Graham and Doddsville - Issue 4 - Winter-Fall 2008

8/2/2019 Graham and Doddsville - Issue 4 - Winter-Fall 2008

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by the Indian approach calledDhandho. When asked abouthis investment philosophy, heoften repeats the mantraHeads I win, tails I dont losethat much. Graham andDoddsville was lucky enough tosit down and delve deeper intoMohnish Pabrais investment

philosophy.

Question: How did you get

started with value investing?

Until I was 30 years old, frankly,I had never heard of Mr. Buffett.I had never heard of value in-vesting. This was 1994 and Iwas vacationing in London withmy wife. I was looking forsomething to read on the flightback to Chicago, and I picked upone of Peter Lynchs books. Iam an engineer by training, sothis was a different field for me.I read that book on the flightand I loved it. It made all the

sense in the world to me, in(Continued on page 2)

Mohnish Pabrai launched PabraiFunds in 1999. Less than a dec-ade later, Mr. Pabrais name isoften mentioned in the samebreath as legendary value inves-tors who have been in the busi-ness for decades. The PabraiFunds annual shareholder meet-ing has become a stop on a

value investing tour that in-cludes the annual meetings ofBerkshire Hathaway, Wesco,and The Sequoia Fund. He isalso a frequent guest ofBloomberg, CNBC, and The

Value Investing Congress.

In 2007, Mr. Pabrai published hissecond book, The Dhandho In-vestor, which is quickly becominga must read for all value inves-tors. Last year, along with GuySpier, manager of Aquamarine

Fund, Mr. Pabrai was the highestbidder in an eBay auction forlunch with Warren Buffett.With his daughters sitting oneither side of Buffett, Mr. Pabrai,Mr. Spier and their families

spent the afternoon of July 25

with their mentor.

In April, Mohnish made his firstappearance at Columbia Busi-ness School where he appearedas the guest lecturer in Profes-sor Bruce Greenwalds ValueInvesting Seminar. Mr. Pabraisinvestment style has not onlybeen influenced by BenjaminGraham, Warren Buffett, andother value investors, but also

Making Heads and Tails of Mohnish Pabrai

Graham and Doddsville Celebrates the 75th

Anniversary of Graham and Dodds Classic

Welcome back to Graham andDoddsville! The summer hascome to an end, and a newschool year has begun amidstthe largest shake-up on WallStreet since the Great Depres-sion. While the times havechanged, the original tenets ofColumbia Business School Pro-fessors Benjamin Graham and

David Dodd remain the same.

Along with the new school year,September also marks the publi-

cation of the sixth edition ofSecurity Analysis. This editioncomes as we celebrate the 75thanniversary of the first edition,published in 1934. ProfessorBruce Greenwald continuesColumbias rich tradition ofvalue investing as co-editor ofthe new edition along with Jim

Grant and Seth Klarman.

Graham and Doddsville strivesto bring you insight and infor-mation from the current gen-

eration of investors who followthe framework set forth byGraham and Dodd. This issueis no exception, and we areespecially pleased to present aninterview with Mohnish Pabrai

of Pabrai Funds.

Inside you will learn from inves-tors such as Warren Buffett,

Joel Greenblatt, Bill Ackman,Rich Pzena, Daniel Loeb, and

many others. We are also(Continued on page 2)

Summer / Fall 2008Volume II, Issue 2

Editors:

David KesslerMBA 2008

Charles Murphy

MBA 2009

David SilvermanMBA 2009

Inside this issue:

Joel Greenblatt p. 9

Pershing SquareChallenge

p. 14

The Winning Pitch:NutriSystem

p. 16

11th Annual CIMAConference

p. 18

Visiting the Oracle p. 10

Advice from TheOracle

p. 21

Contact us at:[email protected]

Visit us at:www.grahamanddodd.com

www.gsb.columbia.edu/students/

organizations/cima/

Graham and DoddsvilleAn investment newsletter from the students of Columbia Business School

Mohnish PabraiPabrai Funds


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proud to feature Shilpa Mardaswinning pitch from The FirstAnnual Pershing Square Chal-

lenge.

This year promises to be anexciting one for all investors.We will continue to bring youinsights from some of the mostprominent citizens of Grahamand Doddsville. If you have anycomments or suggestions, e-mail

us at:[email protected].

Go online to find this and pastissues of Graham and

Doddsville, as well as otherresources from CIMA:

http://www0.gsb.columbia.edu/

students/organizations/cima

(Continued from page 1)

Graham And DoddsvilleCelebrates (continued from page 1)

Mohnish Pabrai (continued from page 1)

The thing that I found verystrange was that if there is sucha thing as the laws of investing,Warren Buffett has pretty

much laid them out. What Icouldnt understand was thatwhen I looked at the entiremutual fund industry at thetime, which were the profes-sional managers that I had ex-posure to, I saw that these guysnot only did not follow thefundamental laws of investing,but most of them didnt evenknow what they were. At thesame time, their results re-flected sub-par performance.So I thought there must be acorrelation between these guys

not following the rules andhaving poor performance.

The second thing I found verystrange was how you can havean entire industry which doesnot function with a solid frame-work. To me, it is like peopledoing brain surgery by just

winging it. That is how I sawmutual funds work they were

just winging it, or they come upwith any nuance or flavor of

the day they want to pursue. Ihad a thought that if noviceslike me simply adopted Buffettsapproach and invested in theequity markets with a concen-trated portfolio, etc. that I waslikely to do better than most ofthe industry professionals. So Isaid it was worth testing thishypothesis out. I was lucky atthe time in 1994; I had about$1 million in cash. I had justsold some assets of my busi-ness and I decided to go aheadand manage that in a Buffett-

style concentrated portfolio,buying things I understood, etc.That is how I got into value

investing.

Question: You have man-aged Pabrai Funds since1999. That must have

(Continued on page 3)

terms of how to and how notto invest. I thought this was aninteresting area and I wantedto know more about it, so I

found that Peter Lynch hadanother book and I read thatone too. I wanted to learneven more, but I ran out ofPeter Lynch books to read. Iremembered that in one of thebooks, Peter Lynch mentionedWarren Buffett and told astory of how Buffett had calledhim to get his permission touse a quote. This was the firsttime I had ever heard of War-ren Buffett. I figured sinceLynch was talking to Buffett, Ishould learn more about who

Buffett is. I looked around, andfound the first two biographiesthat had just been published:Lowensteins The Making of an

American Capitalist and Hag-stroms The Warren BuffettWay. I read those books and I

just had an epiphany. Theyresonated strongly with me.

The thing that I

found very strange

was that if there is

such a thing as the

laws of investing,

Warren Buffett has

pretty much laid

them out.

Page 2

Erin Bellissimo, co-director of the Heilbrunn Center, andprofessor Dan Kruger, Professor of Distressed Value In-

vesting catch up at the 11th Annual CIMA Conference


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What I couldnt

understand was

that when I looked

at the entire mutual

fund industry at the

time I saw that

these guys not only

did not follow the

fundamental laws

of investing, but

most of them didnt

even know what

they were. At the

same time, their

results reflected

s u b - p a r performance. So I

thought there must

be a correlation

between these guys

not following the

rules and having

poor performance.

Page 3Volume II, Issue 2

Question: Where do you

hunt for your ideas?

When I look for ideas, I look inplaces like the 52-week-lowlist, Value Line, as well as stockswith low P/E ratios, low P/Bratios, or large discount-to-book value. Now I have JoelGreenblatts Magic Formula; Ilook at that on a daily basis aswell. I also subscribe to Portfo-lio Reports, published by Out-standing Investor Digest, whichgives a listing of all the buyingof major value investors everyfew weeks. I also look at 13F

filings of the usual suspectssuch as the Fairholme Fund,Marty Whitman, Einhorn, andall of those folks. That is basi-

cally where I go fishing.

Question: What are char-acteristics of the compa-

nies that attract you?

In general, I look for industrieswith a slow rate of change,companies with some type ofmoat, and companies with hardassets. I look to buy businesses

where I can rest my hat on thehard assets of the business.Other times, I look at busi-nesses that have more of afranchise value, so the intrinsicvalue is made up more of intan-gibles such as brand, etc. Basi-cally, what Im trying to do isfind businesses that I can buywell below what they areworth. I usually try to makeone bet per industry, and Itypically put 10% of the fundsassets into each idea. An idealportfolio would be comprisedof 10 positions from 10 differ-ent industries all priced at adiscount to what they areworth. In terms of what ex-actly I focus on is determined

by what is on sale.

Question: Once you iden-tify a potential investmentidea, what is your processfor determining whether it

is in fact a good invest-

ment?

After I identify an interestingcompany, I begin to drill downreading the 10Ks and 10Qs.When I first come across abusiness, I generally ask myselfwithin the first few minutes: Isthis something I understandwell? Is this a relativelystraight-forward business tounderstand? If I am not gettinga clear idea in my head of howthe business works and how itmakes money, then I will gen-erally stop and move on to the

next business. In fact, I oftenmove on if I cant answer thatquestion right way. So the firstquestion you have to ask your-self is: In general, is this a busi-ness I can understand? I madean investment in 2001 in acompany called Stewart Enter-prises which is in the funeralservices business. I can under-stand that business. You burypeople, cremate them, you getpaid, etc. Then you can startto think about understandingthe finer points, such as the

brand, and what people thinkabout the community of funeralservice providers. It is not abusiness where a competitorcan open up overnight withcheaper pricing and just takeyour business away. Then,there is the fact that it is rarefor someone to aspire to gointo the funeral business. Ingeneral, it is not an attractivebusiness for a 25-year-old tothink about entering, so itkeeps the number of new en-trants down. Finally, all hu-mans eventually die. They maylive longer, but eventually wedie, so you also have a steady

stream of customers coming in.

