Interview with Footnotes Expert

A while ago I got the chance to interview Michelle Leder one of the few footnote experts around. Leder wrote a book and writes a blog I highly recommend both.

Right Price Investing:In the book you mentioned different ways different investors read the footnotes, would you recommend starting at the beginning and ploughing all the way through or skipping only to those which are important for the company in question ( i.e. R&D for Pharmaceuticals, Leases for Retailers, etc.)?

Michelle Leder:I never say read all of the footnotes. But you should try to skim all of them. Obviously certain footnotes aren't important at every company (i.e. pensions). But if you consider yourself a long-term investor, you need to at least read the summary of significant accounting policies (usually footnote #2), the footnote on commitments and contingencies (lawsuits, etc), and the footnote on income taxes. After that, it's a case-by-case basis depending on how large your investment is and how much time you have.

RP:Do you short companies whose fine print you find particularly deceitful?

ML:While I do invest (long and short), I always disclose when I have an interest in a particular stock. I actually short very very rarely, since I'm still testing out some of my theories and don't want to be wrong the same way I was with Qwest.

RP:Out of all the red flags mentioned in your book which one do you see the most often?

ML:I can't really say that I see one more than others. But in general, most problems boil down to being too aggressive on revenue and too liberal on expenses.

RP:What more could the SEC and/or FASB do to make footnotes more understandable to individual investors and prevent fraud?

ML:Set a minimum type-size would be a great first step. Some of these footnotes truly require you to squint or blow up your screen 200%.

RP:What are three examples that stand out in your mind of companies who manipulated their accounting the most?

ML:That's a tough contest. When I give presentations based on my book, Enron is always a good example because they did just about everything. But there's also Healtsouth and Tyco, and of course, Qwest, which I was stupid enough to invest in based on the hype. And now we're just starting to learn more about this options back-dating fiasco which looks like it could be a huge scandal based on everything I've read so far.

Thsi interview was done during the summer since then 100's of companies have been found to have been back dating options.

Festival of Stocks #3

Welcome to this week's Festival of Stocks I hope you enjoy the articles and remember to send in your articles to next week's Festival. Thanks to all the contributors.

Commentary

Learning How to Invest6 at 1stmillionat33
How to learn about Investing to gain good long-term returns.
Stocks:

Stocks

Apache Corp. Moat Check at Fat Pitch Financials
George takes a look to see if Apache has a most but decides he wants to stay away from commodities.
Stocks: APA

The Eighty Cent Dollar at Inelegant Investor
* Editor’s Choice *
The Inelegant Investor finds a rare cash-flow positive company trading below cash in Cadus. He thinks it has a potential for great upside.
Stocks: KDUS

Why reinsurance companies like MRH are the place to be. at HJL Money Blog
HeJustLaughs explains why he thinks reinsurance companies like MRH are great
Stocks: MRH

Throwing in the Towel with Ford at SINLetter Blog - Monthly Stock Investment Newsletter
After picking Ford as a contrarian bet late last year, Asif Suria have finally thrown in the towel after Ford pushed out its profitability target and decided to scrap its dividend.
Stocks: F

Riding the Biodeisel Boom with Nova at goldguru

Commentary

Still Bullish on the US dollar at Trader Insights

Buffett Partnership Letters at Value Blogger
Kevin Kelly goes over the Buffett Partnership letters in a three post sequence. The letters were previously never posted publicly and hold a wealth of information on how Buffett can make, "50% a year with less than $1,000,000."

Stocks

Why I still like Chesapeake at Deep Thoughts
Eric Schleien explains why he thinks CHK is still a bragain.
Stocks: CHK

Next Monday's Festival will be hosted by My First Million at 33. Use this form to send in articles for next week's Festival.

Stock Pickr

I've been checking out a new super-investor-tracker, Stock Pickr.

Stock Pickr tracks the SEC filings of mutual funds and hedge funds. Currently there are 250 pro portfolios being tracked, more are added each day.

You can search for the holders of a stock or post a list of stocks you love or hate and it will show you who owns it among the tracked superinvestors and other members and show the correlation between your portfolio and others entered.

