I was doing, I was making the first 5 mistakes.
So why wasn't I doing anything about it? If you read my about me page you would know that I believed I was incapable of investing on my own. But here I am doing it old school style.

Fast Forward with Clarity
I began to notice a trend whenever I went out to a restaurant or even a health supplement shop and asked for a recommendation. Guess where the salesperson always led me? Straight to the highest margin product. Sure they would mention something about another product, but the conversation would quickly focus again on the high margin product.

Witnessing this time after time, a question finally popped into my head. Are brokerage firms or financial advisers trying to sell me something based on margins or commissions without much regard for my financial future? For the majority, the answer is YES. They are all businesses and like all businesses, they need to sell something, sometimes anything, in order to make a buck. This means mutual fund companies have to sell the good the mediocre and even the bad funds. They will pass it all off as good funds of course.

Mutual funds also spend truckloads of cash in advertising and marketing to seduce the first time investors by claiming "performance figures" and diversification, but with so many companies in a mutual fund, there are sure to be bad companies in the mix. The truth is that mutual funds are a product of the financial markets so that companies can make money. Not to make you money.

I'll end this with a Munger quote.

When you mix raisins and turds, you still have turds - Charlie Munger

Advice of the Day
Throw your rubbish in the bin. If it's too far, throw it from where you are.

With the big drop in the market last week and things not looking particularly bright, having cash on hand will be important in order to pounce on opportunities. Here are some possible ideas and other readings that may be of interest.
* Monish Pabrai Interview

*Banking Lessons from Buffett

*Actively Manage Your Career to Stay On Top of Your Game

*The Graham Number

*Lionsgate Entertainment: Misunderstood, Too Cheap to Ignore

*An Overview of the Global Shipping Industry

Advice of the Day
There's a point where you have to accept that your teacher is wrong and that saying the right answer doesn't help anyone.

For all value investors or those seeking to purchase $1 for 50c, I highly recommend you visit Value Investors Club. This is a site where people submit their best ideas once a year in order to gain or maintain their free membership. For those that just want to get some ideas, you can sign up for free to view valuations that were written 45 or 90 days prior.

Missed Boat?
As I was looking through, I came across a nice valuation on WellPoint, a company that came into my radar when it dropped to the low $40's in March due to a lot of fear and uncertainty. Add to that Hilary Clinton's healthcare policy and it surely was a great opportunity. Unfortunately, my research and due diligence wasn't up to speed so here I am waiting for the boat to moor again.

This valuation is from Value Investors Club and written by miser861. Full credit goes to the author. Written Feb 20 2008.


WellPoint Valuation by Miser861
WellPoint trades for 7x my 2010 estimate of free cash flow, and 10x 2008 estimated free cash flow. This seems cheap for a business that should grow EPS 15% per year, has mild cyclicality, earns 50% returns on tangible invested capital, and is run by a shareholder friendly management that deploys capital aggressively into share repurchases.

My 10,000 Foot View of Managed Care
Managed Care Organizations (MCOs) add value by purchasing healthcare for its customers in bulk, and secondarily pricing and spreading risk. MCOs negotiate prices with providers, and mark up those services by around 20%. The MCO collects insurance premiums upfront and earns investment income on the float, but also has some overhead.

As the industry operates today medical costs per member may increase 7% for example, and WLP might raise premiums per member 7.5%. The business is very scalable on G&A. At WLP G&A has declined as a percent of revenue by 100 bps per year on average over the last several years.

Each MCO has a unique mix of members in Commercial, Medicare and Medicaid plans. The consensus is that Commercial in general has the least member growth potential as incrementally healthcare inflation is pricing many employers out of the market. On the plus side employees who aren’t covered by a group plan often purchase individual plans that carry higher margins than group plans since MCOs can be more choosy about who they cover. Medicare is viewed by most as the high growth segment for two reasons. First, a higher percentage of seniors are going to privately-run Medicare Advantage plans as opposed to government-run traditional Medicare plans. Second, the senior population is growing. However there’s considerable controversy surrounding Medicare Advantage funding as it is about 13% higher per member than traditional Medicare, and MLRs are likely lower. The Medicaid business is viewed by many as a potential minefield given straining state budgets, but is generally viewed as having decent member growth potential.

Politics
The market seems concerned about the outcome of any potential healthcare reform. While I think in some scenarios reform could be a threat, based on conversations with industry experts I think it could more easily be an opportunity, particularly for WLP.

