Insight Asset Management LLC

Reflexivity, Reality and Markets

2011-10-28T11:49:00.000-07:00

I have been trying to make sense of the developments in Europe, and especially the huge up move on October 27, 2011 in the US stock market as the plan was announced in Europe to leverage up the stabilization facility (EFSF). George Soros’ concept of reflexivity comes to mind. I had been wrestling with whether the reported European debt relief plan amounted to just kicking the can down the road in which a debt problem is endeavored to be solved with ever more debt, or whether it amounts to something more substantive. Suddenly it occurred to me that in a way it doesn’t matter, and that the answer lies in reflexivity. Reflexivity is the case where perceptions create a reality which then leads to further actions reinforcing that reality. When you have an illness and you go to a doctor, the doctor will do an assessment and possibly tests to ascertain the exact illness. You either have the illness or you don’t; the illness is an objective reality. This is not the case in finance and economics, where perceptions can create reality to a high degree, one reason why there are so many tail or rare events in finance. In the case of the Europe sovereign crisis, if a critical mass of market participants believe in the viability of the debt plan and then go on to buy financial assets such as stocks, thereby lifting the price and improving the market and confidence , thereby improving the real economy, increasing tax revenues enabling government debt burdens to be reduced: the perception becomes a reality: In other words real conditions can improve or deteriorate via reflexivity. Reflexivity is close in concept to that of animal spirits, but reflexivity explains the process more exactly.

Of course, perceptions are based at least to some extent on reality. It’s not just a matter of unreasoned reflexivity but of the market now having some evidence via the announced deal that Germany will do anything to save the Euro including issuing Eurobonds or having the ECB print money if need be, even if it has to be forced on Europe via market turmoil. I think the market believes Germany will throw overboard its hyper-vigilance regarding inflation to save the Euro. So it’s not so much that the announced deal as given is so good but what it portends for the future. Of course a reflexivity generated reality must in the end must be backed up by the facts. Should there be evidence that Europe is balking at implementing the above scenario, stock markets could fall substantially. In addition, the problem of European growth remains. PIIGS countries are not able to devalue their Euro currency, thus inhibiting one means of future growth, and then there is the general problem of a socialized Europe with structural unemployment. But I do believe that as long as markets see money printing on the horizon they might even be able to live with a managed exit from the Euro for one or more of the PIIGS countries. In the end though ,money printing is no substitute for true debt reduction and restraint in government spending.

I do believe though that more fundamentally through increased fiscal restraint Europe is taking some steps toward a more substantive solution along the lines suggested by Reinhart and Rogoff in their seminal book, This Time Is Different. And grudgingly through mandated cuts (unless the US Congressional Super Committee comes to a solution, which I doubt) , the US may also be pursuing some fiscal restraint. The central question is whether US entitlements of Medicare and social security will be reformed in the next presidential term. Taxing the rich would provide just a drop in the bucket toward reducing a trillion dollar debt problem. There is no long term solution to the US debt problem without entitlement reform. Money printing and a European TARP will only carry the markets so far as we learned via the US TARP and Quantitative easing programs, which led initially to huge stock market rise but then a significant pullback.

Philip I. Frank, Ph.D.
President and Portfolio Manager,
Insight Asset Management LLC
Tel: 212-223-2715
e-mail: insight-asset@earthlink.net

Multidisciplinary Approach, Technology Revolution, and Ultra-Fast Information Flow

2011-05-07T10:00:00.000-07:00

As a portfolio manager and analyst I believe it is important not only to focus on finance and accounting which are of course vital when conducting analysis, but to have a broad multidisciplinary approach which includes an understanding of business strategy, economics, geopolitics, history, demographics, and technology. A distinguishing characteristic of today's world as compared to say ten years ago is how fast information moves today. It’s not that the internet wasn’t around then, it’s just that the internet is so much more embedded now, and I think information moves much faster now. Arguably Facebook and Twitter have a lot to do with the change going on in the Middle East today. But I also wonder as to its effect on markets. Could it be that market cycles themselves are being accelerated by this ultra-fast flow of information? That would make some sense, just as you could argue that the Middle East turbulence we see today was not necessarily caused by the internet, but that the internet accelerated the process. If market cycles are being accelerated that would help to explain both the US stock market's plunge in 2008 as well as the market’s huge bounce back since 2009. This would bolster the view that the 2009-2011 advance isn't just a brief reprieve like the market’s recovery from the 1929 crash only to take a second leg down. Rather, information is being digested and integrated more quickly as the markets "see" further ahead. Today, markets may well be forecasting accelerating social development such as a Middle East moving toward democracy,and the beneficial effects this would have on global economic growth. Faster information flow has been a hallmark of the world's development over the centuries, but the Internet technology revolution has accelerated it greatly, in Insight's view.

This ultra-fast flow of information could also be accelerating business development in general . There could be a virtuous cycle which develops such that accelerated information flow leads to faster corporate development which in turn leads to research and development expenditures further enhancing information flow. This should enhance the present value of corporations, as well as providing a tailwind for continuing technological innovation. A wonderful book I’m reading now, Why the West Rules -For Now by Ian Morris expounds the argument that advances in social development (which includes energy capture, organization, war making and information technology) from 2000 to 2050 will rise two times as much as that which occurred in the previous 15,000 years. Of course the author brings out that there are large risks to this scenario including war, famine, and disease. Still, the possibility of such an advancement is breathtaking, and it can be argued that the world is still in the early stages of the technology revolution heralded by the Internet. Yes, the problems the financial world faces are very real including developed world debt, a continuing US housing problem, stubbornly high US unemployment, and Chinese inflation. As clients know, Insight is not dogmatically bullish, having sold significant amounts of stock and raised cash during both 2002 and 2008, based on macroeconomic analysis. Nevertheless, the ongoing technology revolution is reason for bullishness, supported by a reasonably valued US stock market chastened by past excesses, and a US government intent on reflating the US stock market, in Insight's view. Insight has positioned clients portfolios accordingly.