I believe Stock Pickr is a good resource for anyone looking to easily track the picks of proven professional investors or find out who owns their favorite stock.

My Portfolio Revised

I'll be following my grandpa's portfolio in my newsletter[1] because he'll be subscribing so I decided to follow my portfolio here, this is a real money portfolio, all of my money is invested in it.

As of late I've been taking to arbitrage[2] and it's potential gains, I have a relatively small position in this portfolio, a portfolio of my size is probably the only size it would help.

Because of a recent deposit this portfolio is valued slightly over $5,000 at $5,173.10[3] I don't really trust the TMF portfolio tracker -- dividends aren't counted -- so every month I'll just use the current balance to calculate gains and losses.

K-Swiss

K-Swiss is my favorite position; I love the business model and personally only buy their shoes[4]. A lot of analysts are looking down on K-Swiss, last quarter - y-o-y - K-Swiss' Euro revenue grew 103%, Gwen Stefani has a contract with their Royal Elastics brand which has yet to give them a profit[5], but I believe Royal will have a big impact in the future.

Right now if you wanted a 15% CAGR from a K-Swiss investment over the next 10 years K-Swiss would need 14.7% earnings CAGR, I believe they will achieve that and value them about 30% over today's price of 30.64.[6]

KSWS          $30.64          $704.72          38.62%[7]

____________________________________________________

Pfizer

Pfizer is the first company I bought stock of, I didn't do any analysis at first, and bought at an extremely bad time, it hasn't been a very good investment so far, but I believe I'll be able to add shares and hold onto it for a long time.

The price has gone down recently because of the Merck trial, I believe it would be a good buying point but my cost basis already puts it at almost 20% of the portfolio so I'll just watch from here.[8]

PFE          $25.48          $764.40          -19.73%[9]

____________________________________________________

Faro

I bought this after reading about it on the HG boards[10], I thought I bought it at a good valuation, apparently not.

This is also a great long-term hold[11] -- as I think most of my positions are :-) -- and Tom Garnder seems really enthusiastic.

So far Faro is the worst performer in my portfolio.

FARO         $20.65          $474.95           -28.28%[12]

___________________________________________________

Paxar

Paxar makes those annoying little tags on the back of your shirt.

I got Paxar from Bill Mann in HG; he says that right now they're valued so you get the tag business, and the RFID business for free.[13]

PAXR         18.81            $545.49             4.26%

____________________________________________________

Fairmont Hotels

Also got this one from Bill Mann who says it has valuable real estate that is worth ~ the current price.

Hasn't done that well for me so far, but I'm confident it will.[14]

 FHR         $31.38            $502.08           -13.07%

____________________________________________________

Freescale Semiconductor

Freescale was spun-off of Motorola, David Einhorn believes they were undervalued at $17.05, currently they're at $23.88 and I'm going to re-evaluate my position.

FSL       $23.88              $620.88             34.1%[15]

____________________________________________________

JB Oxford

I saved the best for last.

Currently JBOH represents about 3.5% of my portfolio, it's the smallest position, but it has to be that way or I don't profit off of it.

JB wants to split 100-1, which means for every 100 shares you own it gives you one, they are doing this so they won't have to make periodic reports to the SEC.

In order for me to profit off of this split I have to buy less than 100 shares, they are paying $2.96 for every fractional share you own. If I bought 100 shares I would own 1 whole share - no fractional shares.

I bought 99 shares in a limit order that was executed on Monday, I bought my shares at $1.85 per share. This month when they will split and I will get $2.96 for all of the 99 shares I own, since I paid 1.85 per share this will be a gain of about 60% in one month, not that shabby.

The catch is the restriction of buying only 99 shares, this means it can only represent 3.5% of my portfolio for me to get maximum profitability; next month I'll probably have a few more positions similar to this.[16]

_______________________________________________

15% of my portfolio, $770, is currently in cash, I believe in being fully invested and will be trying to find new positions for a lot of my "investing time" over the next month. [17]

---

[1] I never actually did that just gave him phone calls about it.

[2] By arbitrage I mean special situations, I hadn’t yet figured out the difference between Arbitrage and specials situations yet.

[3] Right now its sits at $5,290.55 that’s up - I’m excited.

