Business Plan

Part 1: General Model

Mental Models
A mental model is an explanation of someones thought
process about how something works in the real world.
In more simple terms, it is how we think about what
we think about, or our framework for thinking about
the world.
Important because two people who are given the same
information about a given subject often come to different
conclusions about it. Their varying life experiences leave
them with differing mental frameworks for processing
information and ideas.
Not all mental frameworks are created equally, some
people are more successful than others given similar
circumstances, some vastly so.
Mental Model Subjectivity
Example: The economy as a mental model.
The economy consists of billions of transactions every day. It is
impossible for it to be fully perceived by any one person who
could not possibly observe every transaction himself. Faced with
that limitation, that person builds a mental model of what the
economy is to them as they perceive it around them. Two people
working and living in different areas of the economy, one with
more or less information or resources than the other, may have a
completely different perception of the same thing.
When two people are forced to make, for example, an identical
business decision pertaining to their respective perception of the
condition of the economy, one person may make a better
decision than the other, based upon the rationale that his mental
model of the economy may have been more accurate than the
second persons.
In such a scenario, the second person may benefit to learn the
economic mental model of the first person to replace their own
current mental model of what the economy may be.
Cloning
One of the most effective things we can do is to
look around and implement successful models or
ideas that we see around us into our lives.
We want to take as many good successful mental
models and ideas as we can and implement them into
our own lives if we are able. In effect we become
cloners, which I define as a person who takes
successful mental models and ideas from around
them and then implements them into their own life to
produce change for the better.
It cannot hurt to turn yourself into a patchwork of
good ideas.
Successful Cloners
An old story: There was once an old man in a retail store
in Sao Paulo Brazil who was found lying down in-between
one of the store aisles, stretched out. Another customer
was concerned and had the store call an ambulance
thinking he needed medical attention. It turned out that
the man was not in need of medical attention at all. It
was Sam Walton. It turns out that he was measuring the
distance between the aisles in a competing store to get
an idea about the efficiency of their retail space usage.
He did not have a tape measure on him so he decided to
stretch his body out between the aisles to measure them.
Walton was known for spending an intense amount of
time in competitors stores looking for ideas for his own
stores.
Sam Walton Did Not Invent
Commercial retailing
High volume low margin discount big box business
model. (K-Mart)
Efficient distribution centers.
Electronic inventory monitoring.
Aggressive growth model.
Most of the features in Wal-Mart stores today.
Despite his lack of innovation, Sam Walton was
able to take as many good ideas from around him
as he could and implement them into his stores.
His cloning ways allowed him to become one of
the greatest success stories in retailing.






Loud Quiet Loud
Kurt Cobain, famous rocker, is known for pretty well
copying the sounds and style of numerous other bands.
You can go back and figure out whos style he copied on
many songs, especially the biggest hits.
Smells Like Teen Spirit: I was basically trying to rip off the Pixies. I
have to admit it K.C.
About A Girl: Admitted that he wrote it after spending three hours
listening to the Beatles Meet the Beatles!
The sounds for many songs on the album Bleach came from the
Melvins.
Cobain was able to create one of the all time great rock
bands by taking good ideas from around him and
implementing them into his music.
Windows for Dummies
The idea for almost every product that Microsoft has ever
made significant profits from was taken from somewhere
else.
DOS was acquired from Seattle Computer and flipped to IBM.
Windows GUI is copied from Apple Mac.
Office suite programs
Word is derived from Corel Word Perfect.
Excel is derived from IBM Lotus 1-2-3.
Power Point was acquired in a purchase from Forethought.
Xbox is derived from Nintendo and Playstation.
Surface is derived from iPad.
Microsofts cloning business model has made Bill Gates one
of the wealthiest people alive today.
Surprise, Surprise
It turns out that some of the worlds great
entrepreneurs arent very creative after all.
Now that we understand the potential of
cloning, where do we start? It is logistically
difficult to start a huge tech company or a
giant retail store, and we may not have any
musical talent. Luckily Ive found a great idea
that we can easily clone on a small scale with
minimal risks and no leverage:
Mohnish Pabrai
Self described shameless lowlife cloner.
Bio:
Indian American immigrant from Mumbai India.
50 years old. Degree in Computer Engineering
from Clemson.
1986-1991 Worked for Tellabs in high speed
networking and marketing.