Philip Frank, PhD
President and Portfolio Manager,
Insight Asset Management LLC
e-mail: insight-asset@earthlink.net

An Analysis of a Chinese Hotel company

2009-11-10T10:48:00.001-08:00

Insight views Home Inns and Hotels Management Inc. (HMIN), a Chinese hotel company, as providing broad exposure to the Chinese economy, ex exports. The Chinese economy is growing quickly, and Insight views such growth as likely to continue for many years to come. In addition, an investment in HMIN will benefit from a weak dollar, which Insight views as likely to continue. Insight conducted a market opportunity analysis for the company. The general idea was to use hotel penetration and revpar (revenue per available room) in 2009 in the US as a basis for determining the total Chinese hotel revenue opportunity. To do this it was necessary to ascertain when Chinese GDP would catch up to 2009 US GDP. Having done the above, HMIN's market share and margin could be estimated , capitalized, and then discounted back to get the present value of HMIN stock. Implicit in the analysis is the assumption that hotel usage in China 19 years from now will constitute a greater share of GDP than it does in the US now. This assumption was made based on the hugely greater Chinese population vis the US and thus what Insight believes will be greater domestic demand for leisure services in China than in the US. Insight also believes foreigners will provide significant demand for tourism China in future years, although such demand has not been quantified in the current analysis. Available data suggests that the total number of hotel rooms in the US today is about 4.7 million, and the current US GDP is about $14 trillion. It was then calculated how long it will take Chinese GSP, currently around $3.4 trillion, to get to current US GDP of $14 trillion. Chinese real GDP has averaged about 10% growth annually over the last 19 years. In the analysis this figure was haircutted and 8% average annual real GDP growth was assumed for the next 19 years, which leads to the conclusion that after 19 years Chinese GDP will be about at 2009 US GDP levels. It was then calculated what the total revenue opportunity for the Chinese hotel market will be in 19 years assuming the same proportion of hotel rooms in China as exists today in the US. The Chinese population today is about 1.3 bn, or some 4X greater than the US population. Based on this demographic analysis it was assumed that there will be about 4X more hotel rooms in China 19 years from now as there are in the US now, or some 20 mn. Since it was assumed that Chinese GDP will be in 19 years the same as US GDP today, it was assumed that in 19 years, the revpar in China will be the same as in the US today. Marriott International's recent revpar of $100 was used in Insight's calculation. The total hotel revenue opportunity in China 19 years from now was then calculated. Revpar of $100 times 360(days per year) times the projected number of hotel rooms (20 mn) =$728bn. It was assumed that HMIN will remain one of the top ten economy brands in China over the next 19 years and at that time have a 5% share of the total market, or some $36 bn. Marriott's net margin was in the 20% area in 2006, a good year, so it was assumed that HMIN would have a net margin of 15% for total net income of $5.5 bn. Let's assume the market puts a 15 PE multiple on this net income for a total market cap of $82bn. HMIN's beta is 2, and to be conservative this market cap was discounted at 15% over 19 years for a total present value of $ 5.8bn. Based on a current share price of about $35, the current market cap is about $1.4 bn. Thus by this analysis HMIN provides an opportunity for a potential 300% return. Even if it is assumed HMIN only gets a 2.5% market share it provides potential for a 100% return from here. Please note the above analysis contains several assumptions, which may not hold or come to fruition. Still, Insight views HMIN as an investment with significant potential.

Philip Frank, PhD
President and Portfolio Manager,
Insight Asset Management LLC
insight-asset@earthlink.net

Insight Asset Management LLC is currently long Home Inns and Hotels Management Inc. (HMIN) in its model portfolio and in its client portfolios

March 2009: The Market is Treacherous Still

2009-03-28T15:31:00.001-07:00

The market has been rallying I think on optimism about the TALF plan and the related plan to get toxic assets off of bank balance sheets. Also, and more importantly to me, the economic numbers such as home sales and durable goods numbers have been better (and in a way too good. Given the state of the world the durable goods number seems odd. I wouldn;t be surprised to see downward revisions). For the private equity firms, buying toxic assets and asset backed paper are in essence LBOs financed by the government, providing the private equity firms with call options on the economy. But how do the private equity firms get a low enough price to make a good profit? I think the answer lies in the government owning big pieces of the major banks. The government through "stress tests" will put pressure on the banks, forcing them to either sell assets at a cheap enough price and line up private capital to cover shortfalls or merge with another bank, or the government will seize the bank. The government I think hopes that via this approach, while the government will have to pony up some capital, a lot of the capital will come from the private sector. Will this work? You cannot get water from a stone, and alot of toxic assets are terminally so--CDOs, CLOs, and many CMBS securities worth maybe $.25 on the dollar. Also as Chanos pointed out in the Wall Street Journal only a small percentage of toxic assets have been truly marked to market. I think we will see further consolidation in the banks. And Geithner's hands may be progressively tied. Congress is going to be very reluctant after AIG to ok more bailouts. If this toxic asset plan does not work the government is going to have problems, and will probably try an end run around Congress via the Fed and FDIC (as they are doing even now). Zombie banks, ala Japan, are still not out of the question, as the government hopes time, spread lending, and moving away from mark to market accounting will help the banks. What of the "stimulus program?" Much of it is fundamentally based on taxing and and spending, rather than truly on investing. It looks like US debt is going to double to about $20 trillion within 10 years, based on what's been provided. I think in the end the present government is counting on nationalizing health care and putting price controls on doctors and drug companies and cutting back drastically on social security to the "rich", under the present government’s basically redistributioning wealth to the "poor", non-capitalist agenda. You can see the US moving very deliberately now to a European style soft socialist model. Ironic that the government is trying to use the private sector and private equity and hedge funds to bring this about. While the "stimulus" may provide a near term boost, and the Fed is trying to use the same playbook it has used for a long time of inflating us out of problems, I can't see where the framework is now being set for robust economic growth. Becker, a Noble Prize winning economist pointed out in the Wall Street Journal that the multiplier effect of government spending is less than 1. I think government efforts to prop up the housing market may have some small effect in the short run,but in the end impede price discovery, and impede a bull market in real estate. We are entering an era of increased regulation, higher taxes, government debt crowding out private sector investment, coupled with cutbacks in defense. Europe has endured chronically high unemployment and subpar GDP growth under such a regimen. The government is too cute by half, in my view. They are trying to use the private sector toward their redistributionist ends, rather than letting private enterprise flourish via low taxes and as little government intervention as possible. It's interesting to see how much the US has gotten away with. We have the privilege of being able to denominate our debt in dollars and having the world's reserve currency along with 30% of world GDP. Absent this, given our huge run up in debt our currency would share the same fate as Iceland's or Hungary's. And even so we are beginning to see strains in the Treasury market. If Treasury yields rise appreciably, which could happen as China pulls back from buying our debt and in the midst of heavy issuance, reverberating problems in the markets could arise. The government has taken a radical Kenynesian approach in what amounts only to a grand experiment, based on the view that FDR's New Deal led the US out of the Great Depression. It can easily be argued that FDR’s New Deal did not work, and instead World War II, and the world wide demand for US manufacturing is what did work to put the economy on the right path. Currently, at about 20X potential trough earnings, the S&P 500 is not cheap. In my view, this remains a treacherous market due to the global structural problems we have not witnessed since the Great Depression. Bear market rallies can be seductive. In Insight’s model portfolio, therefore, much cash is being held along with short positions as hedges against limited long positions. There will be a time to allocate heavily to long equity positions. The markets now are in much flux, and that time could come soon, depending on a variety of factors including valuation. But that time has not yet arrived, in Insight’s view.

