Friday, June 01, 2007

The Marginal Investing Framework Self-Test:

I wanted to do a quick overview to show how my portfolio holds up to my marginal company framework.

Fairfax Financial (FFH)
The Industry: Insurance. Barriers to Entry: Capital.
The Price: when I purchased Fairfax, the company was trading at approximately 70% of book value.
Qualitative Aspects: Fairfax has one of the most astute value investing teams around, with an amazing track record to match. In an industry where most participants break even at underwriting, the investment side of the business can be critical to success.

Bancinsurance (BCIS)
The Industry: Insurance. Barriers to Entry: Capital.
The Price: Bancinsurance is currently trading at 85% of book value.
Qualitative Aspects: Bancinsurance is a microcap company that serves a small niche market, and it has a history of generating very profitable underwriting income.

SFK Pulp Fund (SFK-UN.TO)
The Industry: Pulp. Barriers to Entry: Capital.
The Price: At an enterprise value of 600 million, SFK is trading below the replacement cost of their businesses, which i calculate to be 750 to 850 million.
Qualitative Aspects: A globally growing industry protected by the limited nature of softwood fibers. The company has one of the lowest manufacturing costs in the business and can benefit greatly from a rationalization of fibre prices in the Quebec region. Finally, the company has a very great management team and does not have to pay taxes until 2011.

Delta Financial (DFC)
The Industry: Subprime Mortgage Origination. Barriers to Entry: Capital.
The Price: The price paid for Delta was in excess of the 150 million in equity of the company. However, this understates the income the company expects to generate from its 7 billion securitized mortgage portfolio. When you look at the fair value of this portfolio, which should approximate the economic reality behind the present value of this portfolio, the "true" equity is approximately 350 million.
Qualitative Aspects: One of the only subprime originators that maintained its strict quality standards and avoided the loan volume frenzy of its peers.

I left out Brick because I have treated it as a quality company and hence I am valuing it based on earnings power instead of replacement cost. It is interesting to note however, that many of my most successful past holdings, such as Posco, Sino-Forest, and KHDH, were trading at "marginal investing" prices while still having some respectable qualitative aspects to them. Conversely, Most of my losing investments have occured when I overestimated the quality of a company and paid an exuberant price. So, I should probably look over my investment in Brick one more time to see if I am not making this mistake again. I think the message is that it is much more difficult to understand quality than value, and that the growth of a value investor involves a sharpened ability to assess the qualitative merits of a company. Until that ultimate stage is reached, it is best to look for companies trading at a "marginal investing" prices and to treat most qualitative aspects as just potential bonuses.

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