Mohnish Pabrai
At 27 years old he strikes out on his own by
starting TransTech, an IT consulting and
systems integration company to help clients
integrate computer systems into their
businesses. Initial funding was $30,000 from
his 401k and $70,000 in credit card debt.
Was successful in growing TransTech and sold
the business during the dot.com bubble for
$20,000,000 in 1999.
Started a capital intensive, (but un-named in
his book) business that failed. He lost much of
his wealth.


Mohnish Pabrai
Being a cloner, Pabrai had been
reading an autobiography about
legendary investor Warren
Buffett, looking for models or
ideas that he could use.
Intrigued, he decided that it
would be best to learn from
Warren himself, so he sent him a
letter asking if he could work
under him for zero pay.
Buffetts Reply Letter

Disappointed, But Undeterred
Pabrai decided that if he could not work with
Buffett and learn from him directly, then he
would simply emulate him as much as he
could.
He resolved to set up an investment fund that
closely resembled the strategy and structure
of the original Buffett Partnerships that Buffett
founded in 1956 at the age of 25.
The Early Buffett Partnerships
Explained
It all starts with an investor and Columbia University
business adjunct professor named Benjamin
Graham. Graham did considerable work in the field
of investing and created the mental framework for
a highly successful approach to investing in two
books. First Security Analysis in 1934, and later a
more complete work called The Intelligent Investor
in 1949. Buffett attended Colombia and was able to
learn from Graham, as well as work at his
investment operation later on, the Graham-
Newman partnership. Today we call Grahams
investment framework value investing.
A Value Approach
First we consider the owner of equity stocks as
a part owner in the business.
With this framework in mind, we are more
concerned with the well being of the business,
and not so concerned with the price fluctuations
of the stock. In the short term, the market acts
like a voting machine, but in the long term, it acts
like a weighing machine. We believe that true
underlying business value will be reflected in the
price of a stock eventually.

Second, we conduct a rigorous valuation process
to determine the intrinsic value of the underlying
business.
When studying a business, we pretend that there is no
stock, and we behave as we would if were
considering buying the business as a whole. We
determine the true value of the business based upon
their financial condition and by their apparent future
prospects for earnings and distributions, among other
parameters. (Detailed later.)
Graham uses this model to judge between investing
and speculation, with a speculative investments price
not representing adequate value to the intrinsic
underlying assets of the business being considered.
Finally, after determining the intrinsic value of the
business, we seek to buy our stake at a
considerable discount to that intrinsic value.
We consider the difference between the discounted
price and the intrinsic value of a stock a margin of
safety from inherent risks in the business and in the
markets. It is a built in hedge. We expect to achieve
high returns from the cash flows of the business as
well as a superior appreciation for our shares over
time, versus market averages as the business becomes
more fairly valued on the market.
Basically, we are looking to buy legitimate, quality
assets for considerably less than they are worth.
A Concentrated Portfolio
Buffett would buy a handful of the best value
stocks that he could find and built a portfolio
which typically consisted of no more than 5
investments.
Working alone, Buffett would need to limit the
number of stocks that he would have to follow.
The concentrated portfolio would yield him superior
returns as opposed to a more diversified portfolio
because of a scarcity of good ideas. He figured, why
would I put money into my 10
th
or 20
th
best idea when
I can put more into my 1
st
?
Compensation Rules
Buffett set up his fund with a set of rules that
would strongly incentivize him to do well, and
which was also very fair to the investors in his
fund.
The first 6% annual return for investors was not
charged. For any returns over 6%, Buffett would keep
25% annually. If the fund was down for the year,
Buffett would not be paid until he got the value of the
fund back, and over 6% once again. (He never had a
down year.)
Buffetts personal wealth was invested alongside his
investors.
Partnership Results
Buffett was capitalized by friends and family. He
operated his fund from 1957 to 1969.
He continued to stick with his strategy and bought
value type stocks and sold them when they became
fairly valued. He would turn them over and compound
his returns into new investments as they appeared.
He closed his fund in 1969 because the market became
highly speculative and over-valued. He could no longer
find attractively priced companies, so he liquidated and
returned the money to his investors.
He was able to achieve a 29.5% annual return.
The Power Of Compounding
Buffetts model has the unique ability to
efficiently compound capital.
Once a security is sold at a profit, it can immediately
be deployed towards another investment.
If one is able to compound capital at a rate that is
higher than average market returns, the results are
spectacular.
Few business ventures can match the compounding
ability of Buffetts early investment model. He was
able to double his wealth every 3 years.
Buffetts Compounded Returns
Pabrai Clones the Partnerships
Pabrai did some research on the Buffett Partnerships
strategy and was surprised to find that only a handful
of people had copied the idea. He claimed that
people just wont run with a good idea, to caricature
his observation that people are resistant to change and
to cloning various strategies.
Pabrai learned as much as he could about the value
investing philosophy by reading The Intelligent Investor,
as well as other classics on the topic. He became an
expert.
He set up his fund close to the same way as the Buffett
Partnerships investment model, as well as its
compensation arrangement.

