Benjamin Graham - 'The Memoirs of the Dean of Wall Street'

This is the latest book I have finished, written by the Dean himself. Faithful to the title it shows in a nonlinear fashion several episodes of his life. He was a well-off kid in his early years, but after his father died he lived through some economic hardships and had to work and study simultaneously. At that time there was no TV and he had lots of time to devour books, mostly classics. Being intelligent and having a very good memory and literary interests, he basically taught himself several languages in order to read the original versions. He taught himself Greek, Latin and French; he also spoke German and Spanish good enough to translate a famous Spanish book.

Graham did not have any formal training in economics since most of the courses he took were in humanities. Having had during his youth financial problems he felt driven to make money and he wanted to help his family, especially his mother. So when he was recommended by a teacher to work in Wall Street as a bond analyst, he immediately took the job.

At that time stocks were considered to be for gamblers. It is interesting to see that even though he is famous for being the father of value investing he wrote that he does not consider knowledge of it made him earn much. Actually, he made most money in other things like Geico, the insurer, at prices not considered extremely low. He also specialized in hedges like buying convertible bonds and at the same time shorted the underlying stock in order to have a hedged trades. Hedges played out quite well until the 1929 crash came and he covered most of the short stocks at an initial profit without closing the convertible bonds at the same time. That had bad consequences since the stock market fell for years and being more than 100% leveraged he accumulated 80% of losses.

He was quite depressed at the time but he made it all back after some years. He once speculated with IPOs of almost unknown companies, which is something he did exceptionally. He made money the first two times but ! had very big losses the third time, also with much larger amounts of other peoples money.

Other times he made money were by being an activist: by buying a stock in a company that had lots of money in bonds and pushing the management to return the money to the shareholders. He found the companies by gathering information from different sources at a time where very little information was disclosed but where a lot of it was possible to get if you had the drive and time to ask for it.

It is impressive to see how honest he was with himself. When you read the autobiographical book it gives another image than when you read "Security Analysis." In "Security Analysis" it looks like a god is writing and the message he sends is strong. On the other hand when you read his memoirs you see that he is human and that he deviated at times from his own principles.

One thing that is clear is that he could invest unemotionally, hold on to losses without panicking or caring much about it and selecting investments in cold blood, mostly when it was clearly an opportunity. He did not care much about money; he cared more about other things, especially cultural things like reading, the theater and traveling. His lack of interest in money is the reason his partner Newman made more money than he did, he even said that Newman was much more involved in business than himself.

Another thing that struck me is that not a word was mentioned about Warren Buffett. On the other hand, Buffett mentions Graham lots of times. Graham was impressed by few persons in his life. One of them was Bernard Baruch, even though he did not apparently like him since he thought that all his actions had a financial and not a human purpose and that even his philanthropic deeds were done in order to increase his personal fame.

In conclusion the book was great, a rare example of a great investor writing about his life. You understand a lot more about Graham after reading it and it gives good insights on how to be a better i! nvestor. ! It shows how complete his life was. It talks about his travels, lovers, wives, children, about the theater screenplays he wrote and his writing interest that pushed him to write "Security Analysis" and the "Intelligent Investor." He talks about the books he read, his other work as a tax consultant and an expert at valuing companies. He describes the people he met, his economic theory about making a currency not based on gold but on commodities.

In summary, it shows that he was quite a normal person with much less material interests than most people. He actually seems to have made money because he worked in that environment and wanted to have a well-off life after having had financial troubles. What he enjoyed the most in life were simple things that basically had no cost at all, that's why he recommended to his grand children, on his 80th birthday speech, to follow a cultural life.

Cheers!
JVB

An Overlooked Stock May Be This 'Hated' Sector's Best Bargain

It's a story that hasn't gotten a whole lot of press recently, but U.S. banks are doing well.

Very well.

Wells Fargo (NYSE: WFC) shares hit an all-time high on July 8. The other three large U.S. banks are also on the rise: Citigroup (NYSE: C) is up 25%, Bank of America (NYSE: BAC) is up 14%, and JPMorgan Chase (NYSE: JPM) is up 24%.

The reason? Put simply, banks make money by borrowing at a low rate and lending at a high rate. The rates being offered for the average savings account are next to nothing these days. Yet banks are able to turn around and issue loans to businesses and individual customers for rates of 4% to 5%. This difference is called the interest rate spread. On top of that, banks are able to loan many times the amount of money they are required to keep in reserve. This use of leverage maximizes profits even further.