Philip Frank, PhD
President and Portfolio Manager, Insight Asset Management LLC
e-mail: insight-asset@earthlink.net

Disclaimer

2009-03-28T15:29:00.000-07:00

The information that Philip Frank, PhD of Insight Asset Management LLC provides or that may be derived from this website is not intended to be, nor should it be construed as, personal investment, tax or other advice to any party or a solicitation to effect any transaction in any security. We publish information, discussions and opinions about companies that are of interest to us. None of our content is a recommendation that any particular security, transaction or strategy is suitable for any particular person. Our content should not be used as a substitute for advice from an investment professional who has been retained by you and is familiar with your finances, risk tolerance and financial goals. Investments in the securities markets are speculative and involve substantial risk and only you and your advisers can determine what level of risk is appropriate for you. Our content will not contain a description of all or any relevant risk factors pertinent to any particular investment. We do not in any way guarantee or warrant the success of any action that you might take in reliance on the information provided by, or derived from, this website. We disclaim any and all warranties regarding such information, express or implied, including, without limitation, any warranties of merchantability or fitness for a particular purpose. Information and discussions on this site are of a specific date and, due to changing market conditions and other factors may no longer be current and may no longer reflect our current views. We may or may not take positions in the companies that are discussed in this website and any position that we have may change at any time after the publication of any discussion about such companies. The content of this website is derived from publicly-available sources, such as the companies themselves and other sources that we consider to be reliable, without independent verification by us. Accordingly, we cannot assure you that our information is accurate or complete. Any links to other websites contained in this website in no way mean or imply that we endorse or warrant the information or recommendations contained on such websites or that we have any affiliation with the operators of those websites.

Four Ideas

2009-03-02T10:50:00.000-08:00

1) The government is exchanging preferred for common re: Citigroup, and mandating that no dividends be paid to preferreds. Through its actions, the governmentt has basically compelled the other preferreds of Citi to convert to common: If you're not going to get a dividend, you might as well at least get a vote by converting to common. Govt actions have made the preferreds of other companies worry that the same fate applies to them, and in so doing upended the whole preferred market, just as happened when the govt took over Fannie Mae. Another unintended consequence of govt meddling in private business. 2) Re: banks. Where are we? The government is backing away from doing something about toxic assets , instead moving again to capital injections. The govt won't nationalize or put the banks into receivership for fear of another Lehman-like effect on the market. But this course of action leads down the path of a Japanese style lost decade. There is no easy way out of the current predicament. 3) I cracked out by macro notes from my MBA studies, and my macro textbook, co-written by Bernanke no less. What determines investment? I f(-r, -t, Af). Investment is negatively affected by higher real interest rates, negatively affected by higher taxes on investment and positively affected by the future marginal product of capital , which itself is a function of productivity. In the long run the government's massive issuance of debt will likely raise interest rates. Unless the government can repeal the laws of economics, higher taxes and issuance of govt debt should hurt investment which will in turn hurt GDP, which will in turn hurt the stock market. 4) Re: taxes--The new administration wants to eliminate the tax shield that companies get from conducting business abroad. This is a big deal. Many of the companies I model have effective tax rates in the 25% range because of this tax shield. If you move from a 25% tax rate to a 35% tax rate, EBITDA (1-t) goes down by in excess of 10%. And incorporating this into my discounted cash flow (DCF) models, DCF price values are lessened by 20% in several cases I've looked at. There is a reason the market is falling. If 600 to 700 was a price target on the S&P before, 550 to 650 is a credible price target now, and that's assuming we have a depression with a small d and not a Depression with a big D.

Philip Frank, PhD
President and Portfolio Manager,
Insight Asset Management LLC
e-mail: insight-asset@earthlink.net

Berkshire Hathaway Class A (BRKA) Would Be Conservatively Valued at $152,000 Per Share