[4] Still do that

[5] Getting closer

[6] This value strategy is from It’s earnings That Count and I had forgot about it, I’m gonna start using it again.

[7] K-Swiss is now worth $1,042.50, is up 47% and is 19.6% of my portfolio.

[8] Because my portfolio has gained ground PFE’s cost basis is now 18% of the portfolio

[9] Pfizer is now worth $796.5, down 16% and 15% of my portfolio.

[10] Another one of the stocks I just wrote about.

[11] That didn’t happen either crappy management pushed the stock down further and I sold it at a loss.

[12] I sold this stock at $19.73.

[13] This one I read in Hidden Gems, a Motley Fool Newsletter and bought it. When I purchased it I didn’t know much other then what had been in the article. Eventually I did research the company but wasn’t satisfied with my own valuation and sold at $17.61.

[14] Almost same exact thing as PXR, only I sold it right before it got bought out at $44.75.

[15] This is beginning to become a theme here, I read about it in an interview in Value Investor Insight and bought on the spot. I got lucky and the thesis is right, when I got some sense knocked into my head I sold on the spot as I had bought on the spot, at $23.50.

[16] OK this is the first Going Private Transaction, since then I have bought 8 more and still own two. I got my 66%, as I wanted, thought it took four months instead of one. I have yet to lose money on any of these transactions.

[17] Right now I am only .7% in cash after recent special situations buys, a going private transaction and a discounted Closed-End Fund.

My Investing Philosophy Revised

This post is the second part of a 3-part series around my 100th post. Here's the intro. I thought for a while on how do these revised articles, I decided to use Microsoft Word's insert a footnote function, instead of typing in italics and parenthesis. Whenever there's a footnote it links to the bottom of the page where the footnote is. You can then click back on the link to go back where the footnote was.

My (developing) Investment Philosophy

Lately I've been confusing myself with a lot of different ways of investing[1], this weekend I went to the new Salt Lake library and borrowed Janet Lowe's book on Ben Graham's investing technique, Security Analysis, the 1934 edition, Pat Dorsey's Morningstar book and a book on analyzing financial statements by Edgar.[2]

Anyway I decided to write this to find where I currently sit in my investment philosophy.

Value, of course

I was first introduced to the concept of value investing in the summer of 2004, I knew a little bit about it from Hidden Gem article that were published on the website, but now TMF was creating yet another newsletter “Inside Value”

At that point the only boards I read were Ask a Foolish Question, Investing Beginners and the Teen Board, none of those boards had anything to do with Value Investing, then because of this new newsletter TMF did a special hot topics that only had things from posts about value investing, about 75% of them were from the Foolish Collective board, so I started reading that board – actually just skimming the threads ;) – and I bought “The Warren Buffet Way” from a second hand book store and I was on my way.[3]

I still depend 100% on value investing – no growth speculation or “TA” here -- but I've shied away from depending on the DCF 100%. Why?

I think Warren Buffet said if you have to do a DCF it's too close. I've been reading a lot lately about “Private Market Value” which is buying shares of a company for less than you think a competitor would pay for it. I don't know much else about how to find that, but I'll look into it.[4]

Basically right now I'm not going to buy anything without a margin of safety.

Different ways of Investing

I believe that owning more than twenty companies at once is just asking for average returns, I will never own 50 or 100 companies, and strongly advise against it for anyone looking to beat the market.

I've been thinking about it and have found four categories that I am currently looking for opportunities in:

     - Blue Chips

     - Small Companies

     - Cigar Butts

     - Special Situations

Blue Chips

I may have poorly titled this; by blue chips I just mean companies I'll hold for longer than five years.

Large Caps, and The BMW Method[5]

I hope to own at least three or four large cap stalwarts that may have relative returns to the market over the next one – three years, but over periods longer than that will outperform the market.

I'll try to apply a Rule Maker – post Bill Mann – analysis to these big companies; another big aspect will be the BMW Method.

Just in case you didn't know – I'm still kind of confused :-) – The BMW method uses CAGR lines to find undervalued companies based on how their stock price has performed over long period in the past – not less than 16 years – for more on that go here .[6]

Mid-Caps

These companies usually have already proved themselves enough to not have a market cap below 2 Billion, but also have room to grow.[7]

I'll be OK if there's a point when I don't own any of these companies, but I hope to usually own one or two.