Universal coverage in itself would be positive – 47 million potential new customers – but margins are more important than members. Of the iterations of universal coverage models, one that concerns me is guaranteed issuance combined with optional coverage. Guaranteed issuance would ensure that no one is denied coverage. Auto insurance operates on a universal coverage model, but coverage is mandated. Actuarially speaking this is important because safe drivers, who wouldn’t buy insurance voluntarily, subsidize risky ones. Were auto insurance optional, premiums would be significantly higher for everyone. The managed care industry in New York operates under a guaranteed issuance/optional coverage model. MCOs can operate profitably in New York, but anecdotally average premiums are $400-500 per month versus $200 per month in California where there is no guaranteed issuance. Guaranteed issuance could disincentivize good membership. As you probably know, groups already operate on a sort of guaranteed issuance model, it would only be a risk for the individual business. Individuals are 7% of WLP’s membership, so exiting that business would be relatively painless.

Another byproduct of universal coverage might be government funding cuts to Medicare and/or Medicaid as these programs might be expanded to extend coverage to a larger population. So many industry insiders fear that Medicare Advantage margins are at risk, but again any margin compression would likely accompany an influx of volume.

The risks to the group business seem minimal to me. The issue is about covering the uninsured, not nationalizing the already insured.

My overriding thesis on reform is that MCOs have a number of levers they can pull to stay profitable, and MCOs are good at pulling levers. Benefits can be cut, premiums can be raised, in every imaginable combination. Case in point, last year California had an ambitious reform agenda that included putting a floor on medical loss ratios. In the commercial segment the target floor was to be 85%. After some back and forth, concessions were made. Premium taxes were allowed into the MLR calculation (not the case for GAAP), which lowered effective GAAP MLR to maybe 82.5%, and some GAAP G&A was permitted into the calculation which brought effective GAAP MLR to around 80%, pretty close to where most insurers write commercial business anyway. Note that California ultimately abandoned the reform effort because of the state’s precarious budget situation. Ultimately, in America we generally don’t impair an industry without some input from industry participants who understand the implications of the action.

Choosing Among the MCOs
The table below is my best attempt to level the comparison quantitatively. The estimates are a combination of sell-side consensus peppered with my judgment.

	2008 P/FCF	2010 P/FCF	2010 FCF/Shr Growth
UNH	11.2	8.6	15%
WLP	9.8	7.5	15%
AET	11.1	8.7	12%
CVH	11.4	9.1	12%
HNT	10.8	8.4	13%
HS	10.8	8.5	12%
HUM	12.5	9.4	16%
AGP	14.0	10.7	14%
CNC	9.5	8.2	8%
MOH	14.8	11.6	12%
SIE	15.4	12.4	12%
WCG	10.3	9.1	6%

WLP appears statistically cheapest. I think WLP is also superior qualitatively.

For starters WLP is a Blue Cross Blue Shield carrier. BCBS is the most valuable brand in managed care. 33% of Americans have a BCBS plan. BCBS has five times the brand awareness of their biggest competitor. BCBS has more bargaining power versus providers than any MCO because of its large membership. BCBS’ provider network is also the largest. WLP adds the most value for members by providing a superior product for similar prices. For this reason, WLP continually takes market share in the commercial space and is able to grow members profitably in this stagnant market.

In my analysis, rightly or wrongly, I’ve prioritized minimizing my exposure to Medicare as Medicare funding cuts are a single point of failure. My rationale is thusly: a plan’s exposure to Medicare today has little to no bearing on future exposure. I want to minimize my immediate Medicare blowup risk but I don’t want to give up any upside from Medicare/Medicaid expansion in the future if that’s how universal coverage materializes. If Medicare and/or Medicaid are expanded to extend coverage to a greater population, funding cuts will likely be necessary but would only affect existing members. A plan with no Medicare members today could benefit from member growth in the future without having to take a step back first. Larger plans have a cost advantage in bidding. Anecdotally I’m told that as long as an MCO has Medicare infrastructure and know-how there is no real barrier to acquiring as many members as the plan can bid for successfully. So I want to position myself with a large carrier with Medicare infrastructure but minimal exposure today.

The below table is a rough estimate of EPS contribution from Medicare Advantage and Medicaid for the various MCOs. I have no doubt it contains errors, but clearly WLP is at the very low end of the spectrum. WLP management has intentionally avoided aggressively moving into Medicare because of the questionable value proposition of Medicare Advantage that makes funding uncertain.