2008-03-03T10:29:00.000-08:00

Berkshire Hathaway stock (BRKB) is a core holding in Insight’s client portfolios. BRKB has the same claim on Berkshire Hathaway’s assets as does Berkshire Hathaway Class A stock (BRKA), but is worth 1/30th of BRKA, which makes BRKB more affordable. BRKA recently sold for $140,000 per share. The stock may be under some pressure after its recent earnings release, showing a quarterly earnings decline. Those who use PE ratios to value stocks may also focus on the stock selling for 16X trailing earnings, with the prospect of a tougher insurance climate in 2008. However, PE ratios are the least sophisticated way to value stocks, and I believe BRKA would be conservatively valued at $152,000 per share. If the economy should surprise on the upside, a case could easily be made for a BRKA price of $180,000 per share. Further, BRKA with its $38 billion in cash and strong balance sheet, is well positioned to make opportunistic deals. In the years to come I believe activist hedge funds may well push for spin-offs and the like which will further realize Berkshire Hathaway’s (Berkshire) value. What follows is a very conservative analysis which supports the view that BRKA’s stock price is certainly not overvalued, and that BRKB and BRKA are excellent holdings in today’s turbulent market. I utilized four valuation methods in valuing Berkshire Hathaway: a discounted cash flow analysis, price/book, look through earnings, and a sum of the parts analysis. First, I conducted a 30 year discounted cash flow analysis (DCF) by adding taxed earnings, look through earnings (tax effected), and depreciation, and subtracting capital expenditure, and acquisition expense (projected by using historical acquisition expense as a percentage of revenues). I assumed 5% in annual growth in revenues, 10% operating margins declining to 8% operating margins in later years, 3% growth in perpetuity, and an 8% discount factor. I also assumed growth in look through earnings will slow from 10% to 8% over the years. Working capital is not easy to forecast, and a case can be made for either positive or negative working capital needs, so working capital needs were not incorporated in the DCF. As a check I calculated on a revenue basis what Berkshire’s share of GDP would be under my model in year 30, as compared to share of GDP presently. The fact that GDP share would be roughly comparable in year 30 suggests I am not being overly-aggressive in my revenue growth assumptions. The discount factor of of 8% is based upon CAPM which includes a risk premium of 4.5% , a riskless rate of 4% ( a little higher than the current ten-year treasury interest rate, to be conservative) , and a beta of 1. I assumed Berkshire will have the same beta as the S&P over the long-term. This is actually a conservative discount rate as one could argue that Berkshire’s cost of capital is substantially lower. I have treated acquisitions as an expense even though this item does not flow through the income statement. Growth through acquisition has been a major component of Berkshire’s strategy over recent years as it has transformed itself into a conglomerate. And acquisitions, whether by way of cash or by the issuance of stock represent an expense (cash) or a cost (stock issuance) to the Company even though this expense or cost does not run through the income statement. The DCF suggests a conservative valuation of $141,000 to $150,000 per share for BRKA. Since Berkshire is conservatively capitalized and relatively unleveraged, its ROE is lower than that of a more leveraged entity. I believe that some investors make the mistake of seeing this lower ROE as making Berkshire less valuable than an entity with a higher ROE. Rather, I see Berkshire’s lower ROE as indicative of a less leveraged balance sheet, and thus of a company which will hold up better in a market correction, as it has proven in 2007. In addition, stated accounting ROE actually underestimates economic ROE, as stated ROE excludes look through earnings. In general, I believe Wall Street does not fully grasp Berkshire as an entity. It is vastly transformed from what it was several years ago when it was largely an insurance operation with a portfolio of common stocks. Over recent years Mr. Buffett has transformed Berkshire into what we it is now as part conglomerate (with additions ranging from the Israeli company Iscar Metalworking to MidAmerican Energy Holdings to Shaw Industries to Clayton Homes), part hedge fund (which has included a significant bet against the dollar, and in the past a large bet on bonds), and part a portfolio of common stocks. ) The stock was recently trading at 1.80X book value, a 1/3 discount to the S&P 500 average of 2.7X (at 12/31/2007). I see Berkshire’s non-insurance parts as being worth at least the 2.7X book of the typical S&P company. Given Berkshire’s diverse interests, I believe that the S&P 500 average book value is a better comparison for the stock than are other insurance companies whose sole business is insurance. Incidentally, if we add back to book value ½ the liability of deferred taxes and the full value of unearned premiums, Berkshire is trading at 1.6X book value. Since Berkshire’s non-insurance earnings before tax (EBT) and minority interest constitute about 45% of total EBT and minority interest, it could be argued that Berkshire’s proper price to book should be a blended rate of 45% of the S&P 500 average book value, and 55% of the average book value of 1.08 of various insurance companies (which has been depressed by the travails of AIG and the problem of writeoffs). This is about where BRKA recently traded, at $140,000 per share. Let us now look at Berkshire on a look-through earnings basis. Look through earnings are earnings of companies in which Berkshire holds minority investments, in proportion to shares owned, treated as if they are Berkshire’s own earnings. Dividend income is subtracted to avoid double counting. In essence look through earnings account for minority investments as if they met the criteria for utilizing the equity method of accounting. I estimate BRKA is now trading for 13X trailing look through earnings. If we use a conservative 15X 2007 earnings multiple to value Berkshire, a fair price per share for BRKA is $156,000. Let us now look at Berkshire on a sum of the parts basis. First, the current value of Berkshire’s cash and investments minus all liabilities (excluding unearned premiums and ½ of deferred taxes) is computed. This amounts to $4,900 per share. Next I value the current insurance business by placing a 10X multiple on EBT. This amounts to $52,500 per share. Next I value Berkshire’s float by utilizing a ten-year DCF, growth in float year per year of 5%, conservative margins of 10% on float, and growth in perpetuity of 3%. This DCF indicates that Berkshire’s float should be valued at $49,000 per share. I next value the non-insurance business, assuming a 10X multiple of 2007 trailing earnings before tax. This amounts to $43,500 per share. Next we determine the value of Berkshire’s after-tax investment gains exclusive of its equity holdings. This would include such things as its previous bets against the dollar and bets on bonds. These investment gains have averaged $2,750 per share over the last five years. If we put a 10X multiple on this number, we come to a value of $18,000 per share. This sum of the parts analysis suggests a fair price for BRKA of $168,000 per share. Overall then, whether we use a price/book value approach, look through earnings, a discounted cash flow analysis or a sum of the parts analysis, Berkshire appears undervalued. The average of all the valuations conducted provides the best estimate of BRKA’s value. This average estimate is about $152,000 per A share, some $12,000 per share more than its recent value of $140,000. Concern has often been expressed that no successor could duplicate Buffett’s prowess. Insight has shared similar concerns. However, the valuation work above assumes almost no Buffett premium. Even in the sum of the parts analysis, if the investment gain portion of $18,000 is subtracted, BRKA would still be worth $150,000 per share in the sum of the parts analysis. The Buffett model of acquisitions in which talented managers are left to run their businesses as they see fit, puts Berkshire on very solid footing even after Buffett is no longer at the helm. Further, I view Buffett’s donation of Berkshire stock to the Gates Foundation as a long-term positive for the stock. As the Gates Foundation sells its Berkshire stock, activist hedge funds may well be buyers and push for a break up of Berkshire, which as the sum of the parts analysis shows is undervalued. Further, stand alone entities such as MidAmerican and Geico would quite possibly fetch even higher valuations than are implicit in my modeling. The future activity of activist hedge funds could eliminate Berkshire’s holding company discount, in my view. In addition, Berkshire’s strong balance sheet, with some $38 billion in cash, provides outstanding opportunities in these turbulent stock market times. Berkshire’s deal with Swiss Re, its deal with the Pritzkers for Marmon, its creation of a new bond insurer, are but a few examples of Berkshire’s saavy. Whereas many companies are value destroyers with ill timed stock buybacks and poor acquisitions, Berkshire has shown itself to be a master allocator of capital in which building shareholder value is paramount.

Philip Frank, PhD
President and Portfolio Manager,
Insight Asset Management LLC
e-mail: insight-asset@earthlink.net

Note: Insight Asset Management LLC is long BRKB in its model portfolio, and in its client portfolios.