I'll analyze these companies like I did in the K-Swiss report.

Options

In the future I'll attempt to use options to magnify risk-adjusted returns.

I'm not sure how I'll do it, but it'll probably be something like the stuff in “You Can Be a Stock Market Genius” using LEAPS.[8]

Small Companies

This portion – 20-35% of the portfolio – will be the growth part.[9]

Small Caps

These are the Hidden Gems, small companies that are being ignored by Wall St. and are trading below what they're potential growth will provide in cash flow.

Small Caps are risky and volatile; I'm going to attempt to douse that risk by knowing any small cap I buy in and out, so I can take advantage of volatility.

I convinced my Dad to buy Select Comfort – actually he convinced me to look at it :-). Select Comfort makes the Sleep Number beds. Select Comfort wasn't doing very well, My dad bought it at ~$19 and it was down under $16, he asked me why so I searched Select Comfort and found that one of the beds had fungus or something on it, I watched the video and read an article on how heinous the fungus was, by Rex Moore, I was convinced it was not going to damage the fundamentals of SCSS, so my dad bought more at ~$16, SCSS now trades at $19, and has been as high $24.[10]

Micro Caps

Companies with market caps below 100 million.

This is where most of the speculation will be.[11] Like small caps micro caps are extremely volatile, and must be watched closely, also you'd have to know the company in and out.

Sometimes these companies don't trade on any of the major stock exchanges, so risk is extremely high.

Cigar Butts

Companies trading below Net, Net Working Capital[12], cash, real estate they own, etc are cigar butts that is you hold them for one puff then sell.

I won't own a lot of these[13]; a lot of the time I may not own any. I want to focus on holding companies for a long time, and cigar butts don't let you do that.

Special Situations

Although there are a lot of special situations I will only invest in a few.[14]

Companies Going Private, Reverse Splits

When companies no longer want to make periodic filings to the SEC they can do a reverse split to make less than 300 shareholders. When they do this the set a price they will pay for all fractional shares; you try buying the maximum amount of potential fractional share under the price the company is paying for those fractional shares.

When companies go private they also set a price they will pay for shares, if it looks like shareholders will vote in favor – Board owns >50% -- of the company going private, you try to buy shares for less than that set price, however if the company decides not to go private, you could lose a lot of money.

Spin-offs, Merger Securities, Bankruptcies

Sometimes a company will decide they'll do better, or a part of them will do better, without one part, so they spin-off that part to shareholders. Doesn't sound that exciting, but most institutions aren't aloud to own that spin-off – too small, no research, etc – so the mass selling of these shares creates a buying opportunity.

Similar things happen with:

Merger Securities, although it's way to risky to buy a company that is about to be bought out, sometimes when one companies buys another they issue merger securities – bonds or other things – institutions may not be able to hold bonds, but for whatever reason they usually sell these immediately, giving us another buying opportunity.

When a company comes out of bankruptcy – and only when it has come out – it usually pays the old shareholders with new shares or bonds, whatever they pay them with, once again institutions sell these immediately, the volume sends the share price down, and gives us a buying opportunity. It’s not that long, I kind of over simplified it, but in order to maintain a concentrated portfolio this is all I'm going to look at.

---

[1] Huh, still doing that.

[2] I ended up only reading the Morningstar one, because I found out I owned the Lowe one the Edgar one was crap and Security Analysis was like 1400 pages. This is the kinda stuff you need to know that you learn in revised articles.

[3] If these whole two paragraphs seem strange it’s because I posted this on The Motley Fool boards before my blog to get feed back.

[4] These next two paragraphs show an evolution about to happen, for a while I only used DCF and didn’t look at anything else, now I use every value technique there is, Private Market Value when I can, target price with earnings and a multiple, reverse DCF to see how much it has to grow, comps, etc..

[5] I only want to say this once so I’ll get it over with, I don’t really look for companies in different ‘categories’ I just look for value where I can get it, if it’s big good if its small maybe better I don’t care anymore.

