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                   INTELLIGENT BUSINESSLIKE INVESTMENT

There is something in the Weitz name. Take Fred Weitz who, according to my knowledge, has no relation to the main subject under discussion today, Wallace R Weitz (to whom I will introduce you shortly). Fred Weitz took his family's business and turned it into a leading construction company in Des Moines, Iowa (U.S.). Frequently you will find successful businessman started out in bad circumstances. Fred, for instance, grew up during the Great Depression. However, he didn't realise he was poor simply because 'so was everyone else'. The first secret of his success was to work very hard. Another part of his secret was his 'Light of Day-rule'. "We try to run a business that will make money for owners, be a good place to work for employees, where they can gain self esteem from their accomplishments," says Weitz "Above all, make some positive contribution to the communities we work in. I've always believed in the Rule of the Light of Day. The Rule of the Light of Day, according to Weitz, is an ethical standard for making business decisions. It's simple, really: Would you make the same decisions or actions, if they were on display for the world to see? I always figured that if what we did - the activities and decisions -would stand the Light of Day rule, that would be the test," says Weitz.
This sounds like something Warren Buffett would say. Buffett says that you shouldn't do anything you wouldn't want to see on the front page of your local newspaper the next morning. Buffett resides in Omaha, Nebraska (U.S.) and shares the city with Wallace R Weitz, an exemplary money manager in his own right. They have a lot in common, but Weitz did not move to Omaha to be close to Buffett. It is the old story - "I married an Omaha girl", says New Orleans native Weitz.
The comparison with Buffett is apt for other reasons as well. Buffett's investments grew at a compounded rate of 23% over more than 30 years. Although Weitz's funds lag those of the Master by a healthy margin, they still represent an outstanding performance. He runs three equity funds: "Value", "Hickory" and "Partners". The respective inception date and compounded growth rates for each follow. 1986 (15.3%), 1993 (16.3%), 1983 (17.2%). I am not sure what the benchmark (the S&P500) did over the same period, but I do know that over the last 10 years the S&P500 compounded by 15.1%, while the Value Fund, for instance, compounded by 19.9%. What might seem like a small difference to you translates to a $20,000 DIFFERENCE in the investment result over 10 years if $10,000 was invested. That 4.8% DIFFERENCE alone is worth twice your initial capital.
Weitz shares common ground with Buffett for the majority of his investment philosophy. Two of his funds are even invested in Berkshire Hathaway (so are Cherubim shareholders and Mr B's Shibumi fund with Marketocracy). When you study the approaches of these two gurus you will find that both of them emphasize the importance of cash. 'Cash is king' is what Buffett would say. The areas where they differ are not a difference in investment styles or principles but simply because they are comfortable in different industries. Remember that Buffett tells us to invest within our circle of competence? He also stresses that it is not important how big the circle is, but how well it is defined. One notable difference is Weitz's love for cable and telephone companies. Liberty Media, for instance, is a one of Weitz's favourites and a stock Mr B also holds in the Shibumi fund with Marketocracy. I cannot see Buffett ever investing in this stock, although I think Geico manager Lou Simpson might. It seems to me that Buffett just doesn't feel comfortable in the cable industry. However, Weitz's argument for investing in Liberty could have been preached by Buffett himself. Buffett always uses the example of a toll bridge when explaining a sustainable competitive advantage. You build the bridge and whoever wishes to cross needs to pay up. The owner of the bridge also has considerable pricing power. Weitz points out that you cannot forget that you will incur considerable capital expenditure in building the bridge. Your principal asset (i.e. the bridge) is also depreciating heavily from year one, so your earnings will be very poor. However, your cash flow is what is of greatest importance. Although you have a large initial capital outlay, you will make it back over time if the cash flows are there. Liberty Media has put together exemplary content (e.g. Discovery channel) and is now assembling a cable distribution network to hedge that content. Despite current earnings being depressed, the long-term picture makes Liberty a great investment. Where Buffett might also have a problem is with the certainty of future events taking place. He would probably feel uncomfortable with the fact that it is unclear how far out those future cash inflows are. Time is money and the longer you wait, the more value you lose on your future dollars. This is my main criticism of Liberty Media. The Shibumi Fund holds Liberty but the more conservative Cherubim Ventures does not.
So, how did this man get to invest in stocks you might wonder? Apparently it started in 1959. His grandparents got worried because his mother, who was a social worker, was not investing. They gave her $25,000 and invited her up to New York to see a broker. While his mother was 'totally bored' Weitz was transfixed. He hung onto every word the broker said, while knocking back martinis over lunch (the broker of course). As soon as he got back home he started corresponding with the broker and invested his grass-cutting money in stocks. Although his first investment went south right after he bought it, he stuck with it and sold out 5 years later with a 10% compounded gain. Great stuff!
This brings us to another point he recently made about returns. Investors frown upon 10% gains in this day and age. I heard the other day from The Lawyer in New York that 60% of current fund mangers have not seen a serious recession or market crash. Maybe that explains part of the unhappiness with 10% returns. Last year it was reported that 'Wally Weitz, president and namesake of the Omaha-based mutual fund company, warned investors during the Wednesday night meeting at the Marriott Hotel that the 25-year bull market of 15 percent to 18 percent annual returns had raised investors' expectations. And he expects future returns in the stock market and from his company's three stock mutual funds won't be as high. In fact, returns may be as low as a middle to high single digit'. When Weitz says that, you'd better be careful.
The last point I wish to raise is something that was mentioned in an article in 'Financial Planning' a couple of years ago. The article contended that most fund mangers with large stakes in the funds they administered outperformed their benchmarks. Weitz agreed that having their own money at stake gave fund managers an edge because it provided them with extra motivation to perform. In the aforementioned article Weitz said that, 'It is hard to imagine not having money in there. If the stocks are good enough for me, they are good enough for all my clients.' This is something I have discussed before and I still deem as vital. I prefer the managers of the companies we invest in to own substantial stakes in those companies. Surely the same logic applies when I invest money for others. Maybe Enron executives would have acted a bit differently if all their and their family's money happened to consist of Enron stock? The Banker from Johannesburg mailed me an article on Goldman Sachs supporting the opposite view, which I include here. I also include the above-mentioned 'Financial Planning' article. I leave it to you to make up your own mind.