So these are the kinds of thingsto think about when you startthinking about a business. Ifthey all make sense, then youcan begin to look further into


been quite a time to open a

value fund.

Actually, 1999 was very inter-esting. I think it was a greattime to start as a value investorbecause the market in 1999and 2000 had segregated. As amatter of fact, on the day thatthe NASDAQ hit its peak,Berkshire hit its 52-week low.What happened is that a lot ofmoney had gone into thesefrothy dot-com type stocks,but effectively it had come outof brick-and-mortar, normal

businesses. A lot of brick-and-mortar, real-world businesseswere trading really cheap. So itwas actually a great time to gointo the equity markets as longas you didnt drink the sameKool Aid that everyone elsewas drinking. In fact, afterPabrai Funds first year, in June2000, we were up approxi-mately 38% after fees. Thenthe second year we were up bymid- 30% after fees. We didreally well in the year wheneverything crashed and burned,

for that reason.

Question: Over the past10 years, how have youseen the value investing

landscape change?

There isnt much of a change.The good news is that there isnow more of a community withthings like Whitneys newslet-ter (Value Investor Insight),conferences, and the ColumbiaValue Investing Program.Clearly there is now moreinterest. However, if you lookat all of the people involvedwith investing in the equitymarkets worldwide, the per-centage of them that focus ontrue value investing is still avery, very miniscule percent-age. I think that, in general, theopportunity to do value invest-ing is almost as good as it was

10, 20 or even 30 years ago.




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Page 4


the most important tenets thatBen Graham talked about. Youalways want to ask yourself

What is my downside? Youalso want to get some comfortthat you have some protection.In some cases, you can get thatcomfort from liquidation valueor hard assets minus liabilities.In other cases, you may getcomfort from somewhere else.For example, if you look at a

company like Moodys orAmerican Express, you couldntinvest in these based on liquida-tion value. If their brands werepermanently impaired, youwould probably be losingmoney. However, as long as

the brand continues to grow invalue, you can end up making alot of money. When you arelooking at the margin of safetyyou can look at it in terms ofhard assets like Ben Grahamused to, or you can look at it interms of more intangible assets

which can be very valuable.

Question: As a value inves-tor, you have mentionedyou look out over the 3- to

5-year period. Wall Streetobviously has a muchshorter horizon. How doyou maintain the tempera-ment to hold a security thetime it takes to realize its

value?

Im very blessed with the inves-tors I have at Pabrai Funds. Ihave about 400 families acrossthe five funds I manage atPabrai Funds with over $550million in assets and on a typi-cal day, I never hear from any

of them. I have an annualshareholder meeting that manyof my investors show up to. Itis a great group of investors.Even recently, with the marketturmoil, I really havent hadmany e-mails or calls. I love topartner up with these types offolks. So I dont really facemuch pressure from the inves-

tor base.

Second, I generally dont dis-cuss the existing portfolio posi-

tions. That keeps a lot of thenoise down. Third, I think thetemperament or patiencecomes in part from the way weare wired or the way we canlearn, or not learn, from BenGraham, Warren Buffett, etc.You know, Warren Buffett hassaid many times that peopleeither get value investing in fiveminutes or they wont get it infive years. So, there is some-thing in the human wiring ofour brain that, for some of us,makes all the difference in the

world right away and the pa-tience that it requires is part ofthat wiring process. For oth-ers, they may buy into the con-cept completely, but they tem-peramentally just dont have

the patience.

Question: When do you


the business at things like value,why it is trading where its

trading, what it is really worthand so forth and so on.

Question: You have oftensaid that you look for dollarbills that are selling formuch less than a dollar,then you need to have thestrength to be patient and

wait for the rest of theworld to realize it is wortha dollar. As MBA students,

we are often asked forstock ideas when we inter-view for summer intern-

ships or full-time positions.The first question that weare often asked is what isthe catalyst for your ideato reach its intrinsicvalue? How do you thinkabout catalysts when you

are making an investment?

I dont focus on catalysts. Ihave always felt that value is itsown catalyst and that eventu-ally the stock market becomesa weighing machine and will

weigh stocks correctly. I re-cently bought into a Europeancompany that trades at about1/3 of its hard asset liquidationvalue. I cant see any real cata-lyst in that business. I couldnttell you when or what eventwill make that value converge,but if something is trading at1/3 of what its worth, I thinkthat if you are just patient for afew years, it is highly likely thatyou will make money and it ishighly unlikely that you will lose

money.

Question: How do you

think about downside risk?

At Pabrai Funds, I have madeseveral mistakes in the past andIm sure Ill make several morein the future. You always needto protect the downside risk. Ithink margin of safety is one of


I have always

felt that value is

its own catalyst

a n d t h a t

eventually the

stock market

b e c o m e s a

w e i g h i n g

machine and

will weigh stocks

correctly.

In 2007, MohnishPabrai published hissecond book, The

Dhandho Investor


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Professor Bruce Greenwald andDean Glenn Hubbard

Columbia Business School is

a leading resource for invest-

ment management profession-

als and the only Ivy League

business school in New York

City. The School, where value

investing originated, is consis-

tently ranked among the top

programs for finance in the

world.


Question: Several value-oriented hedge fund man-agers that have spoken to

our class this year talkedabout the advantage theyhave to go both long andshort the market. I knowthat you have differentopinions about shorting

stocks.

I think that Charlie Mungerexpressed it really well at this

years Berkshire HathawayAnnual Meeting when he saidthat they made most of theirmoney going long on a fewgreat businesses. Buffett hasventured into all kinds of de-rivatives or pair trades, orshorting, etc., but clearly he hasmade most of his money bybeing long on great businesses.I think that the math on short-

ing is very bad.

First of all, in general, over verylong periods of time, markets

go up in value. So the startingpoint of a short bet is to havehead-winds against you. That is

the first problem.

The second issue is that themaximum you can make if youshort a stock and it goes tozero is double your money.The maximum you can lose isinfinite, because a stock cankeep going up, but can only godown to zero, so you donthave a symmetrical risk-rewardrelationship. The maximumyou can make is two timesyour investment; the maximum

you can lose is everything. It isa poor bet to have those typesof odds on any bet you are

making.

Third, I think it is so mucheasier temperamentally to golong on a business. If you shorta business, you either have toput up stop-losses, or end upon a leash glued to a monitorall hours the market is open. Idont believe that is a veryproductive way to live your life.Im usually drooling on my

pillow on the West Coastwhen the markets are opening.So it certainly wouldnt workfor me since I generally dontlook at the market until severalhours of the trading day have

passed.

Question: I know you are abig proponent of CharlieMungers Latticework ofMental Models approach.How have you applied thisthought process to invest-

ing?

Well, I think that Mungersmental models approach is avery powerful construct. Firstof all, he talks about the notionof worldly wisdom. He en-courages folks to read andlearn about things that areoutside of the theme of value


think about selling an in-

vestment?

I typically try to buy things forfifty cents or less and I start tothink about selling them whenthey get to be worth ninetycents or more. When thingsare above ninety percent ofintrinsic value, they becomecandidates to be sold. Ofcourse I factor into the deci-sion things such as long-termvs. short-term gains or whatother opportunities there arefor the money. When things

go to one hundred percent ofintrinsic value, I would be look-ing hard for replacements or

thinking about going to cash.

Question: In the past,what were some of thesigns that made you realize

you had made a mistake?

At all times, you have to beasking yourself the questionWhat is the business worth?and What is the intrinsic valueof the business? A couple of

things can happen. First, youcould have made a mistake onwhat you thought the businesswas worth and you could laterhave realized that it isnt worthwhat you thought it was. Inthis case, you should look atthe current stock price. Thealgorithm I use is to askwhether the current worth ofthe business is less than thecurrent stock price. If theanswer is yes, there is no ques-tion that the stock ought to besold. On the other hand, evenif I made a mistake, but thecurrent value of the business isstill above the current stockprice, then I will typically waitfor two or three years fromthe time I bought before Iwould think about selling. Illgive the market some time to

try to close that gap.


I think the

temperament or

patience comes

in part from the

way we are

wired or the way

we can learn, or

not learn, fromBen Graham,

Warren Buffett,

etc.


6/22

Page 6


tion, but you dont have muchof an upside either. Both ways

you are a loser. Most of thetimes that I see people pitchingan idea, I usually see them talk-ing about 65 75 cent dollarsand I think that those ideastend to be lacking on twofronts: There isnt enough of amargin of safety and there isnt

enough of an upside.

Question: We were fortu-nate to have heard youspeak in Professor Greenwalds Value Invest-ing Seminar, where youused an analogy aboutsmoke-filled theaters andspectacular waterfalls. Can

you discuss this concept?

I was recently discussing thisconcept with a bunch of valueinvestors and they all said theynever heard Buffett use thisanalogy, but I could swear thatI heard it from Buffett. So fornow, I will continue to say that

I got it from Warren Buffett.