[6] Here’s how this works you take a chart from the last say 30 years of a big company and draw a line to where the stock price would be if it kept the same CAGR in the past, if this is above the current stock price then the stock is undervalued. This is based on the theory that with good, big companies the stock price moves in cycles and you can find down periods where you can buy by doing this and finding out when the stock price is growing lower then usual.

[7] You know what I’m not sure why I said that market cap doesn’t show that anything proved itself.

[8] I posted on LEAPs in the Special Situation Series but I never had a chance to actually use them I still can’t get options in my Scottrade Account.

[9] Muy Estupido, don’t put percentages to different categories.

[10] Now I can change that to been as high as $40. DOUBLE.

[11] This was a bad choice of words I won’t be and never ‘speculated’ on micro caps, I only own a few, but have good reasoning in them.

[12] Current Assets – All Liabilities

[13] Ha, half my portfolio at times. This was a theory that I’d be able to find good quality companies and wouldn’t have to fill my port with Cigar Butts, hopefully at some point that will happen.

[14] See the Special Situations Series for a crap-load of more info on Special Situations.

Margin of Safety

Remember I will be hosting the festival of Stocks this week. We could use more posts, bloggers can use this handy form to submit posts.

You won’t find Margin of Safety, By Seth Klarman, at Barnes & Noble, and you’ll have to pay $900+ for it on Amazon. It’s a guide to not tripping up, valuing businesses and finding stocks.

Where Most investors trip

Investment Vs. Speculation

Investors buy business; speculators trade stocks.

An investor believes the future the future movements of the stock are tied to its underlying fundamental changes. Investors will buy a stock for one of three reasons: 1. Future free cash flow generation, 2. Rising dividends or 3. a narrowing gap between price and value.

Speculators, on the other hand, buy whatever they think will go up in the near future. For an example a speculator may buy XM satellite radio believing that it’s the “next big thing,” but his failure to recognize negative earnings and extreme over-valuation will probably lead to him losing his money. Speculators are obsessed with predicting macro-economic changes or what the stock will do in the next month, week even day.

Taking Advantage of Mr. Market

Mr. Market is strange, he is ready to buy thousands of securities every day, and sometimes he will price them at prices, which are extremely irrational. Speculators will mistakenly look to Mr. Market for guidance, if he is pricing stocks higher they will keep buying, foolishly thinking they know more than him. The best way to think about Mr. Market is to totally ignore him; unless he is pricing a great company at less than its fair value.

Investors, and Their Emotions

Successful investors respond to Mr. Market calm and rationally; unsuccessful investors react with fear and greed, this is what makes them unsuccessful.

Unsuccessful investors view the stock market as way to make money without working, not as a way to invest capital to earn a decent return.

Unsuccessful investor will think taking tips from a show on TV or at a party is a shortcut to higher returns, but it is probably a shortcut to losing money.

Wall St Works against the Investor

Brokers earn money on the commissions from trades their clients make; whether the clients make or lose money.

Institutions aren’t allowed to buy certain stocks (foreign, unionized, too small, etc.) investigating these companies, and buying the good ones, will lead to market beating returns.

Investing without understanding the behavior of institutional investor is like driving in a foreign land without a map.

Wall St. is focused on self-interest and short-term returns, relying on it will lead to lost money.

A Value Investment Philosophy

Risk

Warren Buffet’s two rules are: don’t lose money, and don’t forget the first rule. This is not just a joke, investigating risk before investing is crucial. Warren Buffet said he would pass on 99:1 odds, preferring to have 100% verification.

Avoiding loss is central to the value investment philosophy. Many years of gains can be reversed by one year of owning too risky investments, and losing money.

Margin of Safety

The main element of value investing is waiting for a bargain. To define this bargain you must wait to find a company that is trading for significantly less than its fair value; therefore it has a margin of safety if something goes wrong. Preferably this margin of safety should be at least 40%, if not higher.

It would be a big mistake to foolishly think you know everything about a company, this is not possible. Knowing that your intrinsic value calculation is not 100% accurate, however, is, what needs to happen.