Goldman brings in tighter rules for its analysts
By John Labate in New York
Published: February 19 2002 20:23 | Last Updated: February 19 2002 20:35

Goldman Sachs announced a series of changes to bolster confidence in the independence of its research operations on Tuesday, as it appointed two new heads of research.

The New York-based investment bank adopted a new policy in which it barred its analysts from buying or selling shares of companies they research. As of Tuesday, analysts could not buy such shares and will be required either to hold their current shares indefinitely or sell when they issue a "sell" rating on the company. The new policy matches that of other US securities firms.

"We want to lead with research that is differentiated by its quality, is clearly independent and creates value for our clients," said Robert Steel, managing director and head of Goldman's equities division.

Investment bank research divisions have come under intense pressure in recent months, including the threat that key institutional clients may depend more on their own in-house research.

At issue is whether investment banks have allowed research departments to come under the sway of their core investment banking operations, and used research as a means of luring business from issuers being covered.

Earlier this month, market regulators released a set of new rules to govern stock analyst compensation related to their dealings with investment banking activities of their firms.

Concerns have been widespread that company research reports function more as a service designed to bring new investment banking business to securities firms than as a source of unbiased analysis.

Critics have often pointed to the overwhelming number of "buy" reports relative to those with a "sell" recommendation as proof of the bias.

Other rules require research reports to have clearer disclosures on their relationships with the companies being reviewed. The new rules must still be approved by the Securities and Exchange Commission.

Goldman named Suzanne Nora Johnson, a managing director at the bank, and Andrew Melnick, former director of global securities at Merrill Lynch, as co-directors of its global investment research division.

In a sign of their heightened importance, the executives will join Goldman's management committee, the bank's top decision-making body.

"These appointments are meant to convey the importance of independence of the research function," said Mr Steel.

MOTIVATED PERFORMANCE

Surprise! Most managers with big stakes in their own mutual funds beat their benchmarks.