He used some of his own investing ideas, as well
as many ideas that he took from some of the
greatest value investors in the world by reading
their S.E.C. form 13f filings.
13fs are quarterly filings to the S.E.C. by every
investment operation that informs everyone of what
they own. We know what stock that every great
current investor purchased or sold quarterly. This
gives us a valuable resource for finding good value
ideas from a number of successful value investors.
He sought to find undervalued ideas which would
return to intrinsic value with an average holding
period of about 2 years.
He would reinvest his profits to compound his
returns.
From 1995 to 1999 Pabrai managed his own
money.
He took on investors in 1999, significantly
growing his fund.
From 1995 to 2013 Pabrai was able to achieve
25.7% annual average returns. Not quite the
Buffett Partnerships, but no complaints either!
(A break down chart for his returns is not
available.)
Other Buffett Partnership Clones
Joel Greenblatt, a now famous value investor,
started a fund similar to the Buffett
Partnerships in 1985.
Greenblatt was fortunate in his timing, as much of
the 80s and 90s represent one of the all time
great periods for stock investors.
He was able to achieve 50% average annual
returns from 1985 to 1994.
Greenblatts returns are said to be the greatest 10
year run for a hedge fund ever, all using the
Buffett Partnerships investment model. (Taken
from his book)
David Einhorn started Greenlight Capital in
1996 with $900,000 from his parents. He uses
a concentrated value strategy much of the
time and has better than a 20% annual
average return.
Bill Ackman got his start in 1992 using a
concentrated value strategy also. It is believed
that he has a near 25% annual return.
Michael Burry used the strategy from 2000 to
2008, achieving over 20% returns as well.

Part 1: Conclusions
It is smart and effective to observe good
models and ideas and implement them into
our lives.
The early Buffett Partnerships is a highly
effective investment model that is relatively
simple to implement.
I want to start a fund that follows the Buffett
Partnerships model.