Ever since the financial crisis, lending has been on the rise. And when the money flows, banks get rich.

As you can see in this chart showing the total loans and leases of U.S. commercial banks over the past five years, lending levels are now surpassing the same $7.3 trillion mark reached just before the financial crisis.

 

StreetAuthority expert Michael Vodicka pointed out in a recent article that Warren Buffett has been stocking up on financial stocks: "Buffett was busy loading up on shares of Wells Fargo between January and March, closing this year's first quarter with 460 million shares, up 4% from last year and his biggest holding with a 20% allocation.

"But while Buffett has been accumulating shares of Wells Fargo for years, he initiated a new position in another bank stock during the first quarter. Berkshire Hathaway disclosed ownership of 50 million shares of U.S. Bancorp (NYSE: USB), Berkshire's seventh-largest holding with a 2.6% allocation."

While all the aforementioned companies deserve a closer look, today I'd like to tell you about another financial stock that is selling for what I think is a bargain price and just announced a $1 billion share buyback program.

Although it doesn't often get the same kind of press as the "big four" banks mentioned above, Capital One Financial (NYSE: COF) is actually the seventh-largest bank in the U.S. by deposits.

On July 2, Capital One received Federal Reserve approval to repurchase up to $1 billion of its own shares. The bank plans to start buying the shares later this year and complete the buyback by the end of next year's first quarter.
 
Capital One currently has 561 million shares outstanding, which at today's prices bring the total value to roughly $36.9 billion. So $1 billion worth of share repurchases won't have a huge impact on the current value of shares.

But what is more important here is that Capital One is making an effort to increase shareholder value. It's also worth noting that companies often repurchase shares of their own stock when management believes those shares are undervalued.

Earlier this year, there was more good news for Capital One shareholders.

 

On May 2, Capital One raised its dividend to 30 cents a share from 5 cents. This marked its first dividend increase since the financial crisis. The current yield stands at 0.7 %, but analysts at Morningstar forecast a projected yield of 1.8% in the near future.
 
With a price-to-book ratio of 0.9, Capital One's shares are currently trading below book value; compare that with the industry standard of close to 3 times book value. Capital One's trailing 12-month price-to-earnings (P/E) ratio of 11 is almost half of its competitor's average of 21, and its forward P/E is even cheaper at 9.4.

As for the future, Capital One looks to be in a very strong position. To keep things simple, it may be best to look at the three main business segments -- credit cards, consumer banking and commercial banking -- separately. Credit cards represent 40% of revenue, consumer banking 40% and commercial banking the remaining 20%.

The company's credit card segment was bolstered in 2012 when Capital One acquired HSBC's $30 billion credit card portfolio. This transaction made Capital One one of the top five credit card issuers in the world.

In 2012 Capital One's banking division acquired ING Direct's (NYSE: ING) entire U.S. operations. The deal added 7 million customers and $83 billion in additional deposits to the banks' portfolio. The deal also jump-started Capital One's automobile lending -- up an astonishing 24% in 2012 alone.

Finally, the commercial and industrial lending segment is also showing growth -- up 13% in 2012.

In spite of its recent acquisitions, Capital One carries virtually no debt and is gushing free cash flow. In this year's first quarter, Capital One reported free cash flow of $2.5 billion, nearly double its $1.3 billion in the same period last year.

Risks to Consider: Financial stocks have been surging in part due to the recovery in housing. Although housing prices continue to rise, weakness in the sector would be a drag for banks.

Action to Take --> Capital One is a solid, growing business selling at a bargain price. I think Capital One's fortress balance sheet and recent success indicate that this company's best days are still ahead. I rate it a buy for long-term investors at today's prices.

P.S. -- Stocks like COF are similar to a special group of securities we call "Forever Stocks." These are world-dominating companies with fortress balance sheets that buy back massive amounts of stock, boosting the value of the rest of the shares. They're solid enough stocks to buy, forget about and hold "Forever." To learn more about these stocks -- including some of their names and ticker symbols -- click here.