EchoStar’s SpinOff and the New Teleommunications and Media Landscape

2007-12-29T09:10:00.000-08:00

The telecommunications and media landscape is evolving as mobile networks and devices assume more and more prominence as firms strive for control of the underlying software, hardware, content, and networks . EchoStar has significant strategic value in this process. A spun off entity from EchoStar will become effective 1/1/2008. This entity will house EchoStar’s infrastructure assets (SATS), while the remaining entity will be comprised of EchoStar’s pay-TV business (the new Dish). Insight has an interest in both entities post-spin. This is a special situation where value is fairly independent of what the overall stock market does. There is some belief on Wall Street that AT&T is interested in the non-spun entity, the new Dish. There is a law that except in certain circumstances, in the event of a spin-off , a stock deal cannot be done for two years afterward. So it would appear that an AT*T purchase is less likely (they could always do a cash deal), post the spin off. Perhaps this means a DirectTV-Echostar deal is more likely. Based on reports, it looks like there are $3 billion in synergies to be gained from a DirectTV or AT&T merger. That works out to about $44 per a new Dish share (tax effected with a 10 PE slapped on synergies). So even if the synergies are split evenly with the acquirer, there should be $20 per share upside to the new Dish if it is acquired. I think this EchoStar’s spin-off is ultimately about an acquisition, either by AT&T or the new Liberty Entertainment and DirectTV. As far as SATS, as an infrastructure company, it may get a higher valuation. So post-spin, Insight has an interest in both the new Dish and SATS. This deal also underlies Insight’s interest in the spin creating Liberty Entertainment by Liberty Capital which will contain a big chunk of DirectTV. Given the possibility of a Democrat controlled White House and Congress in 2009, there is some pressure I believe to get mergers done in 2008. This factor also provides impetus for an EchoStar deal.

Note: Insight Asset Management LLC's model portfolio currently has long positions in Liberty Capital and EchoStar

Philip Frank, PhD
President and Portfolio Manager,
Insight Asset Management LLC
e-mail: insight-asset@earthlink.net

Thoughts on Google's Valuation

2007-06-11T09:58:00.000-07:00

The price action in Google has been good lately, no question. In general, there has been a market rotation into technology. As interest rates rise, tech is viewed as being less interest rate sensitive, and more removed from a feared economic slowdown which will affect the consumer first. As to Google's valuation, it all comes down to what decision is made about the terminal multiple. In Insight's 30 year discounted cash flow analysis (DCF), a 25% return on invested capital in year 30 has been assumed, as has been a 3% required growth rate. The big question is how to estimate capital expenditures (cap ex) in the terminal year of the DCF. I believe the formula: EBIT * (Required Return/ROIC) is a good one for estimating cap ex. So, Multiplying EBIT by (1- required (growth of 3%/roic of 25%)),dividing by the perpetuity of the discount factor minus 3%, and discounting thirty years back gets you to a stock price of about $525, in Insight's analysis. Now it so happens that this is equivalent to a terminal EBITDA multiple of about 5.5 times. MSFT currently has an EV/EBITDA multiple of about 12X. So if you believe the argument that Google should have the same EBITDA multiple in year 30 as MSFT currently has, a stock price of $800 per share would be indicated. However, I believe that the market is using a higher discount factor to value tech companies than is suggested by the Capital Asset Pricing Model (CAPM). One possible reason for this is that as interest rates rise, tech companies may be disproportionally affected since so much of their valuation stems from the out years. (It is ironic that as interest rates rise presently we are seeing a rotation into techology stocks). Still, based on a PE ratio to growth (PEG) analysis and a DCF sensitivity analysis, the argument for a $600 stock price for Google does make some sense. Insight does hold some Google in its client portfolios. Yet, with a forward PE of about 27X, Google is not cheap and does have significant potential downside. Insight in general feels more comfortable investing its client's assets in stocks with cheaper enterprise values/EBITDA and cheaper PE ratios.

Philip Frank, PhD
President and Portfolio Manager
Insight Asset Management LLC
e-mail: insight-asset@earthlink.net

Special Dividends as a Means of Doing Deals By Shrinking Shareholder Equity

2007-06-07T12:52:00.000-07:00

Merger proxies are quite revealing. I have closely read the merger proxy in which ABC Radio Business is to be spun off from Disney to Disney shareholders and then merged into Citadel Broadcasting. This deal was structured as a reverse Morris trust which enabled both the shareholders of Disney and Disney to escape any taxation. But to structure a reverse Morris Trust it is necessary that a larger entity be merged into a smaller entity. Pre-merger Citadel's equity was valued more highly than ABC radio stations. So, how did the companies manage to structure this deal as tax free? A special dividend will be paid to only Citadel shareholders prior to the merger with the ABC Radio Business, thus increasing debt and shrinking Citadel's equity and enabling Disney to have a greater than 50% equity interest in the merged Citadel-ABC entity. Earlier this week I did some work on the $325 million investment of a private equity firm into Palm in return for a 25% interest in Palm. Here also a special dividend was paid out to Palm shareholders, at the same time that their equity interest was reduced to 75%. This special dividend was promoted as being very shareholder friendly by both providing shareholders with a cash payout while allowing them to retain an interest in the new entity's equity. In reality though the special dividend functioned to shrink shareholder equity of Palm so that the private equity firm would have to pay less than it would have otherwise for a comparable percentage stake in the entity. Had the special dividend not been instituted, in order to gain a 25% stake in Palm, the private equity firm would have had to pony up some $550 mn, as opposed to the $325 mn it did pay. So in both these cases the aim was to shrink existing shareholder equity: In the first case so that the parent spinning off a subsidiary would avoid tax, and in the second case so as to make it cheaper for a PE firm to gain a large voting interest in a public company. In both cases the special dividends were promoted as being shareholder friendly. In both cases I believe the special dividends were structured so as to enable transactions to proceed. After all shareholders could simply have sold their shares to raise cash had they so desired. Since the special dividends served to foist increased debt on both companies, other than in providing the discipline that all debt forces on managers, I can see no particular benefit to the shareholders involved other the lesser tax owed on dividends than capital gains. Still, I think these tax benefits to shareholders were not the primary motivation: Getting the deals done was the primary motivation. A company choosing an innovative deal structure in order to get a deal done does not in of itself make that company a long or a short. At Insight we believe though that understanding the structure of deals is important to understanding valuation which is key for investment decisions.

Philip Frank, PhD
President and Portfolio Manager
Insight Asset Management LLC
e-mail: imailto:insight-asset@earthlink.net