Business Plan

Part 2: Unsuccessful Investors VS
Value Investing
Dont lose the money!
Successful investing means avoiding the
mistakes and temptations that commonly
mislead investors and often result in
permanent capital impairments.
Many investment strategies and programs that are
promoted by Wall Street and the media offer little
hope for real long term investment success.
Many of the following strategies are esoteric in
nature and require heroic skillsets to succeed,
such as market timing and predicting the future.
Sardine Traders.
Another old story: There was once a craze in the
market for canned sardines when the fish
disappeared from their traditional waters.
Commodity traders bid the price of sardines
through the roof. One day a buyer decided to
treat himself to a meal, so he opened a can and
began eating. He quickly became ill, so he found
the seller and told him that the sardines were no
good. The seller said, You dont understand.
These are not eating sardines, they are trading
sardines.
Many market investors do not bother to
understand and value the businesses that they are
trading, and hold them for short periods of time,
just mere seconds in some cases. They speculate
on future price movements and are locked into a
zero sum game with other sardine traders,
typically with poor results.
Firms exist that feature a building filled with Ph.
Ds and supercomputers, all to perfect the art of
sardine trading. It is improbable for almost
anyone to beat them consistently.
Greater Fools.
Others seek to hold stocks for a period of time,
but fail to properly value their assets. They pay
enormously high prices for some of the most
popular securities, prices so high that no sane
person would ever pay for a privately held
business. They essentially are speculating that
they will find a greater fool than themselves in the
future to sell their securities to. All is well and
everyone is a hero until prices fall, when they
themselves become the greatest fool, often taking
a permanent loss of capital.
Startups and Venture Capital.
Startup companies often IPO themselves to a
hungry base of investors who are looking for the
next big thing. Companies are able to sell stock to
the public at inflated prices and then attempt to
grow their businesses to meet expectations.
Startups are an important part of our economy,
however many fail to meet expectations, if they
do succeed at all. This leads to inconsistent
investment results.
Startups are best left for smart doctors and
lawyers and are largely ignored by value investors
who look to invest in more established companies
at discount prices.
If you would have been an early investor in
Amazon.com, you could have made 100X your
money. However, there were dozens of new
internet based companies that started at the same
time with similar business models. Most failed
spectacularly. How were you to know which one
was the winner without buying a lot of the losers?
Value investors avoid the startup lottery.
Top Down Macro Investors
Top down investors look to invest by taking an assessment
of the big picture and then try to predict future prices
based upon cause and effect relationships between market
forces.
A top down investor might say: A hike in interest rates
should put negative pressure on stocks, which would slow
global trade, thus reducing the price of tea in China.
They then put on a large speculative position based upon
their assessment.
The problem with this approach is that usually some
unaccounted for factor comes along and changes the
scenario, which leads to inconsistent investment results.
This contrasts with value investing, which is known as a
bottom up approach due to its reliance on fundamental
analysis to value companies and make buy sell decisions.
Using Excessive Leverage
Many investors borrow money to put on outsized
positions to boost their investment returns.
When money is borrowed it reduces your staying
power in a given investment. You may be right
about an investment long term, but short term
negative price movements could force you to
liquidate before you are proven correct.
Maintaining significant staying power is one of the
most important aspects of successful value
investing.
Leverage is the culprit of nearly every financial
meltdown.
The Efficient Market Hypothesis
Academics at top universities subscribe to a
theory that proposes that it is impossible to
consistently beat the market without taking
excessive risks and consistently getting lucky.
There is no such thing as a school that will teach
you to be a successful investor. (Save for the
traditional 3 day value investing class at
Colombia.)
If professors knew how to beat the market, then
they would not waste their time being professors!
The EMH is a nice cover for ineptitude.
Value Investing Vs. Other Strategies
and the EMH
Value investing strategies have proven to beat
market returns over long periods of time with
a high degree of consistency.
We have significant evidence for this that
includes:
The track records of various value investors.
Empirical studies which back test value type strategies.
Track Records
Id be a bum on the street with a tin cup if the market
was always efficient. Warren Buffett
We have the track records of some of the early value
investors, many of whom were students of Benjamin
Graham.
All were value investors but they each used different
tactics and often invested in different things.
Buffett used their success along with his own to refute
the EMH in a 1984 article The Superinvestors of
Graham-and-Doddsville.
We also have current value investors with great track
records that we can follow.

Track Records
Fund Manager
Investment approach
and constraints
Fund Period Fund Return Market return
WJS Limited Partners
Walter J.
Schloss
Diversified small
portfolio (over 100
stocks, US$ 45M),
second-tier stock
19561984 21.3% / 16.1%
[4]
8.4% (S&P)
TBK Limited Partners Tom Knapp
Mix of passive
investments and
strategic control in
small public
companies
19681983 20.0% / 16.0%
[4]
7.0% (DJIA)
Buffett Partnership, Ltd. Warren Buffett 19571969 29.5% / 23.8%
[4]
7.4% (DJIA)
Sequoia Fund, Inc.
William J.
Ruane
Preference for blue
chips stock
19701984 18.2% 10.0%
Charles Munger, Ltd. Charles Munger
Concentration on a
small number of
undervalued stock
19621975 19.8% / 13.7%
[4]
5.0% (DJIA)
Pacific Partners, Ltd. Rick Guerin 19651983 32.9% / 23.6%
[4]
7.8% (S&P)
Perlmeter Investments,
Ltd
Stan Perlmeter 19651983 23.0% / 19.0%
[4]
7.0% (DJIA)
Washington Post Master
Trust
3 different
managers
Must keep 25% in
fixed interest
instruments
19781983 21.8% 7.0% (DJIA)
FMC Corporation Pension
Fund
8 different
managers
19751983 17.1% 12.6% (Becker Avg.)


