An Excellent Time To Pick Up The Broken Pieces

For some time now, weekends spell a period of trepidation for investors as the Pandora’s box is opened. Bizarre announcements of historical takeovers, bankruptcies and government interventions left investors grabbing for straws in a cesspool when trading resumed on Mondays.

So far, Fannie Mae and Freddie Mac had being seized, Lehman Brothers collapsed, Merrill Lynch was acquired by Bank of America, AIG nationalized, and most recently, Morgan Stanley and Goldman Sachs became bank holding companies which strengthened their hand in raising fresh capital.

This Friday, Washington Mutual was seized by regulators in the biggest US bank failure. Since September 16, WaMu depositors withdrew $16.7 billion from accounts, aggravating the liquidity crisis and causing share prices to plunge to 16 cents from a high of over $35 a year ago. JPMorgan Chase acquired WaMu’s deposits and branches for $1.9 billion and sold 246.9 million shares at $40.50.

Wachoiva seems to be the next mega bank to fail as they possess an excessive baggage of $122 billion in option adjustable-rate mortgages. Time is of the essence in their merger talks, else flagging confidence from shareholders and depositors will turn deadly in the coming days.

By now, it is clear that cash is king. For those who are flush with cash, they can secure sweet deals and drive hard bargains.

Earlier in the week, Warren Buffett announced a $5 billion purchase of Goldman “perpetual” preferred stock with a yield of 10%. The deal also includes warrants to buy $5 billion worth of common stock at $115 per share, or about 8% below where Goldman closed on Tuesday.

Together with the warrants (exercisable in five years), Berkshire could effectively own around 7% of the company. Its Goldman’s stake will leapfrog its positions in Wells Fargo and US Bancorp, and become Berkshire’s largest stock position behind Coca-Cola.

Without borrowing, Buffett’s investments pretty much depletes the piggy bank and increases the risk for Berkshire shareholders. Certainly, there are favorable conditions now that Goldman Sachs is recognized as a bank holding company. That allows Goldman to take in deposits (a cheaper and more stable source of capital for replenishing their balance sheets) rather than short-term borrowing which put them at the mercy of money markets.


However, Goldman Sachs is required to meet stricter requirements and oversight which could curtail their astronomical profits. While Coca-Cola was a master-stroke for Warren Buffett, the jury is out when it comes to his flings with investment banks, especially after the Salomon Brothers debacle in 1991.

A few weeks after plonking $700 million in the former “King of Wall Street,” the stock market crash of 1987 wiped out a huge portion of Buffett’s holdings. Following that, rampant trading impropriety forced chairman John Gutfreund to resign and Warren Buffett had little choice except to assume the role of interim chairman to prevent his investment from being washed out.

Buffett did a credible job in restoring investors’ faith in Salomon Brothers. He cooperated fully in Congressional hearings and was ruthless to those who do not toe the line. It is fair to say that his refusal to compromise on integrity saved Salomon Brothers from collapse in their darkest hour. Goldman Sachs possess a much better franchise than Salomon Brothers and given Buffett’s intimate knowledge of investment banking, I am sure this will be a richly rewarding investment in the long run.

In this recent financial turmoil, Berkshire Hathaway shares could not escape a spanking due to its heavy exposure to the properties and insurance industry. Some critics have questioned if Buffett has lost his MIdas touch.

Warren Buffet has also been labeled unkindly as a dinosaur who was out of touch with changing times but time and again, his disciplined approach to selecting undervalued stocks with clear market advantages and superior management was reaffirmed. Thus, as far as I am concerned, criticizing the Oracle of Omaha based on short term stock market gyrations is a misleading exercise.

That is not to say Warren Buffett has to be placed on a pedestal. He is only human and not infallible. Over the years, Warren Buffett had his fair share of investments gone awry, one of which was US Air. It turned out to be a massive dud and Buffett, in his self-effacing manner, described it as a moment of temporary insanity.

Nevertheless, I maintain a healthy respect for Warren Buffett’s judgment. His track record illustrates his ability to size up opportunities quickly and assess the actual value of a company.

Books can be cooked but based on common sense and clarity of vision, Buffett was not hoodwinked easily by artificies and exaggerations about a company’s strengths and weaknesses. I list down here some of Warren Buffett’s investment philosophy. These have served him well in the past and I believe should be the cornerstone for our investments too.

1. “Price is what you pay. Value is what you get.”

2. “The dumbest reason to buy a stock is because it is going up.”

3. “It doesn’t have to be rock bottom to buy it. It has to be selling for less than you think the value of the business is and it has to be run by able and honest people. If you can buy into a business for less than it is worth today, and you are confident of management, you are going to make money.”

4. “If we find a company we like, the level of the market will not really impact our decisions. We will decide company by company. The market is there only as a reference point to see if anybody is doing anything foolish. We simply try to focus on businesses.”

5. “We have no idea how long the excesses will last. Nor do we know what will change the attitudes of the government, lender, and buyer that fuel them. But we know that the less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs.

Indeed, the mantra of successful investment is to be fearful when others are greedy, and greedy only when others are fearful.  Warren Buffett is in his elements when it comes to investments in down markets.

Buffett predicted that this recession will be long and deep, which was pretty accurate. Now that he has taken a huge stake in Goldman Sachs, there is a clear signal for long-term investors that they should start looking around the wreckage and picking up broken pieces that could be profitable years later.

Of course, we have to stand on the right side of the fence and not buy stocks just because they are cheap. Examine the franchises in our portfolio and if we can envisage a bright future for them (ie. they will still be enjoying a competitive advantage in the next ten years) then we should put in more money instead of selling out.

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Filed under Banking, Stocks

5 Responses to An Excellent Time To Pick Up The Broken Pieces

  1. Hi Jeflin,

    Great article and write-up, and I agree with you ! Please continue to blog – I visit your website every few days for the excellent updates and well-thought through writing. Kudos to you !


    musicwhizs last blog post..

  2. Hi Jeflin,

    Well written article! Things will indeed be long and prolonged. Everyone wants bull market prices during the worse financial crisis of this century.


    stock tradings last blog post..Stock University

  3. @ Musicwhiz -

    Thank you for your encouraging feedback. That really motivates to write better.

    By the way, you have a very informative blog too.

    jeflins last blog post..An Excellent Time To Pick Up The Broken Pieces

  4. Great post … nice to see “some folks” making sense of this whole big mess!!!

    Eric “Speedcat Hollydale”s last blog post..Welcome to Hollydale

  5. @ Eric -

    Thanks for your kind comments. Looking forward to more comments.

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