Thoughts on the market--Green, Global Infrastructure, Tech and CAPM

2007-04-29T11:00:00.000-07:00

Insight believes the green movement is an important and durable market theme. We initially tried to benefit from this theme a few years ago by going long Whole Foods Market. It worked for awhile until the markets began to see that while eating green is a real consumer interest, Whole Foods competitive position is not unassailable. And so the stock has weakened (and Insight is in fact short Whole Foods basically because of its valuation). But we still think green is a real theme. It's one reason why we own Weyerhaeuser, with its large ownership of forestland (In the end we believe wood is going to play an important role in biofuels). It's also why we won Bunge, with its agribusiness, and Cresud with its cheap Argentinean farmland. We believe that by using the Capital Asset Pricing Model (CAPM) to value companies, the market may be seriously understating the proper discount factor for technology companies, and overstating it for companies like Bunge and Weyerhaeuser, because we think these latter companies are strategically in a much more powerful position (sitting as they are at the crossroads of the green movement and the global infrastructure buildout), than is a tech company where competitive position is continuously up for grabs. It may well be that the outperformance by the natural resources sector this year is due to the market's belief that due to the above themes, and the fact that emerging market economies which are so dependent on natural resources for their growth, coupled with geopolitical tensions leading to immense competition for natural resources, natural resources stocks need to be revalued higher. And with many PEs in the group in the 10 range, compared to an overall market PE of 15, it could well be argued this revaluation is not over. In our model portfolio, Insight owns Bombardier, a Canadian airplane and transpiration infrastructure maker. Sitting in a New York City subway car, I wondered if Bombardier made the car, and lo and behold there was Bombardier's nameplate in the corner of the car. The multiyear construction of the Second Avenue subway in Manhattan should be a huge revenue opportunity for Bombardier. This dovetails nicely with the theme of global infrastructure buildout, which Insight is also trying to benefit from with investments in companies like Cummins Engine, Honeywell, Manitowoc, and Grainger. The corollary of this is my developing view that technology companies with high PEs like Google are very difficult to value. Last I looked, to justify Google's valuation you have to believe that in 30 years time it will have almost 10X as much a percentage of GDP as it has now. Maybe Google will be successful, and it certainly has the potential to be. We are in fact long Google in our model portfolio. But it seems to us that there is greater risk in a Google than would be suggested by CAPM. Therefore we have reduced our exposure to Google while buying beaten down tech companies like Dell, Level Three, and Motorola. The margin of safety there seems much higher, and the investor also benefits from regression to the mean.

Philip Frank, PhD
President and Portfolio Manager
Insight Asset Management LLC
e-mail: insight-asset@earthlink.net

The Beneficial Effect of Lower Interest Rates on Growth Stocks With Solid Competitive Positions

2006-10-08T09:54:00.000-07:00

Insight's investment approach is a flexible one. We invest in value stocks as well as growth stocks, and we implement long positions as well as short sales. Incidentally, to us the terms "growth stock" and " value stock" are in many respects artificial, because we pay alot of attention to valuation. So, for example, we would not be buying a growth stock, if we felt it didn't represent good value. What also makes us different from the usual long/short equity approach, is that we pay attention to macroeconomic factors, and will not, for example, slavishly maintain short positions in our portfolio if we think the macroeconomic environment is favorable enough. In the current macroeconomic environment we have drastically reduced our short positions. We do think we are more toward the end of the interest rate tightening cycle by the Fed than the beginning, and so far the economy while slowing, has been doing well. And even were the economy to slow further, as long as there is no recession, the stock market, in our opinion, could still go higher. With this view as a backdrop, we have been increasing our growth stock positions. We have, for example, recently been a buyer of Cisco, due to its reasonable valuation and, in our opinion, preeminent position as a provider of internet and communications infrastructure. While some value investors make the case for buying Microsoft, we think Cisco has a stronger competitive position than Microsoft, and with a similarly strong balance sheet. Growth stocks with solid competitive positions such as Cisco, Whole Foods, and Google, three of Insight's positions, should do well in an environment of lower interest rates, which is Insight's forecast. We know on a discounted cash flow (DCF) basis that lower interest rates make future cash flows more valuable, and since growth stocks get more of their cash flows in the out years than do value stocks, lower interest rates should provide a tailwind for growth stocks. The one macroeconomic proviso being that the economy must hold up for this scenario to unfold. Lower interest rates make future cash flows more valuable, but only where top line revenues can reasonably be expected to expand. We believe that one of the reasons the bear case for the market has not held up is that while lower interest rates often bespeak a slower economy, this time this has not been the case. Unlike previous circumstances in which an end to Fed increases sometimes heralded a massively slowing economy, currently available data suggests the economy is holding its own quite well.

Philip Frank, PhD
President and Portfolio Manager,
Insight Asset Management LLC
e-mail: insight-asset@earthlink.net

Disclaimer

2006-08-29T08:36:00.000-07:00

The information that Philip Frank, PhD of Insight Asset Management LLC provides or that may be derived from this website is not intended to be, nor should it be construed as, personal investment, tax or other advice to any party or a solicitation to effect any transaction in any security. Insight publish information, discussions and opinions about companies that are of interest to Insight. None of Insight's content is a recommendation that any particular security, transaction or strategy is suitable for any particular person. Insight's content should not be used as a substitute for advice from an investment professional who has been retained by you and is familiar with your finances, risk tolerance and financial goals. Investments in the securities markets are speculative and involve substantial risk and only you and your advisers can determine what level of risk is appropriate for you. insight's content will not contain a description of all or any relevant risk factors pertinent to any particular investment. Insight does not in any way guarantee or warrant the success of any action that you might take in reliance on the information provided by, or derived from, this website. Insight disclaims any and all warranties regarding such information, express or implied, including, without limitation, any warranties of merchantability or fitness for a particular purpose. Information and discussions on this site are of a specific date and, due to changing market conditions and other factors may no longer be current and may no longer reflect our current views. Insight may or may not take positions in the companies that are discussed in this website and any position that Insight may have may change at any time after the publication of any discussion about such companies. The content of this website is derived from publicly-available sources, such as the companies themselves and other sources that Insight considers to be reliable, without independent verification by Insight. Accordingly, Insight cannot assure you that our information is accurate or complete. Any links to other websites contained in this website in no way mean or imply that Insight endorses or warrants the information or recommendations contained on such websites or that Insight has any affiliation with the operators of those websites.

Is Aetna a Buyout Candidate?