Statistical Research
Joel Greenblatt has carried the torch for
Benjamin Graham by doing a considerable
amount of research in the value investing
field. He had some nice findings that support
value investing.
He found that most market indexes are market
capitalization weighted, they buy more of the
larger cap stocks and less of the smaller cap
stocks. They essentially automatically buy more of
the expensive stocks and less of the cheaper ones.
To contrast, he found that an equally weighted
index fund that buys the same amount of each
stock, outperformed the cap weighted index fund
by 2% a year because it automatically bought
more of the cheaper valuation stocks.
Greenblatt also started a value weighted index
fund that buys more of the cheaper companies
and less of the more expensive ones. He found
that it beats the market by around 7% a year.
He believes that the types of stocks that
institutional managers systemically avoid because
they have concerns about them, are collectively
able to beat the market. These are the value
stocks that we are looking for!
How is it possible?
Typically when there is some type of market
inefficiency that investors can take advantage
of, they do for as long as they can. After a bit,
too many investors catch on, and the market
inefficiency corrects. The opportunity gets
arbitraged out. I spent a considerable amount
of time trying to figure out why that doesnt
happen with value investing and to make sure
that Im not crazy. I came to the following
conclusions:
Troubles With Value Investing
The majority of people do not use a value
investing strategy for a number of reasons.
It requires extensive patience.
The big secret to value investing is patience. The
opportunity is as good today as it ever was before,
simply because investors are increasingly more and
more impatient. Value situations can take several years
to play out, often with no immediate positive results. It
can be difficult to endure while others seem to be
making money speculating. Value investing can
occasionally underperform the market for a period of
time also, but has always outperformed it in the long
run.


It is psychologically difficult.
Value investing often requires investors to buy and hold
businesses that are heavily out of favor by the market.
Many cannot deal with the lack of positive
reinforcement that value stocks often endure and opt
for stocks with a more positive consensus, but higher
price tags.
Value stocks can be highly volatile.
The market price of a value stock can fluctuate wildly
while the situation plays itself out. Many falsely
perceive volatility to be the same thing as long term
business risk, and steer clear.
Many value investors lose their way.
The apparent quick returns from more speculative
investment programs can tempt investors into other
strategies.

Part 2: Conclusions
Many investment programs are esoteric in nature
and offer little hope of long term outperformance
or success at all.
Value investing strategies are grounded in
objective reality and have a long track record of
investment success by a large number of
practitioners.
Value investing opportunities exist today because
most investors lack the patience and mental
discipline to maintain a value strategy.
Business Plan

Part 3: General Process For Cloning
The Buffett Partnerships For
Ourselves
Building a Fund
Over the years that Ive spent studying and
practicing value investing, Ive developed a
general process for finding and evaluating
ideas as well as fitting them into a Buffett
Partnerships style of fund. I will give an
overview of my methodology in this part.
Typical Situations
When equity shares in a business become
undervalued, it is usually event driven. When
something good or unfortunate happens to a
business, industry, or the economy as a whole,
it can create lucrative value investing
opportunities. I call these market
opportunities as they generally depend on
the market. There are other opportunities
which take place that are not driven by the
market, but rather by the
actions of company managements,
stakeholders, regulators, or others acting upon
the company to enforce change. I call these
opportunities control situations or workout
situations. I will give some examples of both
market and control situations to give you a
general idea of we are looking to invest in.
Market Situations
The recessionary market selloff or crash.
A total market collapse is an ideal situation as it
enables us to buy some of the very best
companies at considerable discounts to intrinsic
value. The last great opportunity like this
occurred in 2009.
Cyclical downturns within industries.
Whole industries can often fall out of favor or
become distressed. Usually the lowest cost
producer or the most competitive business in that
industry can make for a great value investment.