Here is the basic concept.

Lets say you go to see a movieand you pay $10 to buy a

ticket. Every seat in the thea-ter is occupied the house isfull. Suddenly, the smoke alarmgoes off in the middle of themovie and as smoke begins tofill the theater, people run forthe exit. Now, this movietheater has special rules, andthe rule is that you can onlyleave the theater as long as youfind someone from outside thetheater who will take yourticket and seat. You must en-ter into some type of transac-tion where that person pays

you for your ticket. So thequestion that comes up is atwhat price will that $10 ticketsell for now that there is thisalarm and smoke in the thea-ter, and the answer is that itprobably doesnt sell for verymuch, or you might have togive it away for free, or youmay even have to pay the guyto take it off of your hands.That theater is the New YorkStock Exchange, because onthe stock exchange every shareof any business is owned bysomeone at all times. If thereis an event which is a distress-ing event for a company whichleads people to say I no longerwant to own the stock, that islike the smoke in the theaterand people wanting to exit thetheater. The person who youwant to sell the stock to, whichis the person who wants toenter the theater, has access tothe exact same informationthat you do. He also knowsthere is smoke in the theater.

Therefore, for him to still bewilling to buy it, the price atwhich the transaction takesplace, is likely to be a significantdiscount at what the stock wastrading at before the smoke. Ifyou enter selected smoke-filledtheaters, and you later find thatthe smoke is really nothing to


investing or might not seem to

have a connection to valueinvesting, but I think it is veryuseful to know the way theworld works. Reading bookson science, economics, orother different disciplines andto have a basic understandingof all of these different disci-plines is useful to the investingprocess. I think investing ingeneral is one of the broadestdisciplines that one can go into,because any stock you look atis affected by so many differentvariables. Many of these vari-

ables touch on subjects that areoutside of investing and finance.So it is very useful to have abroad set of frameworks andtools to draw on. I think it isvery useful to basically becomea person who is strong on

worldly wisdom.

Question: You are a fre-quent speaker at manyevents, such as the ValueInvesting Congress, whereyou get to hear many in-vestors pitch their favoriteideas. What are some ofthe biggest mistakes yousee investors, especially

younger investors, making?

Many times, when I hear abouta stock idea from another in-vestor, the idea being pre-sented does not seem to havethe margin of safety tenets. Igenerally find margin of safetyto be the weakest part of mostideas. There is a very impor-tant thing about Ben Grahams

idea of margin of safety whichis that the higher the margin ofsafety, the lower the risk,which is obvious. The secondtenet is that the higher themargin of safety, the greaterthe return. If you are buyingsomething that is a 70 centdollar, not only do you nothave much downside protec-


Many times, when I

hear about a stock

idea from another

investor, the idea be-

ing presented does

not seem to have the

margin of safety ten-

ets. I generally find

margin of safety to

be the weakest part

of most ideas.

P r o f e s s o r B r u c eGreenwald

Bruce C. N. Greenwaldholds the Robert Heil-brunn Professorship ofFinance and Asset Man-agement at ColumbiaBusiness School and isthe academic Director ofthe Heilbrunn Centerfor Graham & Dodd

Investing. Described bythe New York Times asa guru to Wall Streetsgurus, Greenwald is anauthority on value in-vesting with additionalexpertise in productivityand the economics of

information.


7/22

A s a v a l u e

investor, you dont

want to enter every

s m o k e - f i l l e d

theater. What you

want to do is

carefully analyze

these smoke-filled

theaters to try to

find one where the

smoke is not real, or

the fire alarm is not

real, it went off for

no reason, and thenbuy those tickets at

hugely discounted

prices, then sit back

and watch the rest

of the movie.



is no data other than news ofthe 200 agents. That is clearlya theater with an alarm going

off, with all kinds of smoke in it.The people sitting watching themovie had signed up for thishigh-growth, high-momentumstock, and they had signed upto see a certain kind of movie.When the federal agentsshowed up, they could clearlysee that this is not the kind ofmovie they want to see. Theydont want to be hangingaround with all the smoke andthey want to leave. When theytry to leave the theater, theyneeded to sell those tickets to

someone else and the clearingprice that they exchanged theirWellcare tickets for was $20 ashare. This was 50% of just thecash on their balance sheet.Forget about the business, theearnings engine, and everythingelse; people were not evenwilling to pay for the hard as-sets of the business at thatpoint not even the liquidassets of the business at thatpoint. So you got a very spec-tacular, real-world case of logic

going out the window, justbecause of the stampede out of

the theater.

Question: What impor-tance do you place on as-sessing management when

you make an investment?

The jockeys are very impor-tant. It depends on the situa-tion. I think that the idealsituation is to have a businessthat is a great business, which isgoing to grow a lot in the fu-

ture and not require muchcapital. The best example ofsomething like that is Moodys

a great business, growing alot, that you can buy at a verycheap price well below itsworth and run by a spectacularmanager. That is utopia, andthat is what you always want to

try and look for.

The real world usually is notthat accommodating. You may

have to look at situations, likeBen Graham did, where hefocused more on the hard as-sets, and not much on manage-ment, etc. So, I have had somevery successful investments inbusinesses where the bet wasbased on hard liquidation value,and I did not spend a lot oftime assessing the quality ofmanagement, other than that

they were competent.

There are other businesseswhere the quality of manage-

ment is more critical, becauseof the nature of the business. Iwas recently looking at thestocks Ive held the longest atPabrai Funds. There are somestocks that I have held now for5 or 6 years. I looked at thesestocks and I asked what aboutthese companies has kept me inthese businesses for so long. Inmany cases they are up two,three, or even four timeswhere I bought them and I stillbelieve they are undervalued,

and still hold onto them. Thereason is, universally, because

of the quality of management.

What I have learned to appre-ciate, when I looked back atthat nuance - historically, I havenot paid that much attention tothe jockey. But I have learned,sometimes very painfully, that

jockeys are much more impor-tant than I had given themcredit for in the past. So goingforward I care a lot moreabout jockeys. Im not always

able to find great jockeys alongwith great businesses that arealso undervalued, but I havelearned to appreciate the im-

portance of jockeys.

One thing I would say is that ifyou take a look at three classicvalue managers: Longleaf Part-


worry about, or it has been putout, then there is a chance you

have gotten a great investmentand you can do quite well with

it.

The second part of this is whenyou have smoke in theaters,you are going to have thesehuge collapses in stock prices.If you look at the stocks chart,these will look like a waterfall.So what this means is thatsmoke-filled theaters are likelyto lead to spectacular water-falls. As a value investor, youdont want to enter every

smoke-filled theater. Whatyou want to do is carefullyanalyze these smoke-filled thea-ters to try to find one wherethe smoke is not real, or thefire alarm is not real, it went offfor no reason, and then buythose tickets at hugely dis-counted prices, then sit backand watch the rest of the

movie.

I think this is a good way tosummarize the framework.

One example I spoke about atColumbia was Wellcare (NYSE:WCG). I generally dont talkabout stocks that I own, but Ifelt that Wellcare was such apure textbook example. Icouldnt come up with a betterexample, even looking at thehistory of stocks. I also thinkpeople learn a lot more withBen Grahams technique oftalking about current stockssince they can relate better.Here is an event that is stillplaying out; there is still some

smoke in the theater.

Wellcare is a situation whereyou have a company that istrading at over $120 a sharewhen 200 federal agents showup at their doorstep, unan-nounced, holding search war-rants. The stock is halted andwhen it resumes trading, there


Page 7


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Page 8


about jockey bets. Most oftheir portfolio is invested inpeople who are great jockeys.They have large positions inLeucadia, Berkshire Hathaway,and Canadian Natural Re-sources. If you start to look atwhy they bought these busi-nesses, it is all about the

jockey.

When I look at Pabrai Funds, Ithink of it as a blend of thethree, because I have mademany investments which arevery much Third Avenue-typebets pure hard-asset plays. Ihave also made investmentswhere it is about the franchisevalue, moats, brands and so on

a Longleaf play. I have alsomade several jockey bets, likeFairholme. I would say that

over the past 12 months, I havelearned to appreciate andspend more time analyzing the

jockeys and put more weight

on it.

Question: What advicewould you give to MBAstudents who aspire to a

career in investing?

I think that the best thing to do

is to actually set up a smallportfolio of your own and startmaking real investment bets.Dont run these virtual portfo-lios take real money that youactually have, and invest it likeyou would invest a $5 millionportfolio. Be rigorous about itbecause I think you learn whenyou make mistakes that actuallycost you money. From mypoint of view, that is the best

way to learn.

Going to Columbia is a great

idea! If you are already at Co-lumbia, follow Buffetts adviceand try to find a shop that isrun by people you admire andhave principles you believe in,and try to convince them tobring you on board without

focusing on compensation.

Thank you, Mr. Pabrai.