Financial planners engage in all sorts of analytical acrobatics when they select mutual funds. One factor they rarely consider is whether the fund manager has his or her own money on the line. Maybe they should.
It's not necessarily past performance statistics that count. It's not the alphas, Sharpe ratios or star ratings that point to well-managed funds.
Over the past three- and five-year periods ending in June 1999, for example, 85% of the 30 funds Financial Planning examined in which the managers, employees, trustees and, in some cases, independent directors hold significant investments have outperformed the average fund in their categories. While this list is not exhaustive, the total the managers and employees invested is more than $1.5 billion.
Fund managers say having their own money at stake gives them an edge, providing them with extra motivation to make the right moves. "I would like to say I wouldn't manage money any differently, but when you have your own net worth on the line, it means you can lose sleep at night when the stocks are doing poorly," says Andrew Davis, manager of the Davis Real Estate Fund, Davis Convertible Securities and Davis Growth Opportunities Fund in Santa Fe, N.M. "When you and your family's net worth and employees' money are invested in the fund, it makes a difference."
Wallace Weitz, manager of the Weitz Value and Partners funds in Omaha, Neb., agrees. He has all of his investable assets tied up in his fund. "It is hard to imagine not having money in there," Weitz says. "If the stocks are good enough for me, they are good enough for all my clients."
Others say having their own money isn't the only bottom line that counts. Fund managers getting paid bonuses for outperforming their peers and the benchmark averages also are highly motivated. Fidelity Investments, T. Rowe Price and Janus Funds, for example, pay their managers attractive bonuses based on superior performance.
Even managers in fund groups where employees are heavily invested in the funds say they would do the best job they could--regardless of who has money in the fund. But they wouldn't have to face shareholders at the water cooler every day. "I would be doing the same thing," maintains Bob Gendelman, co-manager of the Neuberger & Berman Partners Fund in New York. "I am very sensitive to the fact a lot of fellow workers have money invested in the Neuberger & Berman Funds. But I would always be motivated to do the best job I can."
Weitz has managed to do what other value fund managers haven't done over the past three years--perform very well. Both his Weitz Value and Weitz Partners funds carry five-star Morningstar ratings and outrank 99% of funds in their categories and all funds, according to Morningstar in Chicago. The Value Fund has grown at an annual rate of 30.95% and 26.85%, respectively, over the past three and five years ending in June 1999. The Partners Fund gained 32.47% and 28.18% over the same time frames.
Weitz, who has all of his investable assets in his funds, is a value investor who also owns growth stocks if he can find them at reasonable prices. He favors stocks selling below their intrinsic values and searches for stocks with low price-to-earnings, price-to-cash-flow and price-to-book-value ratios.
Five years ago, that put him into telecommunications and cable companies. Weitz says he profited handsomely from these investments because most of the companies were taken over. He now owns just two stocks in these industries--Adelphia Cable and Telephone and Data Systems. "We made tens of millions on those stocks because telecommunications and cable stocks were cheap," Weitz says. "We doubled up on the stocks on market pullbacks in the 1990s. The stocks began performing well due to takeovers and the Internet fever."
Today, Weitz has 35% of both funds' assets in cash because he can't find many values. He has been buying some bank stocks and, in recent months, some converted thrift stocks selling at 70% of book value. Golden State Bancorp and Washington Mutual make up both funds' largest holdings. The stocks are selling at around eight times cash flow while earnings are growing at 12% annually. The companies, he says, are well managed and underestimated by Wall Street. Weitz also has been adding to his positions in existing holdings, such as Berkshire Hathaway and Countrywide Credit.
"I've had 15% to 35% in cash all year," Weitz says. "There are no new undervalued stocks to replace cable and telecommunications stocks we have owned."
David Herro, who has his own money invested in the Oakmark International Fund in Chicago, took advantage of the stock market plunge in Asia and Latin America and doubled up on his holdings. He added to his position in companies that have plenty of cash flow. Typically, these stocks bounce back with a vengeance after a bear market.
Oakmark's managers and employees have more than $40 million invested in their funds. The vast majority of their funds have beaten their peers. "We used that period of implosion to take advantage of what happened and reap the benefits of staying with our strategy," Herro says. "Our fund is up 40% this year to date."
Currently, he has 23% invested in the Pacific Rim, 15% in Latin America and 48% in Europe. British stocks make up the majority of the fund's European holdings.
Herro is convinced Asia has bounced back from its financial crisis. Earnings of financially sound companies already have rebounded. But share prices don't reflect lower interest rates and growing earnings of Pacific Rim companies. For example, the Korean economy is growing at almost 8% today. Inflation in Indonesia and Singapore has dropped to 10% from 35%.
Herro hedged Latin American currencies in early 1999, plus he bought more shares of stocks such as Quilimes, a brewing company that is 15% owned by Heineken, and Unibanco, a Brazilian bank selling at 75% of book value and just five times cash flow. The latter is overcapitalized and its stock should trade at least at twice book value, while the former is selling at just six times cash flow with no debt.
In Asia, he added to his stake in Giordano, a Hong Kong retailer. He started buying the stock at $2 per share until it went to 86 cents. Now it trades at $8.50 a share. The firm had plenty of cash going into the recession. It built up its working capital by negotiating lower rents and costs from supplies. It also expanded same-store sales during the economic downturn.