Management blunders.
Companies can fall upon hard times due to
mistakes made by managements. Investors can
over react to bad news and can create value
investing opportunities.
Economic changes.
The dynamics of a business or industry can change
to create undervalued situations. This can include
changes in supply or demand, competitor entry or
exit, competitive advantages, innovations, or
takeovers.


Control Situations
Shareholder activism.
Investors can group together and enact changes
upon a company. These opportunities are usually
headed up by a lead investor who gathers support
for the changes they wish to enforce to create
value for shareholders.
Restructurings.
Companies that undergo structural changes can
create value situations. Bankruptcy
restructurings, out of court agreements, spinoffs,
or liquidations are examples.
Finding Ideas
There are around 20,000 publicly held
companies in the U.S., and over 100,000 world
wide. It is impossible to follow such a large
number of stocks, even for a large investment
firm. I have a number of methods that I use to
whittle that number down to a few value
stocks that fit the Buffett Partnerships model.
The first way to find ideas is by watching the
52 week lows list.
Every trading session all stocks that are hitting
lows for the year are listed. If a stock or industry
group of stocks is declining precipitously it will
show up on the list and I will be alerted to the
situation.
The majority of the things that show up on the list are
heavily overpriced companies that come back to fair
value, or many of them are simply poor companies.
Occasionally good opportunities come up that are
worth evaluating.
Another great way to find companies to
evaluate is to search for them using a stock
screener.
Screeners allow us search for companies based
upon predefined valuation metrics such as price
to earnings, growth, price to equity, and dividend
yield.
I punch in metrics which could indicate a bargain
deal and evaluate the companies within that list
that are attractive potential value investments.
By far the best way to find ideas is to clone
them from some of the greatest investors in
the world!
Every quarter every investment firm releases a 13f
filing which tells us which stocks that the firm
bought and sold during that period of time.
Two professors, Gerald S. Martin and John
Puthenpurackal, released a study in which they
built a back dated hypothetical portfolio which
only bought what Buffett bought when it became
known that he bought a stock, and similarly sold
the stock when it became known. The study
ranged from 1974 until 2006. Their conclusion

was that if you had followed that program during
that period of time, you would have beaten the
market index returns by an average of 11.4%. You
would have made close to 20% annually for doing
almost no work. If you do no remember anything
from this presentation, remember this: If you
were completely incoherent from 1974 to 1996,
and all you could remember to do was to follow
this program, you could have become
phenomenally wealthy for doing around 20
minutes of work a year. Basically, that is not too
far off from what I am actually doing! I have
compiled a list of some of the greatest investors
today that we can follow and clone from their 13f
filings.
Warren Buffett
Berkshire Hathaway
Omaha, Nebraska based conglomerate specializes
in value investing, insurance, and takeovers.
Started as a small hedge fund but now controls
near 200 billion in assets.
Not as clone-able as in the past due to enormous
size, but Warren will still put out a really golden
idea from time to time. Last great idea was Bank
of America.

Seth Klarman
Baupost Group
Boston based hedge fund specializes in complex
value situations, averages 19% annual returns.
Known for being extremely conservative, often
holds large amounts of cash when ideas are not
abundant.
Strategy fits the Buffett Partnerships model nicely,
which makes this a great place to get ideas.
Details his investment philosophies in his brilliant
book Margin of Safety.



Bruce Berkowitz
Fairholme Capital Management
Coral Gables, Florida based mutual fund.
Pure stock picker specializes in general long term
value investing, special situations, and financial
stocks.
Generates high returns but is notorious for buying
heavily out of favor companies, often drawing ire
from his investor base. Very patient investor.
Solid ideas that are worth looking into, especially
financial companies.
David Einhorn
Greenlight Capital
New York based hedge fund. Uses mixed long
short strategy. Near 20% annual returns.
Pure stock picker specializes in general value,
technology, shareholder activism, and uncovering
frauds.
Firm does high quality research.
Great source to find the best technology stock
ideas and more.


Eddie Lampert
ESL Investments.
Connecticut based hedge fund.
Specializes in retail companies, general value
investing, and takeovers.
Made much of his money by taking controlling
stakes in retailers and turning them around.
Famous for merging Sears and K-Mart.
Fund is married to declining Sears/K-Mart, but will
eventually win out due to their undervalued real
estate holdings.
Good place for retail ideas, high success rate.