-G&Dsville

ners, Third Avenue, and Fair-holme - all three are valuemanagers, but all three havevery different styles. MartyWhitman of Third Avenuecares very much about hardassets and he doesnt care asmuch about things like fran-chise value, or moats or evenmanagement. He cares themost about hard assets. If youlook at someone like Longleaf,they care a lot about the fran-chise. They focus on the en-during moat, franchise, etc.One time they mentioned thatthey thought that Coke bot-tlers were a great business, andthey went looking around theworld making a list of everyCoke bottler on the planet,trying to see which ones they

could invest in at decent prices.In general, they focus on thebusiness and the valuation, butnot as much on the manage-ment. Their focus is more onmoats and franchise value,which is what you will see ifyou look at Longleafs portfolio.Then, if you look at someonelike Fairholme, they are all

(Continued from page 7)Mohnish Pabrai, Warren

Buffett (51), and Guy Spier


9/22


Annual Alumni Reunion with Joel Greenblatt

multiple does that lead you to?What multiple does a companydeserve in normal times and

what kind of a discount doesthat mean a stock is currentlyat? Greenblatts bet is that aturn in the market will come,he just doesnt know when. Byfocusing on normal earnings, aninvestor can create what BillMiller calls Time-Horizon Arbi-trage. There are guys whocan trade short-term, and bangout huge returns every month,but (a) Im not one of them;and (b) you are likely not oneof them either! quipped

Greenblatt.

Professor Greenblatt suggeststhat investors focus on findingareas that are ripe for mispric-ing. When economic forecastsare bleak, people worry, and inturn, misprice securities.Their outlook may be right,says Greenblatt, but this isntwhere I focus when investing. Ifocus on normal earningspower and a long-term normalenvironment. According toGreenblatt there are a lot of

opportunities right now.

Next, investors should be try-ing to figure out what the com-panies they are looking at arelikely to earn in a normal envi-ronment. Whether that nor-mal environment returns nextyear, or a few years from nowis unknown; but investors needto make sure that whateverthey are buying is at a big dis-count to that value. But howshould an investor think aboutnormalizing earnings, on a longterm basis going forward, whenthe last 8 years or so of back-ward data for many industriesmight be inflated? One thing tolook for is whether marginswere higher over the past fewyears than they were on a long-term basis. That analysis wouldgo into your normalized num-ber. According to Professor

Greenblatt, the concepts ofvalue investing arent very com-plicated; however, they aredifficult to put into practice. Itis imperative that one maintaindiscipline in the face of every-thing going on. Assumptionsmay have been too optimisticover the past few years, butinvestors need to adjust theirvaluations based on what they

think normalized is now.

Professor Greenblatt suggestedthat the best thing to differ-

entiate yourself in the processis not just by doing the goodwork, but by having the disci-pline to not buy something justbecause you did the goodwork. Investors need thediscipline to recognize when acompany they have been work-ing on is not selling for thesame discount as they haveseen in the past and pass evenif it is just a little bit cheap. Ifyou are extremely disciplined,only buy when you have a largemargin of safety, and are willingto stick it out for two or threeyears - then I think you have

the right process.

I wait for easy ones, admittedGreenblatt. I wait for oneswhere I say hey, if someonewould have looked at it thisway, it is clearly cheap. This


On April 28, 2008, currentstudents and alumni of theValue Investing Program were

invited to the annual springreunion at the Columbia Clubin Manhattan. In his introduc-t i o n , P ro f e s s o r B ruceGreenwald proclaimed thatspeaker Joel Greenblatt hasachieved the trifecta: he is aterrific investor, he has writtenterrific books, and he is a terri-fic teacher in the Value Invest-

ing Program.

After reading his first book, YouCan be a Stock Market Genius,

one might naturally wonder ifthings were different whenProfessor Greenblatt began asa professional investor. Wasit more of the Wild West 25years ago? asked Greenblatt.Now we keep producing allthese smart guys out of MBAschools who are doing all thisresearch and maybe those effi-cient market guys were right.There are no opportunitiesleft However, ProfessorGreenblatt pointed out severalreasons to be optimistic. First,

the internet bubble wasnt solong ago. Second, in 2002 2003 there were some of thebest bargains in the market thathe had seen in many years.Third, credit markets, whichare much bigger than the stockmarket, were insane just abouta year ago. All this points to a

market that is not efficient.

The longer Greenblatt hasbeen in the business, the moreinstitutionalized he has seen itbecome. Money managershave different directives andnow people only care how youdid last month. If you beat thebenchmark this month or nextmonth, and more people be-come focused on that, then lesspeople can focus on what nor-mal earnings power should bein a normal environment twoto three years out, and what

Professor Bruce Greenwald moderates a Q&A with Pro-

fessor Joel Greenblatt at the Columbia Club.

The concepts of

value investing

a r e n t v e r y

c o m p l i c a t e d ;

however, they are

difficult to put into

practice


10/22

Page 10

This is a difficult market. Re-cently I heard the story of aninvestment banker who had totell his wife that there wouldbe no bonus this year. He says,Were going to have to cutback. If you could learn tocook, then we could fire ourchef. To which she replied, Ifyou could learn to make love,then we could fire the gar-

dener!

And so began Warren Buffetts

opening remarks to a group ofstudents from Columbia Busi-ness School and the Universityof Texas A&M on March 21st atthe Omaha Field Club in

Omaha, Nebraska.

The trek to see the Oraclebegan early the night beforewith nearly 120 of ProfessorGreenwalds students meetingat 116th and Broadway at 3:30am. From there, two busesarrived and brought us to JFKairport, where we boarded achartered Jet Blue plane at 6

am.

The group arrived in Omaha at9 am and proceeded to a Berk-shire-owned subsidiary, theNebraska Furniture Mart,where we were greeted by BobBatt. Mr. Batt, the CEO ofNebraska Furniture, is the third

generation of his family to runthe company, which wasfounded by Rose Blumkin in

1937. The purchase of Ne-braska Furniture Mart is thestuff of Berkshire legend. Andthough Nebraska Furnituremay not contribute as much asGeico to the bottom line, thereis no question that this businessis a quintessential WEB invest-ment. It is a business that is runby honest, hardworking peoplewho could quit at any time, butdont because they love their

jobs.

By noon, we had taken the fulltour of Nebraska Furniture andwere ready to pepper Mr. Buf-fett with as many questions ashed let us ask. The Q&A ses-sion lasted for over two hoursand began with a questionabout Mr. Buffetts thoughts on

derivates.

Financial weapons of mass

destruction

Although he has been warningthe markets about the dangersof derivatives and structuredproducts for years, Mr. Buffettappeared to experience no joyin his recent vindication. Henoted that his primary con-cerns about derivatives involvethe leverage they allow partici-pants to employ, and theopaqueness around their true

value.

On the plus side, Mr. Buffett

noted that there are oftensignificant mispricings in deriva-tives which create opportuni-ties to profit. On the minusside, derivatives present bigopportunities for financial mis-chief. When we purchased GenRe, there were 24,000 con-tracts on the books. One con-tract went out 100 years! said

Buffett.


Annual Pilgrimage: CBS Students Meet With The Oracle Of Omaha

Adam Lindsay (09) listens as Warren Buffett (51) answersquestions posed by students of Professor Greenwalds Value

Investing Seminar

CIMA Co-Presidents DelAnderson (08) and MattLoesch (08) pose with

Mr. Buffett


11/22

Page 11

Annual Pilgrimage: (continued from page 10)

It was in this context that heremarked the CEO should

also be the head of risk man-agement for any major financialinstitution. I personally handleall of our derivative contracts.However, it is now obvious toall of us that most banks, insur-ance companies, and asset man-agers are not run this way.Back when we were runningSalomon, my partner Charliefound a large number of mis-takes in one of the derivativescontracts. We paid ArthurAndersen millions of dollars to

review the contracts for us,and yet they had missed it.These things are designed tofool. They fooled the account-ants, but they didnt fool Char-

lie!

Salomon Brothers

Mr. Buffetts discussion of de-rivatives at Salomon Brothersprovided a nice segue for aquestion about the famous dealin which Berkshire purchased$700 million of preferred con-

vertible stock. The question,akin to asking a chess grand-master what moves he woulduse on himself, asked whetherhe would have done the dealhad he been in Salomonsshoes. Mr. Buffetts answerhighlighted the benefits andpitfalls that he experiences as along-term investor, and as oneconsidered by many to be the

greatest of all time.

Initially, Buffett explained,Ronald Perelman had indicatedinterest in buying Salomon but John Gutfreund was un-happy with the prospect ofselling to someone with a repu-tation for financial engineering.Berkshire clearly had no inter-est in buying it, levering it up,and selling so the firm be-came a very attractive candi-date. Second, it has been ar-gued that Buffett received ex-

(Continued from page 10) ceedingly favorable terms in thedeal. Buffett countered thispoint with the following obser-

vation: Just as stocks often popwhen people find that Berk-shire is buying, they also fallwhen Berkshire is selling.Would you buy a stock thatMr. Buffett didnt want? Tomake up for the discount Berk-shire receives when sellingand to compensate for thelong-term commitment itmakesBerkshire often needsto demand excellent terms to

justify a deal. It is also worthnoting that Mr. Buffett received

a salary of $1 and is widelycredited for keeping Salomonout of bankruptcy. As he said,I think they got their moneys

worth.

U.S. trade deficit

Mr. Buffett described our tradedeficit as the U.S. force feedingthe world $2 billion in U.S.paper every day. It is kind oflike eating an extra roll fordinner every night its notlike you get up from the table

and suddenly people say, Ohmy god, youve gotten fat! Butover time, of course, it has

consequences.