	Medicare	Medicaid
UNH	20%	7%
WLP	4%	6%
AET	6%	2%
CVH	35%	10%
HNT	12%	10%
HS	104%	0%
HUM	69%	2%

Valuing WLP
Management has provided guidance for 2008. I don’t feel smart enough to expound on the guidance except to say the sharecount guidance doesn’t make sense given their buyback guidance. I don’t make any assumptions about benefits from healthcare reform.

	2007	2008E	2009E	2010E
Operating Rev	60.10	62.60	66.50	10.90
Investment Income	1.00	0.85	0.90	0.97
MLR	82.40%	81.60%
G&A Ratio	14.50%	14.40%
EBIT	5.70	6.00	6.50	7.10
EBIT Margin	9.30%	9.50%	9.70%	9.90%
Interest Expense	0.45	0.59	0.69	0.79
Net Income	3.30	3.40	3.70	4.00
Non-cash expense	0.76	0.76	0.76	0.76
Cap Ex	0.20	0.20	0.20	0.20
FCF	3.90	4.00	4.30	4.60
Diluted Shares EOP	0.56	0.50	0.45	0.40
FCF/WTD Avg Shr.	6.60	7.57	9.05	10.75

If we apply a 14-16x multiple on $10.75, WLP could trade for $150-175 in 2-3 years. Barring a legislative disaster I don’t see how EPS will decline, so at less than 10x ’08 FCF it’s hard to lose money from here in my view. But a legislative disaster is possible, and it’d be a gross overestimation of my abilities to assume that I can model a worst case scenario. Some faith that such a scenario is both unlikely and of a manageable magnitude is required.

As an afterthought on valuation, some have raised the possibility of monetizing the captive PBMs. WLP’s PBM is the fourth largest, it processes about 400 million prescriptions per year. Medco (MHS) should do about 570 million prescriptions in 2008, and will do a little over $4 of EBITDA per prescription. If WLP does $3 per prescription, that’d be $1.2 billion of EBITDA. MHS trades for 12x 2008 EBITDA. 10x would mean the WLP PBM is worth $12 billion, leaving us with a stub selling for maybe a multiple point less than today. UNH has announced that it plans to provide more detail on its PBM in 2008. WLP will provide more, though somewhat less helpful, disclosure in 2008 as well.

No, Berkshire Hathaway is not currently priced with a 50% discount. Instead, I followed this article from Stock Pursuit about a trader who did buy Berkshire B (BRK.B) shares at about 50% discount to its market price.

Basically it goes like this.
A person that put in a sell order at market price was given $2,147 per share instead of the quoted $4,448. Well, if this person lost about 50% off his investment, then someone must have bought at a 50% discount. How? A trader put in a limit buy order at $2,147 and since the sell orders were being filled and there wasn't much activity going on, the order was filled.

I can imagine the pain and shock of that poor guy.

I'm also one of the people that tend to buy and sell with market orders but I'll have to protect myself with limit orders from now on as I find myself investing in thinly traded companies.

You can read the article here.

Warren Buffett mentions moats all the time in his talks and writings and emphasizes the importance of finding a company with moats. The thing is, I haven't come across anything specific from Buffett where he explains how to distinguish and categorize moats but The Little Book That Builds Wealth provides a practical framework that helps any investor to identify economic moats/competitive advantages. Let's take a look at some of the ideas from the book.

Mistaken Moats
If you know who Warren Buffett is, I assume that you have been introduced to the notion of moats. But what about the mistaken ideas of moats? With our desire to "fall" for our companies, we begin to claim that even a little positive aspect is a moat. However, here are some illusory moats that the book suggests we should be aware of.

1. In the business world "bet on the jockey, not on the horse" does not apply.
No matter how good a manager is, the fact is that many companies operate in a unattractive environments. If you asked a world class chef to serve superb dishes profitably by placing him in a small local diner along the highway, would be quite a hurdle. There are some exceptions, but we should consider the norm rather than convincing the exception is the norm.

2. Great products do not create moats.
Remember vinyl discs, cassette tapes, CD's, video tape recorders, muscle cars, film cameras, Tommy Hilfiger, Netscape? All were great products but none of them lasted. Who knows what will replace the iPod or the AeroGarden. Or what about Krispy Kreme? They have some fantastic tasting donuts but nothing to lure me back when I decide to go on a diet. Unless a company can leverage its product to create an economic moat profits will probably be reaped for a short time.