Carl Icahn
Icahn Enterprises
Richest guy on Wall Street, unbelievable track record,
near 27% over 51 years.
Lead activist investor. Takes controlling stakes in
companies that he thinks are poorly managed and
makes changes to unlock shareholder value.
Plenty of bite to match his bark, bad news for CEOs.
Says he can go into any company in America and cut
costs 30%, and that most CEOs are promoted nice
guys and not properly qualified.
Good place to find control situation type value plays.
Joel Greenblatt
Gotham Capital
Hedge fund and various mutual funds.
Pure stock picker specializes in general value investing.
Best 10 year % track record of any investor.
Managed a concentrated value fund for a long time
but has now built funds to try to bring value investing
to the casual investor. Uses a more quantitative
approach today.
Good source of general value ideas.
Wrote brilliant book You Can Be A Stock Market
Genius.

Bill Ackman
Pershing Square Capital Management
NYC based hedge fund specializes in general value
investing and activist investing.
Better value investor than activist, notable hits
and misses.
Less resources than Carl Ichan, lobbies support
from other investors to take control of companies.
Creative ideas, very smart investor, firm known for
its exhaustive research.


David Tepper
Appaloosa Management
New Jersey based hedge fund specializes in
distressed securities and general value investing.
Former credit analyst finds value in financial train
wrecks. Known for having the biggest balls on wall
street, made inhuman profits from the recession
and recovery.
Good place to find ideas that involve financially
distressed securities. Typically high upside for his
more quality ideas.
Value Investors Club.com
A website started by Joel Greenblatt for value
investors to share ideas.
When an investor finds an idea he loves, he buys
his stake. The next best thing to do is to get the
word out so that other investors will bid the price
up.
Site has write-ups of investing ideas from some of
the top firms in the country, many Ive already
listed above post ideas there. Great resource.
Idea Selection
My personal preferences for ideas.
I tend to be attracted to large companies that are
heavily out of favor, but have good balance sheets and
earnings. These make up my portfolio core.
I am attracted to smaller companies that appear to be
more than 200% undervalued, usually companies with
resolvable issues.
I try to find ideas that will work themselves out within
2 years, but will hold indefinitely if necessary.
I would say that I mainly buy stakes in companies that
people dont want at the moment, but they are still
good companies long term.
Process For Evaluating Companies
Once I identify a business that appears to be
attractively priced on the market, I begin a
process of evaluation.
I evaluate the company just as if I were in a
position to buy the company as a whole and take
it private.
Usually we are not able to visit the company to
physically kick the tires and perceive everything
in person. As a result, my objective is to gain as
much information about the company as I can so
that I can build an accurate mental model of what
the company is in real life as best that I can.


To build this mental model, my evaluation has
three parts.
A company story/situation evaluation
A quantitative financial evaluation
A qualitative evaluation
Company story/situation evaluation.
First I read about the company to find out what
their business is and what is happening.
Every corporation releases an annual report (10k) to
shareholders which averages from 100 to 300 pages in
length. The report contains extensive information
about the company such as; business description,
prospects, performance, risk factors, capital structure,
current happenings, and plans.
I read company write-ups, news articles, and anything I
can find to understand why the stock of the company
appears to be undervalued, and evaluate how bad the
situation is to determine future prospects.

Quantitative evaluation.
I study the businesses quarterly financial
statements to determine the companies profits,
sum of all parts, and general financial condition.
From this information, I am able to establish a
valuation based upon their earnings and growth.
In the end, the value of any asset depends upon its
ability to generate free cash flow (FCF) so that the
business can grow, pay dividends, or invest elsewhere.
If it is not generating FCF currently, then it will need to
in the not too distant future.
At some point highly priced companies will have to
justify their price tags with sufficient FCF, or the stock is
likely to collapse once optimism wanes.