Herro says he can't find many bargains in continental Europe. Falling interest rates and currency values pushed European stock prices too high. Britain is the only place he can find growth at reasonable prices. For much of the last year, British stocks lagged the rest of Europe due to higher interest rates in the United Kingdom. British share prices are cheap and the companies are committed to shareholder value. Stocks he purchased include Summerfield, a supermarket chain trading at just six times earnings. The company is buying back 10% of the stock, and earnings should hit double digits. Tomkins is an engineering firm selling at seven times cash flow. Its earnings should rise to double digits since selling its food engineering sector.
Ron Baron, manager of the Baron Asset and Baron Growth funds in New York, also buys the same stocks for himself and his shareholders. The high-flying Baron Asset Fund has grown at 18.34% and 25.16% over the past three and five years, respectively, ending in June 1999.
Despite the huge run-up in growth stock returns over the past several years, Baron says he's finding bargains in sectors avoided by investors who have been chasing after the same technology and large-company growth stocks. He's investing in companies whose earnings are growing due to technological innovations. He expects such stocks to double in two or three years.
"There are a lot of stocks selling at just 10 to 15 times earnings that have strong earnings growth," Baron says. "Health-care stocks have been depressed for a long time. Furniture, media and education stocks are also overlooked."
Baron likes to load up on his largest holdings. Earlier in the year, he took profits in some. Now that these growth stocks have been knocked down, he is buying more shares.
One-third of the $6.8 billion Baron Asset Fund is invested in the fund's top 10 holdings, which include Charles Schwab, Sotheby's Holdings, NTL, HCR Manor Care, Robert Half International and Polo Ralph Lauren. He sees these companies growing earnings at more than 25% annually over the next 10 years.
New acquisitions include furniture companies like Natuzzi, a leading couch manufacturer, which has benefited from the strong housing market over the past few years. The company is selling at just 17 times earnings of $1.65, but is growing earnings at 25% annually.
He also has invested in Vail Resorts, Sun International and Mirage Resorts. Their stock prices have been cut in half, but earnings are growing more than 20% annually. Baron expects these stocks to triple in the next three years.
Gendelman says value stocks are on the comeback trail. The fund, buying growth at reasonable prices, has grown at 21.15% and 22.44% a year, respectively, over the past three and five years ending in June 1999.
Rising interest rates are hurting growth stocks. Knocked-down growth stock prices reflect the impact high rates have on corporate earnings. As a result, investors are turning to companies trading at low P/E multiples that don't reflect the earnings.
"We don't invest in deep value stocks," Gendelman says. "We look at high financial returns, free cash flow generation and protectability of the company in its industry. We buy good businesses that are overlooked."
Gendelman wants to own companies that have stumbled, but with businesses that are intact long term. That has put him in stocks such as Cigna, the fund's largest holding, which he bought a year ago. It was losing money on its property and casualty business, but its other lines of health, disability, life and annuity were highly profitable. After he purchased the stock, the company sold off its property and casualty business. Cigna's return on equity is 18% and it has strong free cash flow. Earnings are growing at 20%, but it is selling at just 14 times earnings.
Despite its recent problems, Banc One is another out-of-favor stock that caught Gendelman's attention. Last year, the bank acquired First USA, whose credit card business accounts for 33% of Banc One's earnings. Wall Street was not willing to dissect Banc One's business line. But Gendelman says the stock is selling at just 11.5 times next year's earnings of $4.50 a share--up from $3.90 a share in 1999.
Williams Co. is another with an overlooked business. The firm is one of the last remaining pipeline companies. But it has fiber optic cables running alongside of its pipelines for use in broad-band communication. Currently, the telecommunications business is losing money, but it will contribute strongly to future earnings.
Even though apartment, retail and industrial REITs are running at full occupancy, real estate stocks are down because investors believe the market has peaked.
Davis, whose Davis Real Estate Fund is up 11.64% over the past five years, says investors are mistaken. He has cut his portfolio in half and is fully invested in 35 stocks of those companies he considers the best quality.
"There have been some good values in the real estate sector for some time," Davis says. "There is little confidence REITs can support their dividends. But the market will not collapse. There is a ton of insider money on the line. Even if there were an economic slowdown, there would not be a loss in earnings power."
Davis owns companies selling at just eight times earnings, sporting dividend yields of 7% and growing earnings at 20% annually. His largest holdings concentration is in the industrial/office and apartment sectors, which make up about 55% of the portfolio.
He owns efficient companies that raise rents more quickly than others. These are REITs such as Home Properties of New York, which runs apartments; Vornado Realty, which operates retail rental property; Boston Properties and Spieker Properties, which operate office and industrial properties; and Center Point Properties, which are diversified property rentals.
Just A Sample
Baron Funds: over $25 million invested by manager and employees.
Brandywine Funds: $40 million invested by manager and employees.
Caldwell & Orkin Market Opportunity Fund: Manager has over $3 million invested in the fund.
Davis Group of Funds: Davis family, employees and independent board of directors have $1 billion invested.
Janus Twenty Fund: Manager has an undisclosed amount invested in the fund.
Longleaf Funds: Managers and employees have over $200 invested in the funds.
Neuberger & Berman Funds: Employees including managers have $150 million invested in the funds.
Oakmark Funds: $40 million invested by employees and manager of the funds.
Third Avenue Funds: Manager has over $10 million invested.
Tweedy Browne Funds: $80 million invested by partners and employees.
Weitz Funds: Manager has undisclosed amount invested in the fund.