3. High market share i.e. bigger is not necessarily better.
In highly competitive industries, high market share is not equivalent to a competitive advantage. Kodak (film), IBM (PC's), Netscape (internet browsers), GM (automobiles), and Corel (word processors) were big companies but they failed to maintain their moat which led to either a demise or a sale. Size can help a company create a moat but it is rarely the source of an economic moat by itself.

4. Operational efficiency that we call "great execution".
If a company succeeds by being leaner and meaner than its competition, it is probably because the company operates in a very tough and competitive industry where cutting costs is the only way to profit. You can cut and carve a fat cow but once you get to the bone, where is the meat going to come from?

The Real Deal
So talented CEO's, great products, high market share and great execution aren't defined as moats. Then what is?

1. Intangible assets
2. High switching costs
3. Network economics
4. Cost advantages

The following sections are excerpts from a 2003 Morningstar article.

Intangible assets
Intangible assets generally refer to the intellectual property that firms use to prevent other companies from duplicating a good or service. Of course, patents are the most common economic moat in this category. In techland, Qualcomm's (QCOM) CDMA patents give it a strong moat in the cellphone industry. Patents are also critical for drugmakers like Merck (MRK) and Johnson & Johnson (JNJ). A strong brand name can also be an economic moat. Just consider consumer-product companies like Coca-Cola (KO) and Gillette.

High switching costs
Michael E. Porter defines switching costs as a barrier to entry that involves the one-time inconvenience or expense a buyer incurs to change over from one product or service to another. Buyers in these cases often need a big improvement in either price or performance to make the switch to another product worthwhile. Medical-device companies Biomet (BMET) and Stryker (SYK) benefit from high switching costs because, for example, a surgeon would have have to forgo the comfort and familiarity of doing procedures with one artificial joint product. And because the surgeon would have to be trained to use competing products, he or she would also have to contend with lost time and money resulting from not performing as many surgical procedures.

Network economics
The network effect occurs when the value of a particular good or service increases for both new and existing users as more people use that good or service. It can also occur when other firms design products that compliment an existing product, thereby enhancing that product's value. For example, the fact that there are literally millions of people using eBay (EBAY) is the thing that both makes eBay's service incredibly valuable and makes it all but impossible for another company to duplicate its service.

Cost Advantages
Firms that can figure out ways to provide a good or service at a relatively low cost have an advantage because they can undercut their rivals on price. Walmart (WMT) is a textbook example of a low-cost producer because its large size allows it to negotiate favorable item costs.

Additional Information
The Little Book That Builds Wealth is written by Pat Dorsey from Morningstar. It is a simple to read book that helps with understanding (and brushing up) what and where moats lie. It also lets the reader see how Morningstar goes about defining moats. Do check out the diagram on page 145 that shows the moat identification and labeling process.

The book is a great read to add and apply to any investors mental model as suggested by Charlie Munger. Pat Dosey also wrote The Five Rules for Successful Stock Investing which covers a lot of the ideas from this book but has more information related to valuations and industry specific advantages and disadvantages.

I have only touched the outline of the book. For a detailed and intriguing read, do consider reading it.

This week brought in many interesting ideas and facts, and here are the places you can get them.

* The Festival of Stocks #91 – Israel’s Stock Market Facts Edition featuring my analysis on K-Tron

* Books I’ve Read and Recommend You to Read Too by Mehdi at Strong Lifts. A fantastic strength training site. I particularly like how he says "Let people/boss continue to annoy you, it will motivate you to find something else."

* 8 Quotes That Will Make You a Better Investor

* Major takeaways from the visit with Mr. Warren Buffett

* Reminders from Omaha

* Financial Advice for New Grads

* Is Smallcap Volatility Pain Worth the Gain?

* Setting the Record Straight on Buffett and Derivatives

* J. Crew (JCG) Takes Apparel Out to the Woodshed

* Making Money Where Others Fail

Enoch Ko from The Wealth Accumulator brought up some very good questions related to my K-Tron analysis and wrote a interesting follow up post on Thinking About Growth. So while the topic of growth was still on my mind, I decided to revive a couple of old posts I had written in February.

Looking Back at Growth and Discount Rates
I re-read what I wrote and I still hold to it and I think it is a good time to bring it up again because there have been some new readers and probably think I'm crazy for using the methods that I do when evaluating companies. So I invite you to read it and let me know how big a fool you think I am :)

* Explaining Discount Rates
* Choosing a Growth Rate