He also noted that accompany-ing our deficit are some policydecisions that could proveproblematic. China has accu-mulated foreign exchange re-serves of $1.5 trillion. Yetwhen they tried to take someof those funds and purchase athird-tier oil company, Unocal,Congress went ape. Forcingother countries to take ourmoney and then not allowingthem to spend it as they wishdoes not seem sustainable,

Buffett claimed.

Valuation of international

companies

A Q&A session with Mr. Buf-fett would not be complete

without someone asking howhe values a company. This visitwould be no different but thequestion focused on the valua-tion of international companiesin particular. The Oracle com-pared the valuation of compa-nies to how he used to handi-cap horses. At the race track,the first thing you want to do ,all things equal, is determineeach horses chance of winningthe race. Then you figure outwhich one has the best oddsrelative to its chance of win-

ning. This is the exact ap-proach he took to valuing Pet-roChina. Mr. Buffett remarkedthat when he first looked at thecompany he thought it wasworth about $100 billion. But itwas only selling for $35 billionin the market at the time. Ashe said: That got my atten-tion. While he freely acknowl-edged that investing in China isnot quite like investing in theU.S., Buffett maintained thatPetroChina seemed to be trad-ing at a significant discount forone of the worlds largest oilcompanies. In such a way,Berkshire was able to scoop upshares of PetroChina with asignificant margin of safety. Ingeneral, Mr. Buffett explainedthat he takes the same ap-proach to evaluating foreigncompanies as he does domesticones, but he requires an extra


Volume II, Issue 2

Columbia Business SchoolProfessors Michael Johan-nes and Tano Santos

along with Mr. Buffett


12/22

Page 12

measure of undervaluation tocompensate him for potential

unknowns.

Of course, as any value inves-tor will tell you, a huge compo-nent of valuation is understand-ing competitive advantage.When asked about how heassesses a companys competi-tive advantage, Mr. Buffettwalked us through numerousexamples including SeesCandy, Coca Cola, and Snick-ers. This discussion can besummarized succinctly with

Buffetts first eight words: If itisnt obvious, I dont buy it.

Banks and the financial

crisis

Not surprisingly, the currentturmoil in the financial marketsspurred one student to ask Mr.Buffett his thoughts on Citi-group and the other money-center banks. Acknowledgingall of our concerns, he re-marked that Citi will bearound in the future. You have

to think that when the Fedsteps in to save number fiveBear Stearns, they will printmoney if they have to in orderto get the big banks through.More interesting, perhaps, washow Mr. Buffett betrayed hisfinancial sophistication whendiscussing the possibility ofbankruptcy in the financial mar-kets. Although decrying theabuse of derivatives, Mr. Buffettis unquestionably savvy and willlook just about anywhere formispricings. It is interesting ifyou look at the credit defaultswap market, which is essen-tially the cost of insuranceagainst Citigroup defaulting onits bond obligations, it is imply-ing a 3.4% likelihood of default.

I think that is wrong.

Showcasing his knack forevocative analogies and imagery

(Continued from page 11) even an MBA could under-stand, Mr. Buffett described thefinancial crisis in the following

way: Banks got into trouble bypassing around this toxic Kool -Aid, like Jim Jones. And thenthey drank a couple of gallons

themselves.

Other peoples money

One CBS student displayed aninterest in starting his own firmone day and asked Mr. Buffetthow he knew he was ready tomanage other peoples moneyat such a young age. Mr. Buffett

recalled that he left Columbiawhen he was 20 years old andbecame a stock broker inOmaha. His first call was to hisAunt Alice, to whom he sold100 shares of Geico. Buffettremarked that some of theother calls werent so easy. Iwas always comfortable doingthings with my own money that was never a problem. But Iwas bothered when othersbristled at the price action on astock or investment I had rec-ommended. It was difficult for

me. People would worry ifGeico lost 50 percent, but I

would just buy more.

Acknowledging Ben Grahamsinfluence on him, he said thatafter I met Graham, I felt 100percent confident that I wasdoing the right thing. So thekey was getting my investors toagree to the partnership rules,and they did. Mr. Buffett wenton to describe how he used tocomb through the giant securi-ties manuals published byMoodys or Standard & Poorslooking for value. Recently hetried a similar tact when hebought a manual for securitiesand companies in Korea wherehe quickly found dozens ofcompanies selling for two andthree times earnings: I hadnever heard of any of thesecompanies, and had never been

to Korea. Management couldbe crooks for all I know, but ifyou buy 10 or 20 of these com-

panies, you cant lose money.You can find these investmentstoday, but you may have to

look in places like Korea.

Lesson from past crises

On the topic of managingmoney, a student asked aboutMr. Buffetts thoughts on les-sons learned from past crisessuch as 1973-1974 and 1989-1990. Mr. Buffett reminded usthat the stock market is there

to serve you, not to instructyou. The volatility in a stock isyour best friend! I love it whencompanies prices jump up by100 percent or down by 50percent in the same year. Vola-tility in stocks is what has mademe rich! He further instructedus to be detached from themarket emotionally, but payattention to opportunities as

they arise.

A turnabout on turn-

arounds

Some of us in the audienceapparently are not patientenough to wait around for themarket to throw them a fatpitch. One student askedabout Mr. Buffetts thoughts onturnaround situations andnoted that Buffett had beeninvolved in quite a few when hewas younger. Mr. Buffett ex-pressed a different sentimentnow perhaps because of Berk-shires current size or becauseof the evolution in his invest-ment philosophy. If you aregood at turnarounds, he said,you are probably just a goodmanager. Go join a good busi-ness and you will probably do alot better. Why try to swimagainst the tide? If you want tobuild a good reputation, buy agood business. I cant think of


Annual Pilgrimage: (continued from page 11)

Banks got into

trouble by

passing around

this toxic Kool-

Aid, like Jim

Jones. And then

they drank a

couple of

gallons

themselves.

Students present Mr. Buf-fett with a Yankees Jerseybearing the year he gradu-ated from Columbia Busi-

ness School


13/22

Page 13

Annual Pilgrimage: (continued from page 12)one person who has been re-peatedly successful at turn-

arounds. Capitalism can bebrutal when you are up againstcompetition that has some

advantage over you.

Students, managers, and

investors

The conversation took its finalturn toward three constituen-cies in which Mr. Buffett has alot of interest: students, manag-ers, and investors. Commentingfirst on his advice for students,

Mr. Buffett highlighted the culti-vation of accounting and com-munication skills. Get asmuch accounting as you can,he explained, it is the languageof business. In addition toaccounting, he stressed theimportance of written andverbal skills and pointed outthat the only diploma I havehanging up in my office is fromthe Dale Carnegie School forpublic speaking. I joined 30people every week to work onpublic speaking. It changed the

course of my life. Also, I thinkwriting is extremely important.If you can get ideas across toother people, you will stand

out anywhere you go.

Although he discussed what helooks for in a manager in somedetail, it boils down to oneword: passion theyve got towant to do the job. In perhapshis most colorful analogy of theday, Mr. Buffett described thetype of managers hed buy abusiness from: We dont doauctions. Owners who auctiontheir business dont care aboutwhat happens to them. Theydont think of it like a painting.When you sell your business,you have two options. Sell toBerkshire and it is like sellingyour painting to the Metropoli-tan Museum of Art. We willput up a wing for it. Otherwise


you can sell to a private equityshop, which is like selling to aporn shop. They will buy thecompany and they will want toadjust a few things, make theboobs bigger, and so forth Itwill sit on the shelf for a coupleof months, and then some guyin a trench coat will come

along and buy it from them.

Once the laughter in the crowdsettled down, we left Buffettwith a final question: whichinvestors would you recom-mend today? Although he wasable to tick off a few names,such as Greg Alexander atRuane, Cunniff & Goldfarb andSeth Klarman at Baupost, Mr.Buffett focused more on howwe should think about findingthese great investors. When heclosed his partnership in 1969,he recommended Sandy Got-tesman and Bill Ruane. Heknew them well, knew theirtemperaments, and knew theywould pursue sound strategies(for more on this topic, seeBuffetts article: The Superin-vestors of Graham and Dod-desville). He also noted that, Iwouldnt pick the person who

has the best track record. Youneed to spot great investorswhen they are young and un-known. Nevertheless, as greatas it is to find investors beforethey are famous, he remindedus of the difficulties in managinglarge sums of money. Although

he thinks funds like Sequoia andBaupost will do better thanaverage, these funds will strug-gle to do as well as they did

when they were smaller.

Striking a pose

After a few concluding re-marks, Mr. Buffett accompaniedus outside where we partookin yet another Buffett trip tradi-tion: pictures with the Oraclehimself! It is quite a sight tobehold to see 120 professional

and successful adults swarmaround Mr. Buffett like so manyfifteen-year-old girls at a JustinTimberlake concert. But War-ren took it all in stride andpatiently took photos untilevery camera had run out of

memory

-G&Dsville

Volume II, Issue 2

Professor Bruce Greenwald

and Warren Buffett (51)


14/22

Page 14

Squaring Off Against a Hedge Fund Master

charitable giving. As anadded incentive, Ack-

man pledged to donate$25,000 to ColumbiaBusiness School onbehalf of the studentwith the most promis-

ing investment thesis.