2006-08-03T14:12:00.000-07:00

We are cautious presently on the equity markets, and while we have been holding cash and shorting stocks, we have not been implementing many long positions. In addition, we don’t usually like to invest on the premise that a company will be bought, but we believe Aetna (AET) is a special case due to its cheap valuation. We are well aware that Aetna recently reported disappointing earnings, and was also the subject of a recent story in the Wall Street Journal in which it was brought out that health insurance is becoming too expensive for some employers to afford. Yet, we do not think the problems in the health insurance sector are any more problematic than those in the hospital sector, which faces such problems as possible cuts in insurance and Medicare payments, and the trend away from hospitalization in general. Any yet HCA, a major hospital operator, has recently been the subject of a leveraged buyout offer (LBO) by a private equity consortium. Aetna is a relative bargain compared to HCA, as we will explain. It may be that due to the consolidation that has already occurred in the healthcare insurance area, a buyout of Aetna by a strategic, corporate buyer would fail to gain approval by regulators. Yet, we see no reason why a financial, private equity buyer would not be interested in a LBO of Aetna. Let’s step back for a moment and talk about what a LBO is. By analogy, buying a house is very similar in structure to a LBO. Why? Let’s assume you buy a $200,000 house with 10% down, and borrow the rest. Let’s also assume you put a renter in the house whose payments cover all your expenses including the mortgage. Let’s further assume the renter pays off the mortgage. Forgetting about commissions, taxes, and closing costs, if you sell the house for $200,000, what’s your profit? Well, you bought it for $200,000, and sold it for $200,000, so the profit is zero, right? Wrong! You put in equity of only $20,000, and financed the rest, so your profit is $180,000 ($200,000 minus the $20,000 down payment). You have made 9X your money. The concept of LBOing a company is in theory similar. You buy a company, and restructure the balance sheet, putting in a relatively small slither of equity, while financing the company with a lot of debt (similar to buying a house). You really don’t need to sell the company for much more than its purchase price to make alot of money (assuming you have enough cash flow to pay down your debt while you owned the property). Now, let’s talk about the specifics of Aetna, and why it is so attractive as a LBO candidate. For starters, Aetna at a 2007 forward PE of about 10X earnings sells at a considerable discount to the S&P 500, and at a discount to both HCA(estimated forward 2007 PE of 15X) and UnitedHealth Group (UNH) (estimated forward 2007 PE of 14X). Aetna’s estimated enterprise value/2006 revenue of .20 is also cheap compared to those of UNH and HCA, which are estimated, respectively, at .90, and 1.20. What is perhaps most striking is the huge amount of cash Aetna has on its balance sheet ($23.00 per share net of debt as compared to $-26.00 for HCA and $1.90 for United Healthcare), and hence the opportunity Aetna provides to fund a private equity group’s buyout. In fact, given Aetna’s huge amount of cash, a private equity buyer could probably use that cash for most of its "down payment", and borrow the rest. As well, Aetna’s relatively small amount of debt (25% debt/equity) , provides the opportunity to leverage its balance sheet. As an aside, we would mention that given Aetna’s huge cash reserves, and light debt load, it is in a position to execute a massive stock buyback. For example, if it were to buy back $5 billion in stock, it would shrink its shares outstanding by about 28%, which would increase its earnings per share by about 40%, and lower its forward PE from 10 to about 7. Another way of saying this is if you subtract from Aetna’s market capitalization its cash, and add back its debt, value of options outstanding, its unfunded pension obligations, and a reserve for discontinued pension products, we estimate its enterprise value to projected 2006 revenue is .45. That is very cheap indeed. We ran Aetna through our LBO model, and we estimate that assuming debt is leveraged about 5X to EBIT (which we believe is moderate leverage for an LBO), assuming a buyout at a 25% premium to Aetna’s current stock price, assuming 5% growth in annual cash flows, and assuming Aetna is re-sold to the public market’s at 8X earnings, a buyout of Aetna would yield an internal rate of return to a private equity of about 30%. So, we see considerable upside potential to Aetna’s common stock. To put it another way, a private equity buyer would probably have to pay a hefty premium to Aetna’s current price to buy the whole company. This is called a control premium. We believe that Insight has been able to purchase Aetna’s common stock more cheaply, and without the control premium a buyer of the entire company would have to pay. Insight currently holds a long position in Aetna.

Philip Frank, PhD
President and Portfolio Manager,
Insight Asset Management LLC
e-mail: insight-asset@earthlink.net

Further Thoughts on Insight’s Shorts of Amazon and Centex

2006-07-26T08:22:00.000-07:00

In previous posts we have written of shorts of Centex and Amazon in Insight’s model portfolio. Both these companies recently reported earnings. We continue to believe that Centex has at least 10-15% downside from current levels. Based on the company’s shrinking operating earnings per unit, we can easily make a case for operating earnings in the $5.50 per share range for Centex’s 2007 year, even with the company’s stock buybacks. This estimate is well below the company’s guidance of $7.00 per share. As reported in its 8K, the company’s buybacks in the last quarter were at average prices well above its current stock price. Thus, those buybacks were not value enhancing to shareholders. It should also be remembered that buybacks serve to increase leverage, and make the company riskier, as bondholders are well aware. An LBO of Centex is a possibility, but we don’t see the case for it. If we were an acquirer we would be hesitant to buy a homebuilder in this environment, given their risky cash flows. We project that if operating earnings per unit continued to fall at the rate they did in the just completed quarter, Centex’s eps would be well below $5.50 per share. Even if we were determined to buy, why not wait for the stock to trade down to below book value where it has traded before? Centex’s leverage acts as another disincentive for a prospective buyer. We reiterate our view that Centex has 10-15% downside from here. With regard to Amazon, we noted in our post on our blog on 7/12/06 that we were short the stock. This position has been a big winner for us, but the question is where we go from here. We analyzed the stock today in our discounted cash flow model (DCF). Given the company’s lower guidance on operating earnings for 2007, we have lowered our assumptions about EBITDA margins. On that basis, we can see the stock having downside potential to 25 or less. One way to understand the stock being down 5 points today is to understand that given the company’s lower guidance, we estimate that ten cents per share in projected earnings for 2006 may be lost. Given that the company traded for about 40X earnings for 2007, if a 40 multiple is put on ten cents that equates to a reduction in price of $4.00, which is in the range of how much the stock has been down today. But even if we amend our earnings estimate to $.75 for fiscal 2007, the stock is still trading for over 30X that number. As we have said in our previous post, that is a rich valuation. If we were to place a 20X multiple on an estimate of fiscal 2007 earnings of $.75, that would imply a price target of $15.00. Our DCF analysis projects a higher price for Amazon than does our PE analysis. Why? As we stated on our blog on the 7/12/06 post, when the market gets "nervous", it "believes" less in future cash flows. Cash flows are what drive the DCF model. When the market gets "nervous" it relies more on what "is" the case in the present, that being earnings in the near future. Though there may be a short-term bounce from here, we think further price deterioration in Amazon is a real possibility.