Value investors need to be disciplined enough to let all the bad pitches go by before hitting the perfect pitch


Bottom-up Investing

The majority of institutional investors practice top-down investing - that is they attempt to predict macro-economic conditions, and then be correct in drawing conclusions from that prediction, and then pick stocks that will be positively affected by this prediction.

Top-down investors are buying on a trend or a theme, but because of value.

Value investors use a bottom-up strategy where individual companies are chosen through fundamental analysis. Bottom-up investors can detail their whole investment strategy as “buy a bargain and wait.”

Absolute Performance

Most institutional investors look for relative performance – their return against an index or a peer. Value investors take an absolute performance look at investing, instead of beating the market they aim to gain as much money as possible, while risking the least amount.

Business Valuation

Range of Values


Businesses are not like bonds; their cash flows are not set in stone. Because of this an investor cannot set a definite value for a business, he must set a range of values, and go from there.

Present-Value Analysis

Present-value analysis is identical to the DCF model. By forecasting future cash flows, then discounting them back to the present, you can add them up to predict the future value of the business. This model is not complete though; a small change in any of the inputs can lead to a big change in the resulting number.

Private-Market Value

When using private-market value an investor would try to predict what a sophisticated, prudent businessmen would pay for a business. Usually he would use the multiple a company in the same industry was acquired for and apply it to his companies earnings, then make a decision.

Liquidation Value

Liquidation value involves the assessment of all tangible assets. Because so many assets are worth more than stated, and because intangible assets have no worth this is usually a worst-case scenario.

The Value-Investment Process

Areas of Opportunity for Value Investors

Risk Arbitrage

This is a highly specialized area of investing. Spin-offs, and corporate restructurings are often referred to as long-term arbitrage. Takeover investing is most commonly referred to as risk arbitrage. In takeover investing you would find one company A being acquired by company B for a price higher than the current price, you would then buy shares of A and short (bet on them losing) B.

Spin-offs

Spin-offs can often present a good buying opportunity for value investors. When receiving spin-offs most parent company shareholders will immediately sell their shares of the spin-off (especially if the company was mostly held by institutions), this over-selling drives down the price of the spin-off, when looking hard enough an investor can find good companies that were spun-off and now trade at a bargain to their fair value.

Portfolio Management

Appropriate Diversification

Ten to 15 holdings should usually be held to lower risk, anything more than that would be over-diversification, which leads to poor returns.

Hedging

Market risk can be limited by hedging. Hedging can be done in a number of ways, with options, shorts, investing in foreign securities, basically purchasing, or selling, anything that will protect you against a drop of something else in your portfolio.

Leave room to buy more.

No matter how good of an investor you are you will likely never buy on an absolute bottom. Sometimes a stock may go down 20% after you’ve bough it. A good way to profit from this is to not buy all at once, and to leave room to buy more if the company drops, but still has a good fundamental position.

Festival of Stocks

Geoff just posted the Festival of Stocks.

I encourage you to check out the plethora of good stock posts.

-Mike

Overstock.com

Business Description (From 10k)

"We are an online “closeout” retailer offering discount brand name merchandise, including bed-and-bath goods, home décor, kitchenware, watches, jewelry, electronics and computers, sporting goods, apparel, designer accessories and limited travel services, among other products. We also sell books, magazines, CD’s, DVD’s, videocassettes and video games (“BMV”), and we operate as part of our Website an online auction site—a marketplace for the buying and selling of goods—between our customers. Therefore our Website is comprised of five main tabs: Shopping; Books, Music, Movies and Games; Bulk Buys & Business Supplies; Auctions; and Travel.

Business Model

Overstock's business model is pretty genius if you look at it. Usually liquidators don't work very well for a variety of reasons including retailers not wanting to be close to a store that sells its products at liquidation prices - this doesn't happen with Overstock because it is online - and though the liquidators can buy products at liquidation prices and sell them for lower then wholesale they usually have a volatile selection and may not have what you're looking for - this doesn’t effect Overstock either because it has relationships with many retailers and warehouses stocked full of product waiting to be sold. See the Overstock solution here for more advantages.

40% of revenue comes from direct business, which means Overstock takes direct possession of the inventory in one of it's warehouses located in Utah and Indiana and ships to the customer directly from those warehouses.