Students spent monthspreparing for the con-test. After a series offive training sessionsspanning February toApril, students submit-

ted two-page summaries oftheir investment ideas to a

selection committee, whichconsisted of recent graduatesfrom Columbias Applied ValueInvesting program. Five finalists

09ers Amy Chen, Vikas Jain,Adam Lindsay, Shilpa Marda,and Stephen Walker wereselected to present their ideasto a star-studded panel of

judges:

Bill Ackman Founderand Portfolio Manager, Per-

shing Square

Ali Namvar Senior Ana-

lyst, Pershing Square

Danilo Santiago Founderand Portfolio Manager, Rational

Asset Management

Prof. Bruce Greenwald -Robert Heilbrunn Professor of

Finance and Asset Management

Ken Shubin-Stein - ValueInvesting Program Adjunct

Professor

The final presentations began

on Friday morning, April 25th

.First, Amy Chen presented herthesis on retailer LimitedBrands. After a brisk five-minute presentation, the judgesbegan peppering Chen withquestions, starting with thebalance sheet. Chen explainedthat the Limited had recentlyrestructured; debt was at a

manageable level. The judgespressed further: Do they own

or lease their stores? Howmuch do they pay in rent? Ineach case, Chen respondedcalmly with an impressive com-mand of the facts, and the pan-elists offered suggestions forhow she could improve her

thesis.

Next, Vikas Jain shared hisviews on database marketingfirm Acxiom Corporation,which he believed is a goodbusiness run badly. Jain pre-sented a series of steps man-

agement could take to increasethe firms stock price. Again,the judges asked questions tobetter understand the risks andassumptions behind Jains the-sis, inquiring about whethertheir technology was proprie-tary and about the presence of

a competitive advantage.

Adam Lindsay continued thechallenge by advocating a longposition in used car retailerCARMAX. His comments dem-onstrated a thorough under-standing of the business, em-phasizing its strong competitiveposition and potential expan-sion opportunities. In the Q&Aportion, the panelists asked aseries of detailed questionsabout the companys financingbusiness and receivables. One

judge suggested that a sensitiv-ity analysis of customer defaultrates would be helpful. The

judges also inquired about po-tential threats from nontradi-tional competitors, such as

eBay.

Shilpa Marda made a compellingcase for NutriSystem, theweight management system.Her pitch included primaryresearch on potential competi-tive threats and a sensitivityanalysis of the firms marketing


Announcing the 2ndAnnual Per-shing Square Value Investing and

Philanthropy Challenge

For many investment profes-sionals, making money in thestock and bond markets is theultimate challenge. For thosewho succeed, an additional(arguably no less formidable)challenge can be finding mean-ingful and effective philan-thropic activities. Bill Ackman,Founder of Pershing SquareCapital Management, noted thishigh-class problem in hisintroductory remarks for thefirst annual Pershing SquareValue Investing and Philan-thropy Challenge, which tookplace in Uris Hall on April 25 th

2008.

Ackmans own experience withbusiness school, he reflected,was a lesson in due diligence.He followed in his fathersfootsteps and attended Har-vard Business School, which much to his chagrin did notoffer classes in investment

management. To provide addi-tional training opportunities forstudents of investing, Ackmanworked with Columbias Heil-brunn Center to create thePershing Square Challenge,which has two objectives: toteach students how to developand pitch investment ideas, andto give students exposure to

Judges of the 2008Pershing Square

Challenge included (lto r): ProfessorBruce Greenwald,Danilo Santiago, BillAckman, Ali Namvar,

and Ken Shubin-Stein


15/22


Squaring Off... (continued from page 14)

tions focused on a number ofkey issues from regulatory

pressure that could arise in atough economy, competitionfrom the trucking industry, anda potential shift away from coalgiven a new presidential ad-ministrations emphasis on new

energy sources.

After these spirited discussions,the panel adjourned for severalminutes to debate the merits ofeach idea and select a winner.In the end, the judges selectedShilpa Mardas NutriSystempitch. At a lunch reception that

followed, Ackman presentedthe check for $25,000 to Co-lumbia Business School onMardas behalf and lingered in

order to chat with students.

Attention future hedge fundimpresarios: do not miss thisyears Pershing Square ValueInvesting and PhilanthropyChallenge! The first trainingevent Competition Analysisand Valuation I begins onSeptember 26th at 10:00am inUris 301. For more informa-tion, please contact Sean

McDonald ([email protected]) or Priyanka

Agnihotri ([email protected]), VPs of edu-cation and mentoring for theColumbia Investment Manage-

ment Association.

-G&Dsville

spending. One of the judges

complimented her research oncompetitors but pushed formore detail on the companystrack record of returning cashto shareholders. Marda re-sponded with an easy com-mand of the relevant facts.Another panelist observed thatMardas valuation was veryconservativeshe could goslightly higher and remain con-servative. In response to one

judges question on the impactof a consumer recession, Ack-man interjected, it costs $10

per day thats less thanMcDonalds! You can savemoney and fit in your old

clothes.

Finally, Stephen Walker pitchedCSX, a provider of rail-basedtransportation services. In hisopening remarks, Walkerpointed out that CSX benefitsfrom a combination of growingdemand and tight capacity forcoal, which has to go by rail.As a former employee, Walkerdisplayed a wealth of knowl-edge about the business. Ques-

Addressing the 2009 graduatesof the Value Investing Program,Professor Greenblatt agreedthat for those who have notyet found a job, the economicsituation sounds like bad news;but you dont really want tostart working at a time when

things are at all-time highs,Greenblatt asserts. This isactually a much better environ-ment, if you can find a job., hesays, concluding that it is aharder time to find a job and a

better time to get one!

-G&Dsville

some of the smaller situations.This is where younger inves-tors can excel. One piece ofadvice he would give to inves-tors who are just starting out,especially if they are startingtheir own fund, is to avoidinvesting like you are running

$20 billion if you are running$20 million Look at some ofthe situations that some of thebigger guys arent looking at.Do your own work. You donthave to be as smart as guysthat have been doing this fortwenty years, because thereare situations the older guys

just cant look at anymore.

way, Greenblatt does not haveto make much in the way ofpredictions or have to base hiswhole thesis on normalizedearnings. I look for somethingany idiot would buy if theywere looking at it in the same

way that I was.

Professor Greenblatt thinksyoung managers will alwayshave an advantage in the busi-ness, whether it is value orspecial situations, because theinvestors who have success inthese areas make a lot ofmoney and become too big for


Joel Greenblatt (continued from page 9)

Amy Wu, David Krasne, and Stephen Walker, membersof the Class of 2009, enjoyed the after reception wherethe winner of the 2008 Pershing Square Challenge wasannounced. See Shilpa Mardas winning pitch on the

next page.


16/22

Page 16

The Winning Pitch: NutriSystem Inc.

The following section includes a reproduction of Shilpa Mardas winning investment pitch from the Pershing

Square Philanthropy and Investment Challenge. Please note this information is dated.

Investment ThesisNutriSystem Inc. is a provider of a weight management system based on a portion-controlled, prepared-meal program. NutriSystem utilizes a direct-to-consumer sales and distribution approach and out-sources the bulk of production and distribution of its meals. This results in a business model with lowcapital requirements, high financial returns (ROA 53%), solid free cash flow, and high margins (grossmargin 53% and operating margin 21%). Sales have experienced tremendous growth in the past fewyears: 68% in 2004, 459% in 2005, 167% in 2006 and 37% in 2007. NutriSystem is primarily a sales andmarketing organization with a highly scaleable business (revenue per employee increased from $268k in2002 to $836k in 2006). Since July 2007, the stock price has fallen from about $72 to $20 per share(current) due to a 3rd quarter and 4th quarter earnings miss and new competitive threat from Alli, whichis the first FDA approved OTC weight-loss drug, introduced in June 2007. However, this competitivethreat has been misunderstood by the market and I believe NutriSystem will maintain its pricing power(implemented 15%, 3%, 4%, 2% price increases between 2003-2006) and benefit from a growing indus-

try, proven product efficacy, untapped markets and a strong fundamental business model.

Investment Catalysts Impact of Alli Introduced by GlaxoSmithKline, Alli restricts theabsorption of fat in the body, and has severe side-effects including increasedbowel movement and oily spotting. Alli had 2M customers in 2007 since itsintroduction, resulting in NTRI falling short of new customer acquisitions by40K in Q3. However, I believe this is a short-term shift in the competitivelandscape, as Alli is not sustainable. Initially many people tried it, but didnot continue to use it due to severe side effects, and weight gains after theystopped using the product. Alli sales according to GlaxoSmithKline (inBritish Pounds) were 76M in Q2 (with just 2-weeks of being on the market)34M in Q3, 40M in Q4 and 9M Q1 2008, indicating the faddish nature ofthis new drug. Before Alli was introduced, NTRI was trading at a P/E of

30X around June 2007. Growth in Market Share NTRI is positioned for growth in a number of areas: a) Mens Diet

Market Implemented in July 2006 and represented 30% of the business at the end of 2006. NTRIprovides a simple and private weight-loss solution, ideal for the mens market. b) International mar-ket Business model facilitates easy expansion through local partners/distribution. Canadalaunched in Q1 2008 and Japan, Australia, Germany and UK expected to launch in 2009. c) Seniors

Launched NutriSystem Silver in December 2006. Provides a simple solution to seniors withminimum hassle. d) Domestic Only represented 1.9% share of diet market in 2007. Innovativeproduct launches such as NutriSystem Advanced in 2008 (omega 3s and heart-healthy meal pro-

gram) will help increase share. Stable Business with a Scaleable Model As NTRI's client base increases, customer reactiva-

tions (purchases made outside of the 9-month initial diet cycle) have gone up and in 2007 are ex-pected to represent over 12% of sales. Reactivations yield a net profit margin of 31% vs. new cus-tomers, who yield 15%. In 2007, new customers yielded gross margins of $373/customer and CAC

of $173, yielding a profit margin per customer of $200. Management buyback of stock and Acquisition Target Management has board approval

to buy back up to $200M of stock. Management also alluded to receiving calls from potential ac-

quirers.