Philip Frank, PhD
President and Portfolio Manager
Insight Asset Management LLC
e-mail: insight-asset@earthlink.net

Insight is Short Centex/ Shorting and Leveraged Buyouts/ Understated Inflation

2006-07-19T03:03:00.000-07:00

Insight has been adding to its short of Centex, the homebuilder. This stock has previously traded below book value, and we see no reason why in this environment it should trade above book. Centex is also one of the more leveraged of homebuilders which makes its position more precarious, and less a candidate for a leveraged buyout. Leveraged buyouts are the bane of fixed income investors, and also of short sellers, and one does need to assess the potential for a leveraged buyout in shorting stocks. Still, given Centex’s leverage, and the instability in homebuilder's cash flows, we don’t see much of a risk of an LBO currently. We think the nasty correction in real estate has far from run its course. When consumer and investor sentiment turns negative on real estate it's very hard to change. It will take something dramatic to turn the tide on real estate, like sustained rate decreases by the Federal Reserve, which Insight does not see happening anytime soon. That said, there is much bearish sentiment on homebuilders, and any glimmer of hope in the economic numbers could set off a short-covering rally in the stock. Still, we think there is 10% more downside in the stock, given the stock trades at about 108% of book, and book value may well be overstated given the homebuilders’ use of options on land, which are off-balance sheet. Shorts now constitute about 30% of long positions in our model portfolio, which reflects our cautious view of the US economy. Some of the most severe geopolitical tensions in the past 25 years further buttresses our cautious view. While too many hedge funds do not truly hedge risk but rather increase it, in our view a truly hedged portfolio composed of longs and shorts can significantly diminish risk in a professionally managed portfolio. We did not view the producer price index number yesterday as positive, the market’s rally yesterday notwithstanding. While the core PPI number was in line with estimates, including food and energy the PPI number was higher than expectations. When food and energy prices are in sustained rises as we believe is the situation presently, the notion of excluding food and energy from inflation numbers is tenuous and serves to understate inflation. Inflation in these two items is causing real pain for consumers, which in our view will contribute to a slowing economy. As we have stated in a previous post, we think Wall Street’s current view that when the Federal Reserve stops raising rates everything will be ok, is incorrect and pollyanish. The Fed will stop raising rates only when there are very clear signs that the economy is in trouble. And when economies do get into trouble, as Japan has taught us well, an upturn can be a long time in coming.

Philip Frank, PhD
President and Portfolio Manager
Insight Asset Management LLC
e-mail: insight-asset@earthlink.net

Why Insight is short Ebay and Amazon

2006-07-12T08:12:00.000-07:00

Insight believes there are a number of themes sweeping the US stock market that make shorts of Amazon and Ebay attractive. As our post of July 6,2006 brings out, we have concerns about the health of the overall US economy. Within that theme, as money managers gravitate to more defensive stocks, cyclical and consumer dependent companies are more at risk. One of the lessons of the stock market decline of 2000-2003 was that technology companies are indeed cyclical in nature, and not immune to the fortunes of the overall economy. So we think the tech sector as a whole is risky. We also believe that when the market gets "nervous" high PE stocks become increasingly vulnerable, as the market "believes" less in the certainty of future cash flows. PE multiples afterall are only a proxy for the market’s views of a company’s growth prospects. As well, we believe that the declining PE of Microsoft, a bellwether of the tech sector is having important ramifications. Comparable company comparisons are a major way in which companies are valued. As one company becomes more or less valuable, other companies are correspondingly affected. The forward PE of Microsoft is now 16, down from a PE ratio as high as 70 in 2000. This contraction is having reverberating effects throughout the tech sector. With Microsoft at a forward PE of 16, certainly Amazon’s forward PE of 43 becomes less defensible, and even Ebay’s forward PE of 22 is at a large premium to Microsoft’s. We also do believe that as the economy gets tougher, and given low barriers to entry in technology businesses, tech companies hungry for growth will encroach on each other’s domain. We are seeing it with Google v. EBay, in respect to Google’s new payment software. Strategically, we are also far from convinced of the utility of EBay’s acquisition of Skype. We think Skype faces many challenges from competitors, in an area with few barriers to entry. Amazon too faces forays from competitors, and it is a retailer when all is said and done, making it subject to an economic slowdown. In general, we believe Google, with its entrepreneurial culture and intellectual firepower, casts a long shadow over companies like Ebay and Amazon. There is no sector in the online commerce world which is immune from Google’s aspirations.

Philip Frank, PhD
President and Portfolio Manager
Insight Asset Management LLC
e-mail: insight-asset@earthlink.net

Thoughts on Berkshire Hathaway

2006-07-09T05:04:00.000-07:00

Berkshire Hathaway is a holding in Insight's model portfolio. I heard Buffett speak at a news conference with Melinda and Bill Gates. He talked of the effect of his donation of Berkshire stock on the stock price. He strongly hinted that with the increase in float as a result of the gift that Berkshire would now be a greater candidate for inclusion in the S&P 500. I think this is correct. One stock that I follow Consol Energy was recently added to the S&P 500, and jumped by more than 10% on the announcement. More broadly though for the last several years Berkshire has shown little price appreciation, and I think the big concern has been succession after Buffett dies. My concern had been that after Buffett, Berkshire would be in the hands of Buffett's family who would be resistant as he is to financial engineering such as spin-offs, a sale to an acquirer, a going private LBO, etc. which I think is crucial to unlocking value in Berkshire. Now with the donation and Buffett no longer ultimately a huge controlling block of the stock, there may be some selling as the Gates foundation sells the stock to fund their goals. But in the long run Berkshire stock now has a greater chance to end up in the arms of hedge funds, for example, who could exert the kind of pressure required to unlock value, and I do think the stock is 10% undervalued, perhaps more. So net net I see the donation as a positive development for the stock, though because the donation will be made incrementally over a number of years, it may take some time for the stock to begin to move.

Philip Frank, PhD
President and Portfolio Manager
Insight Asset Management LLC
e-mail: insight-asset@earthlink.net

Views on the U.S. Stock Market July 6, 2006

2006-07-08T17:04:00.000-07:00

Insight's view is that the stock market is believing now in a goldilocks, soft landing. If the economy strengthens too much, it's not good because the Fed raises rates; if it weakens too much there will be worry about recession. What is the probability that the Fed can pull off a soft landing? Their history is not great. And because of the lag effect of their raising rates, the economic numbers should be weaker going forward. And even if the Fed does stop rasing rates, historically the market has been down months after the stoppage, presumably because of a weaker economy. So though Wall Street is rallying because of its belief that the Fed will pause, historically this has not been a plus for the market. Paradoxically a weaker housing market is going to make the inflation numbers look worse because of the rise in demand for rentals and thus higher rents, so the Fed may have trouble pausing even if the economy weakens. The only thing that's really changed over the past few weeks is the belief that the Fed will not let the economy go down the drain (if it can help it) , and will not be focusing solely on inflation but on the health of the economy as well. Insight believes in this environment it is prudent to be maintaining shorts in a professionally managed portfolio.

Philip Frank, PhD
President and Portfolio Manager
Insight Asset Management LLC
e-mail: insight-asset@earthlink.net

Web Counters