Why the Dow Is Falling Behind This Morning

Usually, major market benchmarks trade roughly in tandem, as the same factors that affect one industry tend to affect them all to a greater or lesser extent. Today, though, you can see the disconnect among the most popular stock indexes as different industries post different levels of performance. Overall, the broad market is slightly weaker, with a rise in jobless claims offsetting strong gains in durable-goods orders and capital-goods purchasing activity. But while the Nasdaq has climbed 0.27% due largely to the 25% spike in Facebook shares, the Dow Jones Industrials (DJINDICES: ^DJI  ) lags behind, falling a more substantial 0.37% points by 11 a.m. EDT.

Many of the stocks contributing the most to the Dow's losses are the same stocks that have struggled for a while now. Caterpillar (NYSE: CAT  ) has fallen more than 2%, showing a complete lack of confidence among investors that the morning's economic data marks a turnaround in the foreseeable future. Following its earnings disappointment yesterday, a Wall Street analyst added insult to injury by downgrading the stock. Strength in the U.S. economy will help Caterpillar, but it really needs global expansion to resume in order to make the most of its profit opportunities.

Microsoft (NASDAQ: MSFT  ) has also posted a decline, falling 1.8%. In restructuring its corporate structure, Microsoft clearly hopes to come out with products and services that will be better integrated with each other and take maximum advantage of technological advances it makes. Yet Facebook's strong results underscore the speed at which up-and-coming companies have challenged the business models of big tech stalwarts like Microsoft, further upping the pressure for Microsoft to become more efficient in capitalizing on opportunities in promising areas like the mobile space.

Despite the Dow's overall losses, though, a few Dow stocks have posted gains. Travelers (NYSE: TRV  ) is rising after a report from Fitch Ratings noted favorable trends in earnings throughout the property and casualty insurance sector. With past-year catastrophic events having helped companies boost premiums while loss experiences more recently have become favorable, Travelers and its industry peers have seen loss ratios plunge, boosting profits. The insurance industry tends to run in cycles like this, so investors shouldn't expect Travelers to stay this profitable forever. But after a tough couple of years for the industry, it's good for insurance company investors to see conditions finally improving.

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Some Numbers at Graham that Make Your Stock Look Good

There's no foolproof way to know the future for Graham (AMEX: GHM) or any other company. However, certain clues may help you see potential stumbles before they happen -- and before your stock craters as a result.

A cloudy crystal ball
In this series, we use accounts receivable and days sales outstanding to judge a company's current health and future prospects. It's an important step in separating the pretenders from the market's best stocks. Alone, AR -- the amount of money owed the company -- and DSO -- the number of days' worth of sales owed to the company -- don't tell you much. However, by considering the trends in AR and DSO, you can sometimes get a window onto the future.

Sometimes, problems with AR or DSO simply indicate a change in the business (like an acquisition), or lax collections. However, AR that grows more quickly than revenue, or ballooning DSO, can, at times, suggest a desperate company that's trying to boost sales by giving its customers overly generous payment terms. Alternately, it can indicate that the company sprinted to book a load of sales at the end of the quarter, like used-car dealers on the 29th of the month. (Sometimes, companies do both.)

Why might an upstanding firm like Graham do this? For the same reason any other company might: to make the numbers. Investors don't like revenue shortfalls, and employees don't like reporting them to their superiors.

Is Graham sending any potential warning signs? Take a look at the chart below, which plots revenue growth against AR growth, and DSO:

Source: S&P Capital IQ. Data is current as of last fully reported fiscal quarter. FQ = fiscal quarter.

The standard way to calculate DSO uses average accounts receivable. I prefer to look at end-of-quarter receivables, but I've plotted both above.

Watching the trends
When that red line (AR growth) crosses above the green line (revenue growth), I know I need to consult the filings. Similarly, a spike in the blue bars indicates a trend worth worrying about. Graham's latest average DSO stands at 60.6 days, and the end-of-quarter figure is 65.7 days. Differences in business models can generate variations in DSO, and business needs can require occasional fluctuations, but all things being equal, I like to see this figure stay steady. So, let's get back to our original question: Based on DSO and sales, does Graham look like it might miss its numbers in the next quarter or two?

I don't think so. AR and DSO look healthy. For the last fully reported fiscal quarter, Graham's year-over-year revenue grew 52.6%, and its AR dropped 7.0%. That looks OK. End-of-quarter DSO decreased 39.8% from the prior-year quarter. It was down 3.9% versus the prior quarter. Still, I'm no fortuneteller, and these are just numbers. Investors putting their money on the line always need to dig into the filings for the root causes and draw their own conclusions.

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