Funds Where Managers Have Money Invested with their annual compounded rate as of June 1999.

Fund Group 3 Year 5 year

Baron Asset 18.34% 25.16%
Baron Growth 20.69 NA
Brandywine Blue 14.16 18.78
Brandywine 12.93 18.11
Caldwell Orkin MOP 20.66 18.55
Davis Convertible 19.64 18.11
Davis Financial 30.69 28.93
Davis Growth Op 17.34 NA
Davis Real Estate 12.05 11.64
Davis NY Venture 27.58 25.87
Janus 20 43.74 36.72
Longleaf Partners 24.85 22.40
Longleaf Partners Real Estate 12.90 NA
Longleaf Partners Small Cap 22.68 21.48
Neuberger & Berman Genesis 13.13 17.18
Neuberger & Berman Guardian 16.14 17.19
Neuberger & Berman International 10.26 10.60
Neuberger & Berman Manhattan 17.18 18.67
Neuberger & Berman Partners 21.15 22.44
Neuberger & Berman Soc. Resp 20.44 21.79
Oakmark 18.28 20.09
Oakmark International 11.86 12.39
Oakmark Small Cap 13.44 NA
Oakmark Small Cap International 9.80 NA
Third Avenue Value 15.57 17.46
Tweedy Browne American Value 22.76 23.09
Tweedy Browne Global Value 20.69 17.19
Weitz Hickory 38.65 32.81
Weitz Value 30.95 26.85
Weitz Partners 32.47 28.18

Benchmarks

S&P 500 29.10 27.85

Note: Amount managers, officers, trustees and/or independent
board of directors or employees have invested in the fund or
funds.

Source: Morningstar Mutual Funds

Whatever you are up to, I hope it is profitable and ethical!

Mr. B
mail_mrb@yahoo.com
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