The 60% comes from fulfillment partner revenue. Currently Overstock has relationship with about 460 retailers who sell their overstocked product on the website. Overstock never physically handles the inventory of these transactions it also receives the payment of the transaction in less then a week while it doesn't have to take out its commissions and pay the retailers for one month. This Cash Conversion Cycle is what powers company such as Dell and Costco it will fuel high Returns on Capital for Overstock when it becomes profitable.

Currently Overstock is pursuing a business model hat has proven highly successful in the internet business - see Amazon.com and Netflix - Overstock spends a lot of money building its brand name with technology and marketing expenses, during this period it is unprofitable. Because of the tremendous spending revenue grows extremely fast - from $90milion in 1999 to almost $900million today. As revenue slows down it leverages its variable - marketing and technology - costs and revenue grows faster then them to create an operating profit. This method has been doubted by the smartest Wall St. analysts before but it proved effective as Amazon.com and Netflix both went over 500% in the subsequent few years after becoming profitable.

Dr. Patrick Byrne

Even Byrne-haters have to admit that he is at the very least extremely interesting. His father, Jack Byrne, was the long time CEO of GEICO and reportedly Byrne learned to invest directly from Warren Buffett. Buffett also chose him to be the CEO of Fechheimer Brothers, a Berkshire Hathaway company that made security uniforms.

Byrne also has a Black Belt, is a cancer survivor, has ridden his bike across country numerous times, reportedly has a photographic memory and has a PHD from Stanford.

Overall I believe Byrne is a great CEO, focused on the business and working for the shareholders.

Controversial Stuff

There are two major, separate, problems that the CEO is combating. They are too often confused and too often put together. The simple fact is Patrick Byrne is not fighting investors who short his stock he is fighting people who conspired to write hatchet jobs about his company while shorting the stock and fighting illegal naked shorters who have depressed the stock price.

Traditionally shorting involves borrowing stock from one person then selling it on the open market, the shorter eventually uses the procedes from selling the borrowed shares to buy back the stock and return it to the lender. With naked shorts the shorter sells shares he never borrowed nor intended to borrow, this dilutes the amount of shares trading and depresses the company’s stock price. With Overstock there are twice as many shares trading as were issued because of counterfeit shares from naked shorters.

I don’t have enough space to delve far enough into these subjects here, but I would recommend the following two links for those who are interested.

Look at FTDs

CC Transcript

Valuation

Whether or not you believe Patrick Byrne is a good CEO or Overstock is a good company it is undoubtedly undervalued. Amazon never traded for less than 1x sales - even when Wall St hated Jeff Bezos - Overstock trades for half of sales.

All of the Sales multiple valuations I have done are mouth watering. Even to assume Overstock would trade for 1x Sales within a year it is a double, and possibly more assuming revenue growth.

There are a few variations with different multiples and different ending market caps. I do not subscribe to the ‘target price’ valuation techniques and will post earnings based valuations in a later post.

Amazon – Currently Amazon trades for 1.8x Sales, give or take a tenth depending on the current price. This multiple could be low also because Amazon has fallen in the preceding months to this article and is down well from its high. If we discount the 1.8 because Overstock is not profitable and assume to trade equally to Amazon it would trade between 1.2 and 1.5x Sales its proper market cap should be between, $990 million and $1.2 billion, currently the market cap sits at $445 million.

Industry – According to Morningstar the average P/S for Overstock’s industry is 11.8, trading for this would yield a valuation 24x the current price so we will skip it to be conservative.

Future – Currently the online liquidation industry has annual revenues totaling about $60 billion. If we assume Overstock can grab 5% market share in the industry by 2010 and will then trade for 1x sales we can assume a target market cap in 2010 of $3 billion about 6x the current price.

Catalysts

All of the valuation methods listed gave valuations more than 200% above the current market quoted price, but what will cause the stock price to shoot up to that price? Here are some catalysts I believe will or could happen to push up the stock price:

Overstock Becoming Profitable – Right now a lot of doubt considering Overstock’s future prospects in priced into the stock if the company can prove if self and produce an annual profit the stock price will respond. As before mentioned Amazon and Netflix went up 700% in a few years after becoming profitable.