Industry Landscape and Competitive Advantage In 2006, there were 62M dieters in the U.S. divided into the commercial weight loss market

(approximately 10%) and self-directed (79%). This is expected to grow to 81M dieters in 2010

(30% increase). The international diet market is on the rise with the spread of fast-food chains, increase in wealth

and shift to less physically intensive work. According to WHO, in 2005, 1.1B people were over-

weight.

Shilpa [email protected]

NutriSystem Inc.(NASDAQ: NTRI)

Price: $18.93Shrs Out: 29.56MMarket Cap: 559.60M

PE: 9.14Yield: 3.7%52wk Hi: $50.3352wk Lo: $12.55

52 Week Chart:

(data as of 09/25/2008)


17/22


Bill Ackman and Shilpa

Marda (09)

NutriSystem Inc. (Continued from previous page)

Increasingly busy lifestyles and growing use of the internet are condu-

cive to NTRIs model of a convenient web-based weight loss solution. Also, in addition to diet due to health risks, U.S. consumers are prone

to images in media, fashion, and entertainment that depict thin as theideal body type.

Main competitors are WeightWatchers (center-based), Medifast, JennyCraig (center and direct), eDiets.com (direct caters to a less pricesensitive customer), and self-administered products such as Atkins and

South Beach diet and medically-supervised programs. NTRI targets the price-sensitive consumer who wants a simple-to-use

weight-loss program, but is also used by customers that would not beconsidered price-sensitive. This is a large market as the majority of

overweight people are in the less affluent segment of society. While barriers to entry appear to be low, it is interesting to note that

other entrants into the online diet market have not been successful.This indicates that NTRI does enjoy barriers to entry, including cus-

tomer captivity and cost efficiencies.

Primary Research Surveyed doctors and pharmacists as a potential Alli consumer. 80%

told me they would not recommend the drug, and 20% were neutral,focusing more on the medical aspects. They said the side-effects arevery extreme and involve changing your lifestyle to adapt to them.They also said the results are not that good anyways, if you read thesmall print. One pharmacy had to send back their stock of Alli as inventory levels were too high due

to weak demand. Spoke with people in healthcare field about weight-loss drugs and found out that typically there is an

initial hype with weight-loss drugs, and then demand tailors off as side-effects occur and weight comes

back. After reading internet diet blogs and surveying people who had actually used or tasted NTRI, I got

very positive feedback. People thought it was an extremely simple system that works. They liked the

taste of most of the foods and enjoyed the variety. The major drawback was that people wanted toeat out occasionally and other similarly minor issues.

Valuation Average P/E of peer group is approximately 14x earnings. In my base case scenario, I have assumed

multiple expansion to 13X and an EPS of $3.41 (NTRI repurchased 10% of shares O/S in Q1 2008)

(15% YoY growth). This results in a price target of $45. A discounted cash flow analysis with conservative sales growth estimates and terminal growth of 3%

and WACC of 13% also yields an intrinsic value of close to $45. Employing an Earning Power Value approach, and adjusting for normalized 2007 earnings, depreciation

and capex with no growth, yields a price of $28, which represents an estimate of downside risk.NTRI requires very few assets to generate revenue. I came up with a net balance sheet reproductionvalue for NTRI, including marketing expenses incurred over the past few years as though they werecapitalized at $365M. This indicates the existence of a franchise, as the normalized EPV of the firm is$895M. I believe NTRI enjoys barriers to entry and will be able to grow profitably within its franchise

over the next few years.

Risks NutriSystem may be subject to fluctuations in demand due to the diet industrys vulnerability to

changing fads

Increasing customer acquisition costs and weak consumer discretionary environment

Extended impact of Alli due to strong marketing efforts by GlaxoSmithKline


18/22

Page 18

On February 1, 2008, the Co-lumbia Investment ManagementAssociation, in conjunctionwith The Heilbrunn Center forGraham & Dodd Investing,sponsored the 11th annual Co-lumbia Investment ManagementConference. With students,faculty, alumni, investors, andpress in a packed Lerner HallAuditorium, the conference did

not disappoint.

Dean Hubbard opened theconference with a few remarks.He first noted that great in-vesting is important for dy-namic economies and ex-pressed his conviction thatColumbia Business School is atthe vanguard of the next gen-eration of great investors. Fi-nally, he was sure to thank theconference organizers JonSalinas, Qie Zhang, and Puneet

Kakar.

Richard Pzena, founder of thehighly regarded Pzena Invest-ment Management, which wasrecently taken public, deliveredthe mornings keynote address.His speech was directed to-ward the question all valueinvestors will have to deal with:How do you make it through

the bad periods?

He discussed three types ofinvestors: momentum investors(who ride the wave), valueinvestors (who exploit emo-tions), and savants (who pre-dict the emotions). Mr. Pzenapresented data going back to1968 which suggested that asimple value strategy, based

solely on low price-to-bookcompanies, and a simple mo-mentum strategy, based on thenine-month return, outper-formed the market. He noted,however, that if you had usedthe value strategy during this40-year stretch, there wereeight years when you wouldhave lost 20%. In the grandscheme, he remarked, theseare blips but did commentthat when youre losing 20%,it doesnt feel very good. Cli-

ents begin to question you.You begin to question yourself.And investors ask: Wasnt itobvious this was going to hap-

pen?

He then posed the question:Can you avoid the 20% downperiods? Should you? Mr.Pzena noted the temptation tocombine various strategies to

avoid such down periods, butremarked that you can reallyonly do this with a computer.

Combining momentum andvalue requires bargain huntersto ride the wave somethingthat is hard for them to do.Pzenas solution: Instead ofavoiding these periods prom-ise them! If your investorsdont like it, they can findsomeone else to manage their

money.

Commenting on market volatil-ity and his investment frame-work, Pzena made the observa-

tion that volatility occurs wheninvestors pay attention to themarginal news instead of un-derstanding the entire fran-chise. He went on to describehis rigorous investment proc-ess. The process, whichstresses a formal valuationframework, looks at stocks ona normalized price-to-earningsbasis and focuses on the long-run underlying earnings power

of the business.

Concluding his remarks, Mr.

Pzena gave some insights onwhat it takes to be a valueinvestor: 1) A value investorhas to be willing to invest whenthe outcome is uncertain; 2) Ifyou need to know whats goingto happen, youre not a valueinvestor; 3) The only reasonstock prices get really low isbecause of uncertainty al-though you dont know whatsgoing to happen, you can try to

size the risk/reward trade-off.

Following Mr. Pzenas speechwas the Real Estate Panel withColumbia Business School Pro-fessor Chris Mayer, PershingSquare founder Bill Ackman,and Pennant Capital founderAlan Fournier. Professor Mayerbegan the comments by de-scribing the situation through-out the country and remarking


The 11th Annual CIMA Conference

Panelists (l to r) Profes-sor Bruce Greenwald,Bill Miller (Legg Mason),Lisa Hess (Lowes Corp)and David Winters

(Wintergreen Fund)


19/22

Page 19

CIMA Conference (continued from page 18)

that in some parts of thecountry there are unheard-of

vacancy rates.

Addressing liquidity, Mr. Ack-man suggested that he used tothink the Fed controlled thesupply of money the ratingagencies do it now by endors-ing structured products. Mr.Fournier added that the futuresmarkets are implying lowerhome prices over the nextseveral years bringing us back

to trend.

The panelists continued todiscuss the role of the ratingagencies, the banks, and theindividuals in creating the sub-prime mess. Professor Mayercontrasted credit card securiti-zations with asset backed secu-rities, noting the incentives aremore cleanly aligned in theformer. Mr. Fournier declaredthat structured finance isdead and Mr. Ackman sug-gested that the rating processbe restructured so that thebuyers of credits pay for the

ratings instead of the issuers.

The panelists agreed that, over-all, the presence of sovereignwealth funds will be good for

(Continued from page 18) banks -- and potentially goodfor foreign relations as well.Mr. Ackman said, Theyre not

going to shoot us if they havemoney in our banks. Ackmanexpressed worries that foreigninvestors will be disappointed ifultimately they lose money in

those bank investments.

The second panel of the daycovered the topic of interna-tional value investing and in-cluded Andrew Weiss, founderof Scout Capital, Jean-MarieEveillard, portfolio manager ofthe First Eagle International

Value Fund, and Jeff Lee, a part-ner at Owl Creek.

Responding to where the over-looked pockets of value mightbe, Weiss suggested non-bankfinancials, exchanges, and creditcard processors. Eveillard com-mented that there are worldclass industrial companies in

Japan. And Mr. Lee suggestedJapan, China, and India with thecaveat that one needs to focuson management because youneed to focus on how to close

the discount gap. In the U.S.there are mechanisms for this,in Japan there arent. Mr. Russonoted that there are manyexcellent European companies,

singling out Nestle.