If there is no FCF, then it could still be worth something
if there is liquidation value.
When we are able to buy businesses at cheap
valuations, we are able to maximize the FCF of our
portfolio, and the undervalued stock prices
eventually rise to match these earnings.
Qualitative evaluation.
I evaluate the quality of the company.
This focuses on its ability to maintain or grow FCF in
the future, and its ability to survive difficult times.
Ultimately there are three types of companies.
A growing company or cash cow (good business)
An even, or slow growing company (an average business)
A declining company (bad business or value trap)

The ability for a company to remain a good
business depends upon its competitive
advantages or barriers to entry in an industry.
Companies with significant advantages are able to
protect their FCF and earn higher profits for their
investors. Companies with thin advantages are likely to
be beaten by their competition and become bad
businesses.
I evaluate their financing structure, or their
balance sheet.
The #1 cause of financial blowups is excessive leverage.
You may own a great business, but if it falls upon hard
times and winds up in bankruptcy court, the new
shareholders could be enjoying the profits and not you.
Excessive leverage should be avoided.

I evaluate the quality of company management
and management incentives.
Management incentives are one of the biggest
determining factors for the success of a company.
Managers who are heavily invested in the companies
that they run are likely to align with shareholders to
generate maximum value and avoid foolish risks.
Managers who are incentivized to hit targets so that
they can earn bonuses can cause trouble or losses.
I evaluate the honesty of the company accounting
practices.
Basically every company cheats on their accounting, at least a
little bit. The first thing I think when I look at company
financials: OK. How are they screwing us?
Once I finish researching, I establish a what I
believe would be a fair value for the company in
real life. I then take that number and divide it by
the number of shares outstanding to get to my fair
stock price per share number. If the stock is
trading at a considerable discount to that number I
may consider investing in it. When I buy a stock,
my biggest thought is for this price, would you
take this company private in a heartbeat? If the
answer is yes!, then I usually have a brilliant
value investment on my hands.
Portfolio Management
Concentrated portfolio.
Hold between 5 and 10 stocks depending upon
the situation.
Seek to hold around 2 years on average.
Manage risks with position sizes.
Incredible ideas may be 30% or more allocation.
Higher risk, but very high upside 5X undervalued type
investments might only be 5% of assets or less.
Hold varying amount of cash or equivalents.
Cash is seen as an option on the future if prices fall. If
ideas are limited and the market is very expensive, it
makes sense to hold some cash or bond type assets. If
there are no good ideas available I will hold no stocks.

Market Related Concerns
Everyone has the same fear when dealing with
markets, a crash!
For those who are speculating, those with short term
focused investment programs, and people on TV, this
is a very large concern. Crashes lead to permanent
losses for them as they have called the market wrong.
Value investors are quite likely to show losses during
downturns, but plan to maintain their positions and
even add new ones, believing that market prices will
eventually reflect the intrinsic business value of their
held securities. This has worked out very well
historically.
Its only when the tide goes out that you learn who has
been swimming naked. -Buffett

On market volatility.
Many consider stocks with volatile pricing to be risky.
Value investors believe that volatility is not risk. Only
a real decline in the real life prospects and profits of
the business in question are true risk over the long
term.
Ben Graham uses an analogy in his book to describe
the value investors attitude towards market volatility.
He describes a manic depressive business partner
named Mr. Market who offers to buy or sell shares in
our mutual business daily. He is often efficient, but
occasionally offers us attractive buy or sell prices.
When his offer is not in our favor, we are free to wait
as long as we would like for a better offer.
When you are fairly certain of what something is worth,
then it becomes clear that patience is the key to dealing with
Mr. Market.
I never attempt to make money on the stock
market. I buy on the assumption that they could
close the market the next day and not reopen it for
five years. Buffett
Part 3 Conclusions
Value opportunities are usually situational.
There are a wealth of value investing ideas out
there which includes investing side by side
with some of the greatest investors in the
world.
I have an elaborate process for evaluating
ideas which focuses on minimizing risk.
I possess the proper mindset to manage down
or rough market conditions.



Model Portfolio
I have 5 undervalued stocks that I am invested in
now in my standard Buffett partnerships clone
portfolio. I will give an investment thesis on each
one later on to show some examples of what Im
talking about. I will list them for now.
AIG American International Group
BAC Bank of America
BP BP plc (ADR)
MU Micron Technology
ESI ITT Technical Institute (a distressed situation I
think will work out)