Win Lawsuit – If/When Overstock wins the lawsuit against Rocker Partners and Gradient Analytics the market would probably respond to believe profitability was the company’s main focus.

Byrne has stated before in interviews he has explored the idea of taking the company private. I doubt he will pay $3billion with the company priced at $500million but I do believe he will have shareholders in mind if he decides to take it private.

Risks

The stock price is very volatile. In the month I’ve owned I’ve been down 10% and up 20% within weeks. Value investor do not focus on the stock price instead the intrinsic value, one would do well taking advantage of the volatility instead of fretting over it.

Byrne spends time fighting naked shorters – time that could be spent on improving the business. Byrne has admitted too much of this happened last year but says he has drastically reduced the amount of time not spent on the business.

Overstock’s business model could be flawed to where they may never make a profit, at least not in the near future. I do not believe this, but it is the argument of most OSTK haters.

Conclusion

My conclusion is obviously positive and I have put my money where my mouth is. As of September 15 Overstock represents about 18% of my portfolio, after a 18.9% gain since my first buy at $16.82 per share.

At the time of this Article the author owned share of Overstock, though this could change at any time. This article in no way represents a recommendation to buy or sell any stocks consult your investment advisor before making any decisions.

Carnival of Business

Hi, I haven't had much time to do this carnival with my work and school so I'm using BlogCarnival Beta version which gives me the html for all the posts.

If you find any gliches just note it in the comments and I'll fix it.

-Mike

Welcome to the September 4, 2006 edition of carnival of business.

My Bubble Life presents The Power of Possibility Thinking posted at My Bubble Life, saying, "What can you achieve? Let go of your self-imposed limitations and find out."

Dane Carlson presents 6 Tips for Working at Home With Children posted at Business Opportunities Weblog

Rob Schaumer presents Real Help On How To Build A Business. posted at Label Land.

One Guy presents Blackboard Toes the Line (BBBB) posted at One Guy's Investments, saying, "So is it worth it to get a patent if it makes all your customers angry? Blackboard is setting themselves up to possibly make some money on royalties by enforcing a very broad patent, but in so doing alienate a lot of their customers."

Violeta presents Latest Trends of Google posted at All Tips and Tricks.

HeJustLaughs presents Not dividends, not growth, but both. posted at HJL Money Blog, saying, "Growth and dividends are a great business."

Tracy L. Coenen, CPA, MBA, CFE presents Still nothing done in the Milwaukee Public Museum scandal posted at FRAUDfiles Fraud Blog.

Bryan C. Fleming presents How to be Your Own Bank posted at Bryan C. Fleming .com.

David Maister presents Play Nice posted at Passion, People and Principles

Supermom_in_ny presents Home Based Businesses: Planning Your Day posted at Getting Out Of Debt.

Pawel Brodzinski presents Software Project Management: Geeky CEO posted at Software Project Management, saying, "Geekiness of a CEO as a threat for company development."

MyMoneyForest presents Meez: The Business of Avatars posted at MyMoneyForest.

Dave Cheong presents 13 Problem Solving Nuggets Everyone Should Know posted at Dave Cheong Engineer to Entrepreneur.

Ragnar presents Blogging for money online - a few tips. posted at Internet Marketing Tips - blog.

Jim Logan presents Electronic Firing Is Weak posted at Jim Logan, saying, "Laying off a workforce should never be delivered impersonally. The decision to RIF (reduction in force) staff should never be taken lightly, be it forces outside your control or incompetence, it’s a failure of management to accurately predict and control their business. To not look an employee in the eye and release them from employment is weak. The benefactors of electronic firing are those who don’t have to deal with the employee who’s loosing their job."

Daniel Scocco presents First Mover Advantage Revisited posted at Innovation Zen.

Greg Swann presents Words, words, words: How evocative listing copy helps to sell homes . . . posted at BloodhoundBlog -- The weblog of BloodhoundRealty.com, saying, "There is more to writing real estate copy than clumsy cliches versus just-the-facts-ma’am."

Steve Faber presents The Three Strategies to Maximize Your Financial Success posted at DebtBlog.

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