On assessing foreign manage-

ment, Weiss stressed the needfor humility and the need todemand higher return require-ments as well as big boy cor-porate governance. Jean-MarieEveillard conveyed a skepticalattitude towards management,noting that he never meetswith management until he hasdone a lot of work becausethen they need to be straightwith him. On a lighter note,Mr. Eveillard made the com-ment that Wall Streetsoptimized balance sheets

arent so optimal.

Paraphrasing Warren Buffett,Jean-Mar ie Eveillard under-scored the importance of un-derstanding companies andtheir managements: Whenrowing a boat, what matters isnot how strong your musclesare, but whether the boat isleaking. For example, he ex-plained, stupid acquisitionsbother me more than excess

cash on the balance sheet.

In the next panel, Bill Miller,Lisa Hess, and David Wintersdiscussed their best ideas andoffered advice to students pur-suing careers in investmentmanagement. Mr. Miller startedwith the point that often thebest places to look are theareas that have done the worst

housing, financials, and con-sumer discretionary. He alsopointed out that, historically,recessions happen 5% of thetime and that if the Fed cant

predict them, theres no pointfor us to try to predict them.

Lisa Hess suggested that theU.S. could offer some goodopportunities and remarkedthat it used to be the emergingmarkets. Hess noted she espe-cially likes financials with


Volume II, Issue 2

Professor Artie Williams (EMBA 02), Jennifer Wallace(MBA 94), and Professor Bruce Greenwald catch up at the

11th Annual CIMA Conference

The Heilbrunn Center forGraham & Dodd Investing is apremier knowledge center forthe practice and theory ofinvesting. Building on Colum-bia Business Schools re-nowned history in value in-vesting and finance, the centerfurthers new developments ininvesting and imparts theoriginal principles of Security

Analysis authors Benjamin

Graham and David Dodd.

Pictured Above: Roger

Murray and Robert Heilbrunn


20/22

Page 20Volume I, Issue 2 Page 20Volume II, Issue 1

moats around them and retail.In contrast, David Winters isfocused outside North Americawhere he says you can get bothgrowth andvalue. He said he hasalso taken an interest in thestocks of luxury goods compa-nies companies whose stockshave gotten smashed. Ms.Hess was generous enough tooffer her walk away from themarkets for five years and sleepwell at night portfolio to the

audience.

Describing the types of compa-nies he looks for, David Winterssaid he likes good businesseswith pricing power at a lowprice he called this thetrifecta. An added bonus iswhen management is pulling theoar in the right direction thatsa beautiful thing thats how

you get rich!

Finally, the panelists were goodenough to offer their careeradvice to the students in theroom. Bill Miller told the eagerstudents that they need anedge and need to know them-selves. He said the biggest ten-dency he sees is that people getvery emotional. He stressedthat the environment whereyou operate is very important.Lisa Hess added that the ones


CIMA Conference (continued from page 19)

who do best are the ones whoknow themselves best. AndDavid Winters echoed: Who

gets rich? People who do solidfundamental work, have stableemotions, and are long-terminvestors. Lastly, Bill Millerquoted Keynes: it is the duty ofthe long-term investor to en-dure great loses with equanim-

ity.

The conference concluded withthe Keynote address of DanielLoeb, the founder of Third PointCapital Management. He beganhis speech describing his early

forays into investing during col-lege. Despite a quick and lever-aged start, he ended up $7,000in debt to his father. He didnt

pay this off until he was 29.

Mr. Loeb then described thefounding of Third Point with$3,000,000, mostly from friendsand family. He suggested thiswas his best career move sincehe was unemployable due tohis varied and eclectic back-ground. Luckily, he observeddryly, I was there to give myself

a job. Mr. Loeb stressed thepoint that there is more to run-ning a hedge fund than just in-vesting. It is also managing abusiness and requires one tothink deeply about retaining,attracting, and moti-vating the best em-ployees. He urgedthose considering asimilar path to give

it some thought.

O f f e r i n g h i sthoughts on invest-ing, he said thatvalue investing isnt

just analyzing num-bers there are anumber of pitfallsyou have to beaware of: value traps, liquiditytraps, catalysts, proper assess-ment of the business climate,portfolio construction, and risk

management. Value investingisnt buying the cheap stocks of

bad businesses.

Mr. Loeb also offered the audi-ence a look into the variousstrategies Third Point employs including special situations, riskarbitrage, and distressed debt.He walked us through his pastinvestment in Dade Behring, agreat but misunderstood busi-ness. On the topic of specialsituations and event investing, hestressed the point that the stu-dents in the room should take

Joel Greenblatts course at Co-

lumbia or at the very leastread his book You Can Be aStock Market Genius (Even IfYoure Not Too Smart). Healso pointed out that althoughThird Point does engage in activ-ism from time to time, it really is

just a small portion of his port-

folio.

Finally, Mr. Loeb left us with hisinsightful comments on riskmanagement. He underscoredthe difference between net andgross exposure and alluding to

the phrase, love means neverhaving to say youre sorry suggested that, good risk man-agement means never having to

sell something you really like.-G&Dsville

Legendary value investor Jean-Marie Eveillard answers questions

from conference attendees

Bill Miller and ThomasRusso catch up at the11th Annual CIMA

Conference


21/22

Page 21

MBA Advice from the Oracle of Omaha

By David Kessler (MBA 08)

On March 21 I flew to Omaha

along with 150 of my class-mates to meet WarrenBuffett, MS 51, a man I haveadmired (some friends wouldsay fanatically idolized) for

close to 15 years.

After a tour of the BerkshireHathaway-owned NebraskaFurniture Mart, we werebrought to a room at theOmaha Field Club. WarrenBuffett stood at the front two of his five daily cans of

Cherry Coke nearby and forthe next two and a half hours,

answered our questions.

The questions covered a widerange of issues, including whathe looks for in a business, thecurrent financial situation, re-cent events at Bear Stearns,ethics, emerging markets, com-modities, his relationship withBenjamin Graham and his typi-cal day. His answers were apowerful reminder of his

unique ability to distill complexissues down to their bare es-

sence.

When asked about how longthe current financial crisis

would last, he replied, I dontknow. I have never mademoney on macro calls. Buffett

said that even if he had per-fectly predicted macro condi-tions in 197374, he would nothave bought Sees Candies in1972 going into a recession andwould have missed out on acompany that he has referredto as the prototype of a

dream business.

After joking that our gradua-tion was not perfectly timed,Buffett warned that we shouldnot be discouraged from pursu-

ing a career in finance. Financeis only going to become moreimportant as time goes on, hesaid, and it is a field where onecan truly stand out and be rec-

ognized.

He advised MBA students tolearn as much about accountingas possible, adding that,accounting is the language ofbusiness. He also said thatwriting and verbal communica-tion are extremely important inthe business world and that

students should seek out waysto improve these skills every

chance they get.

Buffett urged students lookingfor jobs not to pay too much

attention to salary. Who youwork for is extremely impor-tant, so choose carefully, he

counseled, adding that themost important decision of hisown career was going to work

for Benjamin Graham.

As MBA students, we are be-ginning our careers in an agewhere the image of a corporateexecutive has been bruised.Spending time with WarrenBuffett an astute business-man, a legendary investor, arational and disciplined personand a generous philanthropist

afforded us the opportunityto learn much more than just

how to pick stocks.

Before the trip, I was certainthat no one could ever live upto the sincere, humble andgenerous image depicted of himin books, shareholder lettersand TV interviews. I waswrong. Even that lofty imagedid not hold a candle to theman I was lucky enough tospend half the day with in

Omaha.

Originally posted to ColumbiaBusiness School s Blog, Public

Offeringhttp://www4.gsb.columbia.edu/

publicoffering

Volume II, Issue 2

SAVE THE DATE

The 12th Annual CIMA Conference

February 13, 2009Columbia University - Lerner Hall

Past speakers have included: Jean-Marie Eveillard, Marty Whitman, LeonCooperman, Steve Mandel, Daniel Loeb, Thomas Russo, Bruce Berkowitz,

Rich Pzena, James Tisch, David Winters, Bill Ackman, and more...

The conference will sell out, so get your tickets early!

David Kessler (08) and Warren

Buffett (51)


22/22

The Heilbrunn Center for Graham &

Dodd InvestingColumbia Business School

Uris Hall, Suite 325c3022 Broadway

New York, NY 10027212.854.0728

[email protected]

Visit us on the WebThe Heilbrunn Center forGraham & Dodd Investingwww.grahamanddodd.com

Columbia Investment ManagementAssociation

http://www.gsb.columbia.edu/students/organizations/cima/

Contact us at:[email protected]

To hire a Columbia MBA for an internship or full-time position, contact Bruce Lloyd,assistant director, outreach services, in the Office of MBA Career Services at (212) 854-8687 [email protected]. Available positions also may be posted directly on

the Columbia Web site at www.gsb.columbia.edu/jobpost.

AlumniAlumni should sign up via the Alumni Web site. Click here to log in,(www6.gsb.columbia.edu/alumni/emailList/showCategories.do), then go to the Cen-ters a

Documents

Graham and Doddsville - Issue 4 - Winter-Fall 2008